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Thread: Anti-Matter

  1. #1

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    Default Anti-Matter

    Interesting article on SeekingAlpha the week:

    This article posted November 26-
    ++++++++++++++++++++++++++++++++++++++++++++++++++ +++
    The CDS Anti-Matter Bubble

    "In a recent article, I described the contours of a dangerous bubble in the credit default swap (or “CDS”) market. A bubble in the price of CDS is unlike any other type of asset bubble insofar as it leads to dramatic consequences on the macro economy – chief among which being the perception of deteriorating creditworthiness of borrowers.

    Over this year, we have seen the spreads in the CDS market spiral higher, which I have argued is due in large part to the high cost of placing alternative bearish trades (such as short selling – which in some jurisdictions has been curtailed or banned through regulatory action).

    When the price of one bearish trade goes up, the price of all bearish trades goes up. One comment to my last article pointed out another reason why the spreads on CDS are going higher: when I place a trade on one of these things, who the heck is my counterparty and how likely is it that they are going to pay up when the time comes? Hard to quantify that one, so hey, let’s see some risk premium built into the price of CDS. And up up up goes that spread. But notice it has nothing to do with the creditworthiness of the underlying debt.

    Great theory, but how do you know if there a bubble in the CDS market?

    Well, the CDS market effectively rates the creditworthiness of the US Treasury as being comparable to the government of Thailand (which appears under threat of a military coup). So what do YOU think the answer is? We will find out whether there is a bubble in the CDS market when it pops, but when you see a price for an asset (or a spread) jump by over 2000% in a single year (that’s about what we’ve seen for U.S. Treasury CDS insurance), you can form a practical judgment that said asset (or spread) is in a bubble.

    One comment to my last article pointed out that Berkshire Hathaway (BRK.A) effectively has a junk rating in the CDS market. Let’s drill down a bit there. When the spread on a CDS insuring Berkshire Hathaway debt explodes higher, some traders conclude that Berkshire’s creditworthiness is falling off a cliff. It quickly looks like it’s time to dump that stock, maybe even go short. Who knows, maybe Moody’s might even take some cues off the CDS spreads and downgrade Berkshire debt.

    But assume the higher spreads on the CDS have little if anything to do with Berkshire’s creditworthiness, but, instead, simply reflect higher pricing in the CDS market brought on by other factors – counterparty risk, regulatory risk, the high price of borrowing Berkshire stock for short sales purposes? If so, what we now know is that a bubble in CDS can take out nearly 50% of a company’s market cap within days – for reasons that have nothing to do with the intrinsic value of the company in question.

    Conclusion: this is not your father’s asset bubble. This is more like an anti-matter bubble.

    Now let’s get back to that last point, the one about taking out 50% of a company’s market cap in a few days. What are we really seeing? Wolf tracks in the market, that’s what.

    The scenario goes like this: I see a bubble in the CDS market, fueled by rampant fear and, like every bubble I’ve ever seen before, plausible stories to rationalize the sky-high price of the asset in question (in this case, a CDS). I focus in a bit and then see a huge spread on CDS insuring the debt of financials – banks, insurance companies. Now I start to lick my chops because here’s one heck of an opportunity to take a little market fear, magnify it exponentially, and generate a stampede that will make me rich in a couple of days. I buy as much CDS as I can on, let’s say, Citibank debt. See folks, the CDS market is illiquid as heck, so if I buy enough of this stuff, I just might take up the price of a CDS on Citibank.

    And that’s exactly what I want to do, because at the same time I’m buying that CDS, I am shorting Citibank stock. The spread on the CDS goes higher, and that’s likely to create an impression that Citibank’s creditworthiness is going down. That perception will take down the stock price.

    Maybe it will take down the stock price enough that I’ll earn a bit of margin on that short sale, and can now buy some more CDS. Which, I hope, will take down that stock price further still. As long as I keep that game up, my profits grow at a geometric rate within a very short period of time – and once other traders figure out what I’m doing, I’m going to be pretty sure that they will come along for the ride. And the pack will feast over Citibank’s carcass, leaving the U.S. taxpayer holding the bag.

    But here’s what I didn’t think about. What do you think the S.E.C. might have to say about this trading scheme? Sure, they don’t regulate CDS (yet), but they sure do have plenty to say to folks who perpetrate “manipulative” stock trades. That’s right. That trade I just placed probably broke one or two securities laws.

    This author has good cause to believe this trade (and others like it) has contributed to the near collapse of several financial institutions this year.

    For that reason, this author has brought much of what he knows about this trade to the attention of the United States Department of Justice. I suggest that DOJ, together with the S.E.C., will look at everyone who placed short sales or bought put options or sold call options on bank stocks last week, and then see whether any of those folks were snapping up CDS in the debt of those companies at the same time. I gather the Treasury is already doing that. In addition, this author has a call in to the New York State Attorney General’s office as well.

    The American public is furious about what is happening to our markets and our economy. They want heads on a platter. Folks who contributed to, or profited by, the collapse in share price of so many companies. This is where ambitious prosecutors build political careers.

    What’s the practical upshot for investors in all this?

    First, anyone who is placing the “CDS antimatter trade”, you’ve probably had a nice run. It is over. And if there is any way a jury can find that you’ve broken securities laws, you’re going to get a knock on the door.

    Second, for the rest of us. All bubbles burst. The CDS antimatter bubble will burst as well.

    When it does, you’ll see a massive short squeeze in the equities market. Get out of any short positions well before that happens. The squeeze will be like nothing you’ve ever seen before.

    Third, and most important, if what you’ve read in this article disturbs you, let your congressional representative know how you feel. Call the S.E.C., or the Federal Reserve. Take the time, and make your voice heard because this is your market, your economy, and your responsibility. That goes double for any of us whose profession revolves around the market.

    Disclosure: The author owns no stock in any of the companies mentioned in this article."


    Interesting, eh?

  3. #2

    Default Re: Anti-Matter

    What a great read, Jim! I'm surprised nobody else has commented on this.



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