28 November 2008

A familiar swap again; deal risk for systemic risk

The down side of the high life on Planet Finance; the subprime loan, the home equity extraction, bond insurance, the credit default swap was hidden for years and the central weakness was perceived as a strength; it was the elimination of deal risk via insurance. But the dynamic of healthy capitalism is creative distruction; those who pick the wrong side of the risk/reward tradeoff lose and that process of liquidation frees resources that can be employed by the sucessfull.

But risk cannot be eliminated and what was happening was deal risk was being exchanged for systemic risk, the guarantees froze the weightings, the dynamic network hardened and became stiff and unresponsive and was driven to fracture, the rewards paid to the finance sector players was nothing less than the monitisation of the systems capacity for dynamic change.

The final rock of the current order is the dollar system itself and this bailout and stimulus mentality is, I'm afraid, more of the same, the risk of failure of these entities, even though they have been revealed as parasites is being transferred, not eliminated. as this Bloomberg item below reveals, the risks implicit in the bailout are being transferred and at stake is the current geopolitical order and dollar hegemony itself.

That's my take, anyway.


Treasury Credit Swaps Soar to Record on New $800 Billion Pledge

By Michael Shanahan and Abigail Moses

Nov. 26 (Bloomberg) -- The cost of hedging against losses on U.S. Treasuries surged to an all-time high after the Federal Reserve’s new $800 billion effort to combat the financial crisis raised concern about how the ballooning debt will be funded.

Benchmark 10-year credit-default swaps on U.S. government bonds jumped six basis points to 56, according to CMA Datavision prices at 12:20 p.m. in London. The contracts have risen from below two basis points at the start of the credit crisis in July 2007.

“There is a lot more money to be spent and it is not clear how it is going to be financed,” said Tim Brunne, a Munich-based credit strategist at UniCredit SpA. “Credit spreads don’t reflect expectation of default, just the uncertainty over the enormous cost to the government.”

The Fed’s new plan to kick-start markets for loans to students, car buyers, credit-card borrowers and small businesses means it will be taking on credit risk by buying debt. The central bank pledged to purchase as much as $500 billion in mortgage-backed securities as well as up to $100 billion in direct debt of Fannie Mae and Freddie Mac, the world’s two largest mortgage buyers, and Federal Home Loan Banks.

“They are loading their balance sheet with credit risk,” Brunne said in a phone interview. “Where does all the money come from?”

Five-Year Contracts

The cost of five-year contracts on Treasuries rose 3 basis points to 50.5, after earlier trading as high as 52, CMA prices show. That’s higher than the debt of Finland, Germany and Norway, according to data compiled by Bloomberg.

Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a country or company fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline, the opposite.

Contracts on Treasuries are quoted in euros. A basis point on a credit-default swap protecting 10 million euros ($13 million) of debt from default for five years is equivalent to 1,000 euros a year.

The cost of default protection in corporate credit markets was little changed in Europe today. The Markit iTraxx Europe index of 125 companies with investment-grade ratings was unchanged at 168 basis points, JPMorgan Chase & Co. prices show. The Markit iTraxx Crossover Index of 50 companies with mostly high-risk, high-yield credit ratings was rose 2 basis points to 877.

Contracts on the Markit CDX North America Investment Grade Index of 125 companies in the U.S. and Canada declined 12 basis points to 241 at the close of trading in New York, according to Barclays Capital.

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