Tag Archives: George Soros

The EU End Game: Regaining Control

It is one week left before the top leaders of the European Union get together in Brussels for their most important meeting so far. The European debt problems has to be solved; at least a realistic plan that every member state can accept has to be put on the table. The outcome of next weekends summit will determine the future of the union. It’s make or break time. This the first of a series of articles focusing on possible solutions – this is the final countdown.

“The EU ban on naked sovereign CDS may be a signal that regulators and legislators now understand the issues and are prepared to address them, bringing about meaningful reform in the control of derivative trading.”

Satyajit Das

“Predictably the EU ban on “naked” credit default swap (“CDS“) contracts on sovereigns has brought forth an angry response from dealers and the industry body ISDA (International Swap & Derivatives Association). Just as “patriotism is the last refuge of a scoundrel”, arguments citing market efficiency and the benefits of speculation seem to be the first resort of dealers,” Satyajit Das at eurointelligence.com


The EU leaders have lots of important issues to discuss next weekend, but we have to start somewhere so why not with the new regulations and the demonized Credit-default swaps?

Former derivative trader  Satyajit Das with the eurointelligence.com knows what he’s talking about.

Here’s Mr. Das proposal on how to deal with the problem:

The familiar case was that prohibition was unnecessary, would decrease liquidity, increase borrowing costs and create greater uncertainty for European firms. The arguments are self-serving and do not present a balanced view of the issues.

The EU rule does not impede genuine hedging. If an investor owns sovereign securities or a firm has receivables that rely on the sovereign directly or indirectly, then purchasing protection using a CDS is permitted.

ISDA argues that banning naked CDS would have a detrimental effect on individual country’s borrowing costs. An EU study that found that the sovereign CDS market was small relative to the size of underlying bond markets and had negligible effect on credit spreads. Given this evidence, it is puzzling why banning these contracts would somehow affect pricing.

The real issue is that a ban on naked CDS on sovereigns is seen as the “thin end of the wedge”, ushering in greater control on the size of the derivative market, limits on the purposes for which derivatives are used and also on the types of derivative contract permitted. Given the substantial derivative trading profits earned by major dealers, ISDA’s position is predictable.

Historically, CDS contracts were used for hedging. Buyers of protection used these contracts to hedge the risk of default of a firm or country. CDS contracts avoided the need to transfer loans or sell illiquid bonds. It also allowed greater flexibility in hedging and offered ease of documentation. Investors could sell protection to acquire credit exposure, especially advantageous where there was no liquid market in the borrower’s bonds.

Over time, speculative factors came to drive the CDS market. The ability to short sell credit became more important. Buyers of protection, where they did not have any underlying exposure to the issuer, sought to profit from actual default or deterioration in its financial position.

Sellers of protection used CDS contracts for leverage. Selling protection on an issuer required minimal commitment of cash (other than any collateral required by the counterparty). In contrast, purchase of a bond required commitment of the full purchase price.

As trading was not constrained by the physical availability of bonds or loans, the CDS markets were more liquid than comparable bonds, facilitating trading.

The shift from hedging to speculation improved liquidity but at the cost of increased risk. The global financial crisis exposed the complex chains of risk and the inadequate capital resources of many sellers of protection.

ISDA’s argument that a ban on naked sovereign CDS will adversely affect Europe’s financial stability is disingenuous. Speculative trading in sovereign CDS is likely to be more destabilising, allowing potential market manipulation.

In practice, sovereign CDS volumes are low and large traders can influence prices, which frequently affect the values of bonds as well as CDS contracts. Commenting on the problems of AIG’s CDS positions, George Soros accurately stated the true use of these contracts: “People buy [CDS] not because they expect an eventual default, but because they expect the CDS to appreciate in response to adverse developments. AIG thought it was selling insurance on bonds and, as such, they consider CDS outrageously overpriced. In fact, it was selling bear-market warrants and it severely underestimated the risk.” [George Soros “One Way to Stop Bear Raids” (23 March 2009) Wall Street Journal].

The response of the industry to the EU proposal reveals that participants are unwilling to admit the unpalatable realities of derivative trading. Much of what passes for financial innovation is a vehicle for unproductive speculative activity, specifically designed to conceal risk or leverage, obfuscate investors and reduce transparency. The aim is to generate profits for dealers.

The EU ban on naked sovereign CDS may be a signal that regulators and legislators now understand the issues and are prepared to address them, bringing about meaningful reform in the control of derivative trading.

By Satyajit Das


Satyajit Das is a former derivative trader, now author of “Extreme Money: The Masters of the Universe and the Cult of Risk” (Forthcoming in Q3 2011) and “Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives”  (Revised Edition – 2006 and 2010).

Read also Satyajit Das’ 3-part analysis of the European economy and debt crisis:

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Filed under International Econnomic Politics, National Economic Politics, Philosophy

Gold – The Utimate Bubble?

Jonathan Burton has an interesting piece at MarketWatch Saturday morning. San Fransisco based Burton, the website’s money and investment editor, argue that investors are being lured into a speculative gold bubble comparable with the oil spike of 2008. Mr. Burton points out that gold in reality is an insurance against a total market collapse and other catastrophes, and that an even higher gold prize means that the value of most other assets will crash.

“Gold buyers beware — the karat can be a sharp stick. As with any speculation, gold can lose luster as fast as hedge funds and other traders can unload it.”

Jonathan Burton

Rate hikes are kryptonite for gold; accordingly, concerns that China will move aggressively on rates, and that the US and developed Europe will ultimately follow, have dulled gold’s glimmer over the past week, Jonathan Burton at MarketWatch writes.

Gold has become highly prized bling-bling, with the prize per ounce reaching another all-time-high this week at 1.395 dollar per ounce.

Anxious and astute buyers, from hedge-fund players to central bankers, flock around the “currency of fear.”

Gold at around $1,400 an ounce is almost double what it commanded two years ago, and gold’s price is up almost 25% so far this year alone.

“It’s been a great ride. Except gold is a bad investment,” Mr. Burton states.

Adding: “Gold’s feverish run has made a lot of people a lot of money, and though the rally has taken a breather in the last few days, there’s no shortage of flag-waving supporters who claim gold is on a march to $1,600, $1,800, $2,000 and beyond. After all, gold is still well below its 1980 peak, when it was worth around $2,300 an ounce in today’s dollars.”

Pure Speculation

The MarketWatch editor also emphasise that the recent raise in gold prizes is caused by nothing else than pure speculations.

“Certainly there are reasons to own gold in a diversified portfolio. Yet gold isn’t like a stock or a bond. It offers no income, no dividend, no earnings. It is considered a store of value, an alternative currency that’s safe beyond reproach, but it is not cash in the bank, or even the mattress. Gold has no untapped intrinsic value; it is worth only what people are willing to pay for it. And lately, many people have been only too willing,” Jonathan Burton writes, backed up by the following quotes:

“Gold is going up because people are buying it, and people are buying it because it’s going up.” (Leonard Kaplan, president of Prospector Asset Management).

Gold is always a speculation. (James Grant, editor of Grant’s Interest Rate Observer).

“Gold may be a good speculation; even cautionary voices concede that gold is not yet displaying the parabolic hockey-stick pattern that frequently forms an ugly bubble. Low yields on safer assets such as bonds and cash encourage risk-taking and speculation, which favors gold, silver, metals, commodities and many stocks. If the U.S. dollar continues to decline, gold will be a main beneficiary,” Burton continues.

According to the last disclosure in June, the three giant hedge fund managers, George Soros, John Paulson and Eric Mindich, controls 10% of the worlds leading gold ETF, SPDR Gold Trust.

Of course, they staked their claim early, and their view on gold and the dollar may now have changed, as investors will soon discover when these influential funds release Sept. 30 portfolio holdings.

“But gold buyers beware — the karat can be a sharp stick. As with any speculation, gold can lose luster as fast as hedge funds and other traders can unload it,” Burton warns.

The Greater Fool Theory

To Jon Nadler, senior analyst at Kitco Metals Inc. and a veteran gold-market watcher, Wall Street’s buy recommendations remind him of speculation in 2008 that propelled another must-have commodity — oil, the “black gold” — to stratospheric heights.

“I don’t think gold is an opportunity at $1,400 an ounce,” Nadler says. “Just because gold has been above $1,000 for 14 months, everybody thinks it’s a new paradigm. This is very much what we heard about oil a couple of years ago.”

“An investment is something you buy near its value. If gold costs $450 or $500 to produce, at $1,400 you don’t have value, you have momentum.” (Lenord Kaplan at Prospector Asset Management).

Perhaps Leonard Kaplan at Prosoector Asset Management clarifies the issue best: “Gold at $1,400 is not what I would call an investment. An investment is something you buy near its value. If gold costs $450 or $500 to produce, at $1,400 you don’t have value, you have momentum.”

And as any experienced trader should know by now – momentum is just another word for the greater fool theory. (The strategy of buying with no other intent than selling at a higher price – until the rally stops and the greatest fool is not able to find any new buyers).

It is similar in concept to the Keynesian beauty contest principle of stock investing.

An Insurance You Don’t Want To Use

“I called gold the ultimate bubble, which means it may go higher,” Soros told an investor conference in New York in mid-September, repeating a warning he’d made earlier this year. “But it’s certainly not safe and it’s not going to last forever.”

The recommended strategy at the moment is to hold between 5 and 10 percent of a clients’ portfolio in gold.

But this is not a new strategy. In fact, it’s an essential part of the old school investment lesson on long-term planning,  designed to expect the unexpected.

“If it works really well, chances are the other things in the portfolio aren’t going to be looking so good.”  (Karl Mills, president of investment advisory firm Jurika, Mills & Keifer.)

“We actually hope it doesn’t work too well,” Karl Mills, president of investment advisory firm Jurika, Mills & Keifer. says. “If it works really well, chances are the other things in the portfolio aren’t going to be looking so good.”

Jonathan Burton


“Indeed, that’s how most individual investors should look on gold, as a way to mitigate investment risk — and an insurance policy you hope never to use,” Jonathan Burton at MarketWatch concludes.

Well, that’s actually how it’s always have been, and always will be.

PLease, don’t forget that.

Now, read the full story at www.marketwatch.com.

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Survey: Market Surprised By Negative Derivative Perception

The market participants are very surprised by the negative perception of credit derivatives, as expressed by politicians, regulators, the media, internet blogs, and others. They find the extent of blame attributed to credit derivatives, for either causing the market meltdown or otherwise negatively affecting market dynamics, mostly misplaced, the latest Global Credit Derivatives Survey by Fitch Market Research show.

“Also noted were misconceptions regarding the impact of CDS price action on sovereign cash market spreads, as well as comments regarding George Soros’ characterization of naked CDS positions as toxic.”

Fitch Ratings

“The rapid growth of the credit derivatives (CDx) market prior to 2007, its absolute size as measured by gross notional amounts, and its perceived role in the current global financial crisis have led to intense scrutiny and much debate among market participants, regulators and policy makers about the need for significant change in market practices and on ways to strengthen regulatory oversight. This year’s survey was undertaken in the midst of significant and transformational changes taking place within the CDx market,” Fitch Market Research writes.

This year’s survey, which is the seventh conducted by Fitch, includes 29 banks from 10 countries.

The survey was undertaken in the midst of significant and transformational changes taking place within the CDx
market and therefore focuses on some of these key issues in addition to traditional themes such as:

* Surprises and challenges for the CDx market from the perspective of market participants.
* The current state of the market, including key growth trends.
* A brief sector review of banks and insurance companies.

Market Shrinks By 64%

The overall market for credit derivatives (CDx) shrunk to $1,8 trillion in 2009 from $5,1 trillion in 2008, the survey show.

The 29 banks surveyed by Fitch had a notional sold volume of CDx contracts totaling $10.6 trillion at year-end 2009, and a notional bought volume of $10.9 trillion at year end 2009.

(The notional amount refers to the par amount of credit protection bought and sold.)

“The decline in both sold and bought (24% for sold, 22% for bought) notional amounts as compared to 2008 reflects a combination of factors,” Fitch writes and points at the following:

1. Industry initiatives to ‘compress’ and ‘tear up’ CDx transactions that eliminate redundant offsetting contracts (while compressions replace offsetting redundant contracts with a smaller number of replacement contracts, tear-ups eliminate them).

2. A reduction in overall trading activity which is partially attributable to risk aversion, deleveraging within the broader financial sector, and a cautious approach to the CDx market in the face of heightened regulatory uncertainty.

3. Increased use of collateral and netting agreements.

4. The fact that Fitch’s survey sample for the two years differed somewhat.

The survey also confirms that trading for profit is still the main motivator in the derivative market – not the insurance that the instruments originally is designed for.

The Survey Highlights

* Regulation in general was one of the most often cited challenges, with commentary ranging from the prospects of dealing with regulatory perceptions of the market to being over-regulated on several fronts.

* Ninety-six percent of market participants surveyed agree that central clearing is called for, and most believe it would reduce systemic risk. However, there was less of a consensus among survey respondents as to the desirability of having multiple clearing houses or the exchange trading of CDx.

* Some survey respondents were surprised at the extent to which the market meltdown or negative dynamics were attributed by market observers to the use of CDx.

* Hedging, basis trades, the traded indices, and sovereign strategies were all noted by market participants as those that grew over the last year. On the downside, CDOs and more leveraged structures were mentioned as laggards.

* At year-end 2009, single-name CDS and indices continued to dominate the market; while both products make up more than 90% of the total CDx market, it is notable that on a relative basis the use of indices has fallen for the first time.

* The development of the sovereign CDS market in terms of volumes and general relevance was noted by respondents, with 89% expecting sovereign CDS use to grow in the future.

* The top 10 counterparties comprised 78% of the total exposure in terms of the number of times cited, up from the 67% reported last year, reflecting the dominant role of banks and dealers as counterparties and the consolidation of counterparties post-crisis.

* While the banks surveyed by Fitch saw a decline in both sold and bought positions, they continued to have relatively balanced portfolios in the aggregate. Although some banks shifted from being net protection sellers to net protection buyers, there were no significant movements in the other direction.

* Sixty percent of survey respondents acknowledged the growing importance of the risk management function within banks and the role of the chief risk officer, compared with 40% in the previous year.

* Given the concentrated nature of the CDx market, the continued importance of counterparty risk management was highlighted by 53% of survey respondents. The most recent findings matched the results seen two years earlier.

Biggest Surprise: Public’s Perceptions

There has been no shortage of commentary regarding CDx from market observers such as politicians, regulators, the media, Internet blogs, and others.

Among the bigger surprises noted by several respondents was the extent of blame attributed to CDx for either causing the market meltdown or otherwise negatively affecting market dynamics, and a seeming lack of understanding of the role/mechanics of CDS in general.

“One respondent commented on the apparent lack of distinction between structured finance products (e.g. RMBS securities) and CDS. Also noted were misconceptions regarding the impact of CDS price action on sovereign cash market spreads, as well as comments regarding George Soros’ characterization of naked CDS positions as “toxic,” Fitch says.


Read the full post and download the full Fitch report, “Global Credit Derivatives Survey”, at The Swapper.

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Filed under International Econnomic Politics, National Economic Politics