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Posts Tagged ‘Bonds’

The Pros & Cons of Credit Default Swaps

In Financial Engeneering, Financial Markets, High Frequency Trading, International Econnomic Politics, Law & Regulations, Learning, National Economic Politics, Quantitative Finance on 02.12.10 at 02:51

The CDS market, currently perceived as the most toxic market of all, has existed for nearly 20 years. But most people have only just begun to understand what all the fuzz is about. Said as simple as possible; a CDS is a kind of  insurance a lender buys to secure oneself against a possible default by the borrower. These insurance contracts usually has a maturity period between 1 to 10 years, and usually prized as a percentage of every 10 million units (dollars, euro, yen). A new research paper shred a little more light on this rather unknown market.

“In general, CDS trading has lowered the cost of issuing bonds and enhanced the liquidity in the bond market. Nevertheless, CDS trading has also introduced a new source of risk.”

Ilhyock Shimy/Haibin Zhu


According to the two researchers employed by the Monetary and Economic Department of the Bank for International Settlements, CDS trading has lowered the cost of issuing bonds and enhanced the liquidity in the bond market. The positive impact is stronger for smaller firms, non-…nancial …rms and those fi…rms with higher liquidity in the CDS market, while the negative is that companies included in CDS indices must face higher bond yield spreads than those not included.

The rise and fall of the credit derivatives market is considered the single most important event in the global credit market in the past decade.

Even thou it has existed for nearly 20 years, no one has paid much attention to it.

Until it blew up like an Icelandic volcano in 2008 and covered the whole world with a black cloud of hidden financial risks, that is.

By then the credit derivative market had swollen up to a huge, unmeasurable, uncontrollable market, with an estimated value of more than 60 trillion dollar. Credit-default swaps is one of the most traded credit derivatives, making up almost 90% of the totals.

According to the new research, the notional value of this market have been cut in half since the peak in 2008.

A Short Lesson

By the way – to compare a CDS with a credit insurances is not quite accurate:

A (CDS) is a swap contract and agreement in which the protection buyer of the CDS makes a series of payments (referred to as the spread) to the protection seller and, in exchange, receives a payoff if a credit instrument (typically a bond or loan) experiences a credit event. In fact, it’s a form of reverse trading.

The simplest credit-default swap is a bilateral contract between the buyer and seller of protection. The CDS will refer to a “reference entity” or “reference obligor”, usually a corporation or government.

The reference entity is not a party to the contract. The protection buyer makes quarterly premium payments—the spread —to the protection seller.

If the reference entity defaults, the protection seller pays the buyer the par value of the bond in exchange for physical delivery of the bond, although settlement may also be by cash or auction.

A default is referred to as a “credit event” and include such events as failure to pay, restructuring and bankruptcy.

So, with that out-of-the-way, I’ll go on.

A Double-Edge Sword

.

The CDS contracts have been perceived as the main root of all evil in the credit market because of its complex distribution of risk.

The new research paper by Ilhyock Shimy and Haibin Zhu do not confirm, nor dismiss the allegation.

They point, however, to the fact that the CDS market have both positive and negative impact on the financial markets in general.

This is their main findings:

“First, we …find strong evidence that CDS trading is associated with lower cost and higher liquidity for new bond issuance in Asia. This is consistent with the hypothesis that CDS trading helps create new hedging opportunities and improve information transparency for investors. Noticeably, this result is contrary to similar studies based on US data. This contrast provides supporting evidence for our conjecture on the jump-start e¤ect in Asia.

“Second, we …find that the positive impact of CDS trading on the bond market tends to be more remarkable for smaller fi…rms and non-f…nancial …firms. In addition, those …rms with higher liquidity in the CDS market bene…t more in the primary bond market in terms of cost and liquidity.”
“Last, we also …nd that the impact of CDS trading on the bond market is di¤erent during the crisis period. The global …nancial crisis that occurred during the sample period o¤ers a good case study to examine the behaviour of the CDS and bond markets under distress and their linkages. Our analysis shows that, at the peak of the global …nancial crisis, those firms included in CDS indices had to face higher spreads than those not included in CDS indices, above and beyond the general increase in credit spreads observed in the bond market during this period. This suggests that CDS trading could be a double-edged sword: it also introduces new sources of shocks to the bond market.”

Here’s a copy of the full report.

Related by The Swapper:

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EU: No Bail In, Just Eternal Bailouts

In Financial Markets, Health and Environment, International Econnomic Politics, Law & Regulations, National Economic Politics, Views, commentaries and opinions on 29.11.10 at 16:42

It ought to be a happy day for the bondholders of the world. The informal Eurogroup decided Sunday that the Irish rescue plan will not bail in senior bank bondholders and force them take a “haircut” on their liabilities. A decision likely to make precedence for the many bailouts to come. However, Germany and France insist on a bail in facility to be implemented when the 750 billion euro bailout fund, created in May this year, becomes a permanent stabilizing mechanism when it expires in 2013.  But this will only apply for debt issued thereafter. The brilliance of this solution is;  since bond issuers and bond investors, pretty much, are one and the same big banks – it becomes an eternal bailout mechanism.

“The rescue plan stands as a forceful response to vulnerabilities in the banking system.”

Dominique Strauss-Kahn


As usual, the IMF-boss Dominique Strauss-Kahn provides us with valuable insight. It is indeed a forceful response to vulnerabilities in the banking system. First; they’re now protected for two more years. And second; if anyone should default on their loans issued after 2013, and forced to take a so-called “haircut,” there will be a permanent bailout mechanism available so that the bailed in banks can be bailed out again. Pure genius!

The EU countries and the International Monetary Fund (IMF) will provide up to €85 billion under the Irish package, which may be drawn down over a period of up to 7½ years, the informal Eurogroup said last night.

About €50 billion is aimed at bolstering Ireland’s public finances. Of the remaining 35 billion, 10 will be used to recapitalize Ireland’s demolised banking system, and 25 will be put in a contingency fund to provide the banks with additional support if necessary.

The IMF will contribute with a total of 22,5 billion. This include three bilateral loans from the UK, Sweden and Denmark.
Along with the rescue package comes a 15 billion austerity package to be distributed amongst the Irish citizens over the next four years.

The interest rates for the loans will also vary on the different parts of the package. ( But is in general close to 6%,  according to the statements).

Merry Christmas!

The EU leaders have almost scared the bond investors to death with their talk of bailing in bondholders to make them share the burden of the supersized debt bubble they’ve been creating over the years.

But at a press conference last night after the informal Eurogroup and EU’s finance ministers had endorsed the Irish rescue package at an emergency meeting, Olli Rehn said:

“I’m aware that the Irish authorities are considering certain discounts for the subordinated debt but there will be no haircut on senior debt, not to speak of sovereign debt”.

Adding: “The programme rests on three pillars. First, there will be an immediate strengthening and comprehensive overhaul of the banking sector. Second there will be an ambitious fiscal adjustment to restore fiscal sustainability of the sovereign. Third, there will be substantial structural reforms enhancing economic growth, especially in the labour market.”

The aim in the banking measures is to create a smaller and more robust financial system with a stable financing structure.

“It notably includes higher minimum regulatory requirements, plus a capital injection early on to bring capital ratios above the minimum. Moreover a new and rigorous stress test will be conducted based on a severe scenario and moreover, new legislation on insolvency and bank resolution will be introduced.”

Neiter this legislation will not include haircuts on senior debt, according to Mr. Rehn.

So, the major holders of Irish (and other sovereign) bonds can enjoy another big fat Christmas bonus.

(See: The Precious Irish Bondholders – Here’s The Full List)

Deutsche Bank has already decided to hand out the biggest bonuses ever this year to its executives.

Bailing In The People

Now – here’s some of the Christmas gifts for ordinary Irish people:

Labor market:

*Reduce national minimum wage by €1.00 per hour

* An independent review of the Registered Employment Agreements and Employment Regulation Orders.

* Reform of the unemployment benefit system

* Streamline administration of unemployment benefits, social assistance and active labour market policies.

* Reform of activation policies:
A: Improved job profiling and increased engagement;
B:  More effective monitoring of jobseekers’ activities with regular evidence-based reports;
C: The application of sanction mechanisms for beneficiaries not complying with job-search conditionality and recommendations for participation in labour market programmes.

Health Care:

* Medical Profession: Eliminate restrictions on the number of GPs qualifying, remove restrictions on GPs wishing to treat public patients and restrictions on advertising.
* Pharmacy Profession: Ensure the recent elimination of the 50% mark-up paid for medicines under the State’s Drugs Payments Scheme is enforced.

Pensions:

* Savings in Social Protection expenditure through enhanced control measures.

* Increase the state pension age to 66 years in 2014, 67 in 2021 and 68 in 2028.

Public Service:

* Reduction of public service costs through a reduction in numbers and reform of work practices.
* A reduction of existing public service pensions on a progressive basis averaging over 4% will be introduced.
* New public service entrants will also see a 10% pay reduction.
* Reform of Pension entitlements for new entrants to the public service
A: including a review of accelerated retirement for certain categories of public servants and an indexation of pensions to consumer prices.
B: Pensions will be based on career average earnings.
C: New entrants’ retirement age will also be linked to the state pension retirement age.

Taxes:
* A reduction in pension tax relief and pension related deductions
* A reduction in general tax expenditures
* Excise and other tax increases
* A reduction in private pension tax reliefs
* A reduction in general tax expenditures
* Site Valuation Tax to fund local services
* A reform of capital gains tax and acquisitions tax
* An increase in the carbon tax

The Enormous Growth Potential

In a joint statement IMF managing director, Dominique Strauss-Kahn, says the rescue plan stands as a “forceful response to vulnerabilities in the banking system”.

And for once, I totally agree with Mr. Strauss-Kahn.

“By shielding Ireland from the need to go to the markets for a considerable period of time, this support places financing at Ireland’s disposal on more favourable terms than it could obtain elsewhere for the foreseeable future,” the statement says.

(Just to be precise: It’s the Irish banks that are being shield)

“This programme articulates a clear strategy for tackling today’s problems and for harnessing the enormous growth potential of this open and dynamic economy.”

The enormous growth potential?

I better stop now, or I might write something rude and offensive.

You can read the full Iris government/IMF statement for your self here.

Related by The Swapper:


The Precious Irish Bondholders – Here’s The Full List

In Financial Markets, International Econnomic Politics, Law & Regulations, National Economic Politics, Quantitative Finance, Views, commentaries and opinions on 17.11.10 at 15:45

The players in the European credit market are scared senseless by the proposal of channeling some of the losses in the financial sector over to them,  a so-called “Bail-In”.  The element of haircut for bondholders is particular relevant for Ireland who’s banking industry is the main problem. Well, here’s some examples of poor Irish bondholders: Goldman Sachs, HSBC, Deutsche Bank (Asset Management), Alianz, AXA, BNP Paribas, Royal Bank of Scotland, Barclays, Credit Suisse, just to mention a few… You’ll find the full list below.

“Every child in Ireland is being bequeathed a huge debt at birth to protect the interests of foreign, mainly German, bondholders – why?”

Guy Fawkes‘ Blog

BIG BANKERS: Lloyd Blankfein, Kenneth Irvine Chenault, Kenneth Lewis and Edward Yingling.

Anglo-Irish Bank do hardly represent a serious systemic risk to the Irish economy, certainly not to the same degree as AIB or the Bank of Ireland. And if it had been allowed to follow Lehman Brothers,  the shareholders and bondholders would probably have been the only ones to lose money.  However, the Irish government is seeking a way to protect their precious bondholders.

“Every child in Ireland is being bequeathed a huge debt at birth to protect the interests of foreign, mainly German, bondholders – why?”

This interesting question is raised in a recent post at the Guy Fawkes’ Blog.

The Irish state stepped in and nationalised a bank that was basically run by “crooks lending to property speculators,” the blogger writes.

Pointing out that the Irish people are taking the losses that rightfully should have been on the shoulders of the bondholders.

Once upon a time it sometimes happened that  a bond issuer defaulted. And it was seemed as a natural part of the risks investors take.

Yeah, well, times have obviously changed.

One can only wonder why Dublin’s political establishment is so keen to protect foreign investors at the expense of future generations.

The list below of foreign Anglo-Irish bondholders was originally obtained by an Irish bond trader, updated per November 15, and first published at the Guy Fawkes’ Blog.

These are the people whom Dublin’s politicians really seem to care so deeply about – I guess the names are somewhat familiar?


(h/t: Guy Fawkes’ blog)

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Saving Irish Banks Bondholders Is A "Disgrace"

In Financial Markets, International Econnomic Politics, National Economic Politics, Views, commentaries and opinions on 06.10.10 at 01:39

Says Financial Times Deutschland commentator, Wolfgang Munchau, with whom I agree with in most issues. However, when it come to the well-being of Irish bondholders, I don’t have enough information to form an opinion. So, read this interesting post by Mr, Munchau and decide for yourself.

“For a risk-averse politician, dumping the cost on the taxpayer is easy. For the economy it is a nightmare. It is also politically dangerous in the long run, as the distributional unfairness will favor extremist political parties.”

Wolfgang Munchau


No matter how much debt you might have, there always exists a projected income growth rate at which you can pretend to be solvent. The projected rate of growth is the issue on which I differ most with those who claim that Ireland is fundamentally solvent. They are moderately optimistic about future growth whereas I am not.

The Irish government last week recognized the scale of the country’s banking problem, and it deserves credit for that. The decision to recapitalize Anglo Irish Bank, the bank at the heart of Ireland’s property meltdown, will raise the country’s deficit to 32 per cent of gross domestic product this year.

I am not worried by that number or by the projection that the debt-to-GDP ratio is headed towards 100 per cent. What I am worried about is the combined effect of bad policies in Ireland and a deteriorating external environment on Ireland’s solvency.

First, Dublin is still not realistic about what constitutes a worst-case scenario. A fall in commercial property prices by 65 per cent with no subsequent increase this decade hardly qualifies. This is merely a description of a medium-sized bubble – not the real-estate madness we have actually witnessed. Should that not be the central scenario?

Second, and most important, the Irish government and several private sector economists are delusional about the effects of a financial crisis on growth. History tells us it takes a long time for economies to revert to normal after a big financial crisis. In the case of Ireland, where the crisis is one of the biggest ever recorded, a real worst-case scenario would include stagnation for up to a decade, mass emigration, further falls in house prices, a significant fall in tax revenues, more austerity in response, and the further banking problems that would result from such a toxic mix.

I am not predicting this scenario, but it is at least as plausible as Dublin’s naively optimistic V-shape-recovery assumptions.

Third, the monetary environment is going to be tough. The Irish government currently pays an interest rate on 10-year bonds of well over 6 per cent at a time when goods prices are stagnating and asset prices declining.

This implies real long-term interest rates approaching double-digits. A bail-out through the European Financial Stability Facility is not going to help. The EFSF will offer finance when others do not. It will be useful when markets seize up. But rates are hardly going to be more attractive than current market rates.

Short-term finance from the European Central Bank is still cheap, but I expect European short-term rates to go up soon. Last week, overnight euro zone interest rates had already more than doubled to 0.9 per cent.

It looks as though the ECB is preparing the ground for a shift in monetary policy, and we should factor this into our calculations. The euro’s exchange rate is an additional source of tightness. After a brief period of weakness earlier this year, the euro is back to a level that I would consider moderately overvalued.

So if you combine all these factors with an observed slowdown in the global economy, it is unreasonable to assume that Ireland will return to normal growth rates once the acute phase of the crisis is over. Even a decade of stagnation is hardly a worst-case scenario.

So what should Ireland do? Recognizing the scale of the problem was a good decision.

The fundamental problem with the Irish government’s approach was the decision to dump almost the entire adjustment burden on to the taxpayer, rather than to accept or negotiate a partial default.

I am aware that there are legal impediments to the participation of the bondholders in the bank rescue costs. You cannot simply apply a haircut on a bond unless the issuer has formally declared bankruptcy. Dublin is now preparing legislation that would allow it to apply a haircut to the subordinate debt.

First, coming two years after the beginning of the crisis, this is absurdly late.

More importantly, it is just peanut-sized symbolism, especially as no haircut will be applied to holders of senior debt. My concern is that Dublin is overburdening the taxpayer, and might worsen the downward spiral.

This is not just an Irish problem. European governments everywhere are scared of touching bondholders. I had been wondering about this default-phobia for some time.

The most plausible explanation I have heard is based on an asymmetry of risk. Haircuts are a legal minefield, and politicians find it more expedient to dump the problem on the taxpayer than to risk a hugely damaging defeat in court. Some politicians are inclined to always agree with the last person they have spoken to, and the power of the banking lobby is clearly a factor.

For a risk-averse politician, dumping the cost on the taxpayer is easy. For the economy it is a nightmare. It is also politically dangerous in the long run, as the distributional unfairness will favour extremist political parties.

The European political establishment recoils so much at the idea of default, it is willing to accept extreme hardship. Just look at Latvia. But Latvian brutalism is not going to be realistic for Ireland. Brian Lenihan, the Irish finance minister, might wish to ponder whether his monumentally unfair taxpayer bail-out is what will ultimately “bring down Ireland”.

Anglo Irish Downgraded – No Surprise

Irish Sovereign CDS Spread Exceeds 500 Basis Points

Ireland And Portugal Close To Collapse

Irish CDS Spreads Back To Record High After Bond Sale

Irish Finance Minister: Concerted Attack On The Euro Zone

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Anglo Irish Downgraded – No Surprise

In Financial Engeneering, Law & Regulations, Learning, Quantitative Finance, Technology on 27.09.10 at 22:24

The rating action was another blow for the beleaguered bank. But its spreads were little moved as the market had already priced in the downgrade. In fact, Anglo Irish senior CDS trades with an implied rating of B, according to Markit Implied Ratings.

“A report in a Sunday newspaper suggested that some of Anglo Irish’s debt will be tendered at a discount to par or swapped for equity in the ARB.”

Gavan Nolan


Spreads were lacking direction in a relatively uneventful day, Monday. “Perhaps the most notable occurrence of the day was Moody’s downgrade of Anglo Irish Bank,” vice president Gavan Nolan at Markit Credit Research writes in his daily market alert.

The agency cuts its rating on Anglo Irish’s senior debt by three notches to Baa3, citing the likelihood of further asset quality deterioration and the lack of an explicit government guarantee.

Moody’s warned that if the latter issue isn’t rectified then additional downgrades into sub-investment grade are possible.

But it was the agency’s action on the subordinated debt that was more significant, Nolan points out.

Moody’s cut its rating on the bonds by six notches to Caa1 from Ba1, citing the increasing risk that subordinated bondholders will be forced to share some of the burden of the bailout.

Specifically, the agency highlighted three factors that have led to the risk rising:

(i) the need for further capital injections as the non-NAMA loan book deteriorates;

(ii) the thin capitalization of the Asset Recovery Bank (ARB), which is likely to be wound down; and

(iii) the longer maturities of the subordinated debt in comparison to the senior debt.

The rating action was another blow for the beleaguered bank. But its spreads were little moved as the market had already priced in the downgrade.

In fact, Anglo Irish senior CDS trades with an implied rating of B, according to Markit Implied Ratings.

“It should be noted that it is not the most liquid of credits, having a Markit Liquidity Score of between 2 and 3 in the past few months. The government is expected to provide clarification this week on its plans for Anglo Irish and the overall cost of the bailout. A report in a Sunday newspaper suggested that some of Anglo Irish’s debt will be tendered at a discount to par or swapped for equity in the ARB,” Gavan Nolan points out.

  • Markit iTraxx Europe 113.25bp (+0.5), Markit iTraxx Crossover 516bp (-0.5)
  • Markit iTraxx SovX Western Europe 157.5bp (+2.5)
  • Markit iTraxx Senior Financials 144bp (+1.5)
  • Sovereigns – Greece 785bp (-10), Spain 226bp (+3), Portugal 405bp (+12), Italy 195bp (+5), Ireland 470bp (+8), Belgium 137bp (-3)
  • BP 187bp (-2)
  • AIB  – Snr 625bp (+5), Sub 1000bp (+28), Bank of Ireland – Snr 520bp (+11), Sub 815bp (+19), Anglo Irish Bank – Snr 985bp (+25), Sub 47 points upfront

Something wrong with this picture?

CDS curve for Southwest Airline.

* Southwest Airlines (LUV) will buy Airtran in a $1.4 billion cash and stock deal in a consolidation of low cost air carriers.

* CDS curve today is seeing a roughly 5 bps parallel shift in response to the transaction in early trading.

* Stocks on both LUV and Airtran were higher. Stocks on other air carriers (JetBlue, US Airways and Delta) were higher as well on merger speculation.

Markit Research & News

Related by The Swapper:

Irish Sovereign CDS Spread Exceeds 500 Basis Points

Ireland And Portugal Close To Collapse

Irish CDS Spreads Back To Record High After Bond Sale

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Irish Sovereign CDS Spread Exceeds 500 Basis Points

In High Frequency Trading, Law & Regulations, Quantitative Finance on 23.09.10 at 21:17

The Irish sovereign CDS spread exceeded 500 basis points Thursday – for the first time in recorded history. The future of Anglo Irish Bank is at the heart of Ireland‘s problems. The state has poured money into the failed bank but investors are concerned that the eventual cost of a bailout will be too great for the country to bear.

“The government have strenuously denied that senior debt will be restructured. Subordinated debt, on the other hand, is another question.”

Gavan Nolan


Risky assets experienced a difficult session as a combination of mixed economic data and heightened concerns over Ireland fueled negative sentiment as the price of insuring the nations debt went through the roof.

Ireland is the new black sheep of the sovereign CDS world, and its spreads exceeded 500bp Thursday for the first time on record.

“Given that it was only last Friday when the 400bp level was breached, the rapid widening in spreads reflects the severity of Ireland’s credit deterioration as perceived by the market. The prospect of a medium-term IMF/EU intervention – as mooted in a research report last week – triggered the latest bout of widening, and a well-received bond auction on Tuesday failed to provide the boost many expected,” Markit Financial Information Service writes in its daily update.

The future of Anglo Irish Bank is at the heart of Ireland’s problems.

The state has poured funds into the failed bank but investors are concerned that the eventual cost of the bailout will be too great for the country to bear.

Gavan Nolan

“Rumours are circulating abound that bondholders will be forced to share some of the pain. The government have strenuously denied that senior debt will be restructured. Subordinated debt, on the other hand, is another question,” vice president Gavan Nolan at Markit Credit Research writes.

Finance Minister Brian Lenihan has been less than emphatic in denying that subordinated bondholders will not get all of their money back.

The bank’s CDS spreads reflect the bifurcation in senior and subordinated debt.

The latter CDS are now trading around 47 points upfront (equivalent to over 2000bp using 20% recovery rate), indicating high probability of default.

AIB and Bank of Ireland were also significantly wider today, rumours of a bank default in the morning session not helping.

Ireland’s Q2 GDP figures only added to the negative sentiment.

Ireland’s economy shrank by 1.2% in the second quarter, confounding expectations of a small rise.

On a GNP basis – a more useful measure because of the high level of multinational corporate activity – the economy shrank by 0.3%.

“The disappointing figures raise doubts about Ireland’s severe austerity policies, and will no doubt influence the political discourse in the UK,” Nolan says.

More Bad News

Yet more bad news came in the form of Markit PMIs.

The Markit Flash Eurozone PMI slumped to 53.8 in August, a seven-month low and far worse than expected.

The leading indicator is pointing towards a slowing of growth in the region over the third-quarter.

Weaker than expected US initial jobless claims figures completed the negative economic picture.

“But there was glimmer of hope for optimists with the US existing homes sales figures, which were better than expected. Housing starts earlier this week also beat expectations, and the data helped spreads come off their wides. Even banks, which were underperforming throughout the day, improved during the afternoon,” Gavan Nolan points out.

The Markit iTraxx Senior Financials index was 3.5bp wider at 148.5bp after being as wide as 155.5bp earlier in the day.

Sovereigns also staged a comeback, the Markit iTraxx SovX Western Europe finishing the day tighter.

UPDATE:

  • Markit iTraxx Europe 116.5bp (+2.5), Markit iTraxx Crossover 528bp (+9)
  • Markit iTraxx SovX Western Europe 160bp (-1)
  • Markit iTraxx Senior Financials 148.5bp (+3.5)
  • Sovereigns – Greece 797bp (-4), Spain 225bp (-11), Portugal 405bp (+14), Italy 195bp (-2), Ireland 475bp (+15), Belgium 141bp (-4), Hungary 347bp (0)
  • BP 198bp (+1)
  • AIB  – Snr 615bp (+31), Sub 965bp (+35), Bank of Ireland – Snr 525bp (+33), Sub 815bp (+31), Anglo Irish Bank – Snr 16 points upfront, Sub 47 points upfront

Irish CDS Spreds Back To Record High After Bond Sale

Markit Launch Liquidity Metrics for Euro Loans

Survey: Market Surprised By Negative Derivative Perception

Bank Funding Crunch Deepens as Swap Rates Soar

Spec-Grade Liquidity Worsens

Killing My CDS Softly

Living In A Derivative World

El-Erian: Economy Losing Momentum For Recovery

In Financial Markets, International Econnomic Politics, National Economic Politics, Views, commentaries and opinions on 26.08.10 at 20:04

High unemployment and sluggish growth is causing the US economy to lose any momentum it had in terms of a recovery, Pimco‘s Mohamed El-Erian told CNBC on Thursday. El-Erian also pointed to Friday’s upcoming GDP numbers which he says will point to the negative trend.

“We are going to get confirmation with revised GDP numbers that are down and for the last quarter and downward revision for the third and fourth quarter.”

Mohamed El-Erian


“Today’s jobless claims numbers are better than last week’s. But it’s not a good overall. What this tells us is that the employment picture is difficult in creating and holding jobs. And the bigger picture is that the economy is losing momentum when it comes to growth.” Mohamed El-Erian, CEO of the world’s largest bond fund, says.

El-Erian also points to Friday’s upcoming GDP numbers which he says will point to the negative trend.

“We are going to get confirmation with revised GDP numbers that are down and for the last quarter and downward revision for the third and fourth quarter,” El-Erian says.

“This will also show slow growth.”

Negative Economic Trends

El-Erian goes on saying that the negative economic trends are forcing a new way to think about what makes up a recovery.

“If you think in traditional terms, then there will be a back and forth” (on economic numbers), he says.

“But if you think in terms of an economy that has to have escape velocity, so you have to achieve a critical mass in terms of growth and employment creation, the numbers are going to tell us that we are in this new normal of muted growth and high unemployment and we’re going to have to navigate through it.”

As for the bond market and a possible “bond bubble”, El-Erian saya that the rush into buying bonds is due to the fact that many investors are underexposed in the fixed income market– and that people are more risk adversed.

“If you look at what the (bond) market is telling you, it’s saying that the outlook is for low growth and disinflation. “The bond market may be cheap in terms of a slow recovery scenario, “ the Pimco-boss adds:

Vodpod videos no longer available.

Deflation Risk; 25% or higher

El-Erian also agreed with Nouriel Roubini of Roubini Global Economics who told CNBC on Thursday, that the US economy has a high risk of going in to a double dip.

“I think Nouriel is correct when he says the ‘US has no spare tire’ to fix the economy if something happens,” El-Erian says.

“I put the risk of deflation at 25 percent and the latest figures show it may be even higher.”

And in regard to policies of the Federal Reserve, whose members are meeting for their annual symposium on Jackson Hole, Wyoming, El-Erian says that he’d like to hear them talk about the so-called liquidity trap, or the idea of using monetary policy to get companies and banks to take more risks with their money when they don’t want to.

“I’d like to know if they (the FED) have any idea of how close we are to a liquidity trap. I think we are close to one, and if so, we would have to look beyond the Fed to help move the economy. They (the FED) won’t be to force people to use their money and we’ll have to look elsewhere to solve our problems.”

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Morgan Stanley: Governments WILL Default

In Financial Markets, Health and Environment, International Econnomic Politics, National Economic Politics, Views, commentaries and opinions on 25.08.10 at 23:16

This is probably one of the most eye-popping research papers presented by the global bank elite – at least this year. After about a year of babbling on about green shoots and a economic recovery, seen by few, hidden in complicated statistics, Morgan Stanley analysts have finally reached the conclusion that’s been obvious to so many; you can’t fix a debt problem by issuing more debt. Adding that the sovereign debt crisis is not just European – it is global, and it is not over.

“Ask not whether governments will default, but how.”

Morgan Stanley


“It is overly optimistic to assume that this can continue forever. The conflict that opposes bond holders to other government stakeholders is more intense than ever, and their interests are no longer sufficiently well aligned with those of influential political constituencies. Investors should be prepared to face financial oppression, a credible threat against which current yields provide little protection.”

There’s really not much to say, other than wow!

Here are some of the highlights:

* “This is the first issue of Sovereign Subjects, a new Morgan Stanley publication focusing on sovereign risk in advanced economies. In this first installment, we take a broad perspective on government balance sheets and raise several themes to which we will return in more depth in subsequent issues. We encourage clients to provide us with feedback on this new publication.”

* “Debt/GDP ratios are too backward-looking and considerably underestimate the fiscal challenge faced by advanced economies’ governments. On the basis of current policies, most governments are deep in negative equity.”

* “This means governments will impose a loss on some of their stakeholders, in our view. The question is not whether they will renege on their promises, but rather upon which of their promises they will renege, and what form this default will take.”

* “So far during the Great Recession, sovereign (and bank) senior unsecured bond holders have been the only constituency fully protected from partaking in this loss.”

* “It is overly optimistic to assume that this can continue forever. The conflict that opposes bond holders to other government stakeholders is more intense than ever, and their interests are no longer sufficiently well aligned with those of influential political constituencies.”

* “There exists an alternative to outright default. ‘Financial oppression’ (imposing on creditors real rates of return that are either negative or artificially low) has been used repeatedly in history in similar circumstances.”

* “Investors should be prepared to face financial oppression, a credible threat against which current yields provide little protection.”

But there’s more, much more…

Governments Will Default

“The sovereign debt crisis is not European: it is global. And it is not over. The European sovereign debt crisis of spring 2010 was a misnomer in more ways than one: there was not one crisis but two. And it will continue well beyond 2010, in our view. The first crisis was, and remains, an institutional crisis of the euro, caused by a flawed multilateral fiscal surveillance framework. Steps have been taken towards a correction of the flaws with a move from peer pressure to peer control of fiscal policy. This is reflected by the acceptance by the Greek, Spanish and Portuguese governments of fiscal measures largely dictated from Berlin and Brussels. The second crisis was, and remains, a sovereign debt crisis: a crisis caused by sovereign balance sheets being overstretched, to the point where insolvency ceases to be merely possible and becomes plausible. This crisis is not limited to the periphery of Europe. It is a global crisis and it is far from over. We take a high-level perspective on the state of government balance sheets and conclude that debt holders have to be prepared to enter an age of ‘financial oppression’.”

“Debt/GDP has been higher before, so why worry? As government debt and deficits have swollen to levels for which there exist few recent references, all eyes have turned to a more distant past in the hope of finding some guidance as to what future awaits bondholders. At first glance, history appears to be reassuring, though that is deceptive, in our view. Several advanced countries have experienced debt/GDP levels well in excess of current ones. The US emerged from Word War II with a public debt/GDP ratio of approximately 110%, and the UK with a ratio of 250%. The UK national debt has averaged almost 100% of GDP since its creation in 1693 (see Exhibit 1). Yet the UK government never defaulted through that period. France’s public debt stood at about 280% of GDP at the end of World War II. It did not default either. As a matter of fact France defaulted only once – in 1797 – since the creation of its own national debt in 1789. This is remarkable, considering the number of political, military and economic crises the country went through. So why worry now?”

Well, according to Morgan Stanley, there are four reasons to be worried:

“The problem with these historical comparisons is not the reference: how governments dealt with their war debt burdens sheds useful light on what might be in store for coming years. Rather, the problem lies with the measurement tool: debt/GDP is the most widely used debt metric, but we believe that it is a very inadequate indicator of government solvency.”

This is the four reasons why Morgan Stanley it will end in national defaults:

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1. Gross versus net debt. (Statistics lies.)


2. Missing liabilities. (Governments don’t have the assets they need to cover their debt, and who says they have to?)

3. It is not GDP but government revenues that matter. (Unemployment and number of bankruptcies still rising.)

4. Debt/GDP looks at the past. The main problem is in the future. (And no politician plans further ahead then the next election.)

Here you go – a copy of “Ask Not Whether Governments Will Default, but How” by Morgan Stanley analyst Arnaud Marès.

(h/t: ZeroHedge)

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G7-Countries In Deep Trouble

Sovereign Debt – Just Take The Punch?

Fitch Expects More European Sovereign Downgrades

“Greece Will Default”

Lies, Damned Lies And Statistics

E.U. Parliament To Investigate Euro Zone Bailout

Spain Loses AAA Rating – Here’s The Full Report

European Banks: “Lehman Times Ten”

Global Economy On Fast Track To Disaster

Europe’s Bailout: From Bad To Worse

The EU Stress Test: Working The Media

Wolfgang Münchau: A Cynically Calibrated Test To Fix The Result

Ireland Downgraded By Moody’s

EU Member States Disagree On Debt Figures

Housing Bubbles In Australia, Canada, Norway, Sweden Worse Than In USA

Meredith Whitney: Even More Bearish On Housing And Financials

You Sue Me, I Sue You, Oh Peggy, Peggy Sue

Goodbye Keynes – Hello Ricardo!

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Nazi Germany utilized every available resource to fight the Second World War, and one significant weapon in Hitler's economic arsenal was gold - gold looted from the central banks of those European countries which were occupied by the Nazi regime between 1939 and 1942. Calculated at pre-1939 prices, the Germans gained access to about $625 million (US) in monetary gold, only about half of which was recovered by American Forces in April 1945 from a mine in central Germany. The 'Gold War' did not end then, however; it just assumed a different shape. Instead of fuelling Hitler's war effort, the recovered gold soon became a pawn in the Cold War struggle between the United States and the Soviet Union and has remained a controversial issue in international politics for years, one not completely resolved to this day.Although this is an important aspect of the Second World War and its aftermath, it has been largely neglected in historical research because of the lack of adequate source materials. The author succeeded in gaining access to hitherto unavailable but crucial records from archives in West Germany, Britain and the United States and is thus in a position to piece together, for the first time, the story of the Nazi gold loot and the long, complicated restitution of part of this gold by the Western Allies. Hitler's Gold represents an essential contribution to the economic history of the Second World War.

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