Most Popular
1. It’s a New Macro, the Gold Market Knows It, But Dead Men Walking Do Not (yet)- Gary_Tanashian
2.Stock Market Presidential Election Cycle Seasonal Trend Analysis - Nadeem_Walayat
3. Bitcoin S&P Pattern - Nadeem_Walayat
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
4.U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - Raymond_Matison
5. How to Profit from the Global Warming ClImate Change Mega Death Trend - Part1 - Nadeem_Walayat
7.Bitcoin Gravy Train Trend Forecast 2024 - - Nadeem_Walayat
8.The Bond Trade and Interest Rates - Nadeem_Walayat
9.It’s Easy to Scream Stocks Bubble! - Stephen_McBride
10.Fed’s Next Intertest Rate Move might not align with popular consensus - Richard_Mills
Last 7 days
Time to take the RED Pill - 28th May 24
US Economy Slowing Slipping into Recession, But Not There Yet - 28th May 24
Gold vs. Silver – Very Important Medium-term Signal - 28th May 24
Is Gold Price Heading to $2,275 - 2,280? - 28th May 24
Stocks Bull Market Smoking Gun - 25th May 24
Congress Moves against Totalitarian Central Bank Digital Currency Schemes - 25th May 24
Government Tinkering With Prices Is Like Hiding All of the Street Signs - 25th May 24
Gold Mid Tier Mining Stocks Fundamentals - 25th May 24
Why US Interest Rates are a Nothing Burger - 24th May 24
Big Banks Are Pressuring The Fed To Losen Protection For Depositors - 24th May 24
Another Bank Failure: How to Tell if Your Bank is At Risk - 24th May 24
AI Stocks Portfolio and Tesla - 23rd May 24
All That Glitters Isn't Gold: Silver Has Outperformed Gold During This Gold Bull Run - 23rd May 24
Gold and Silver Expose Stock Market’s Phony Gains - 23rd May 24
S&P 500 Cyclical Relative Performance: Stocks Nearing Fully Valued - 23rd May 24
Nvidia NVDA Stock Earnings Rumble After Hours - 22nd May 24
Stock Market Trend Forecasts for 2024 and 2025 - 21st May 24
Silver Price Forecast: Trumpeting the Jubilee | Sovereign Debt Defaults - 21st May 24
Bitcoin Bull Market Bubble MANIA Rug Pulls 2024! - 19th May 24
Important Economic And Geopolitical Questions And Their Answers! - 19th May 24
Pakistan UN Ambassador Grows Some Balls Accuses Israel of Being Like Nazi Germany - 19th May 24
Could We See $27,000 Gold? - 19th May 24
Gold Mining Stocks Fundamentals - 19th May 24
The Gold and Silver Ship Will Set Sail! - 19th May 24
Micro Strategy Bubble Mania - 10th May 24
Biden's Bureau of Labor Statistics is Cooking Jobs Reports - 10th May 24
Bitcoin Price Swings Analysis - 9th May 24
Could Chinese Gold Be the Straw That Breaks the Dollar's Back? - 9th May 24
The Federal Reserve Is Broke! - 9th May 24
The Elliott Wave Crash Course - 9th May 24
Psychologically Prepared for Bitcoin Bull Market Bubble MANIA Rug Pull Corrections 2024 - 8th May 24
Why You Should Pay Attention to This Time-Tested Stock Market Indicator Now - 8th May 24
Copper: The India Factor - 8th May 24
Gold 2008 and 2022 All Over Again? Stocks, USDX - 8th May 24
Holocaust Survivor States Israel is Like Nazi Germany, The Fourth Reich - 8th May 24
Fourth Reich Invades Rafah Concentration Camp To Kill Palestinian Children - 8th May 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

How the Masters of the Financial Universe Use Derivatives for Fun and Profit

Stock-Markets / Derivatives Dec 10, 2013 - 10:34 AM GMT

By: Money_Morning

Stock-Markets

Shah Gilani writes: Jon Stewart just did a very funny piece on “The Daily Show” about a new derivatives dust-up that Bloomberg news broke.

Earlier this year, a big Wall Street firm bought a credit default swap on debt that a private company owed to a third party. So the firm was set up to make money if that company missed any payments. Then the firm offered the company a multi-million-dollar loan… with the condition that they would miss a payment on the other loan. They did. And the Wall Street firm walked away with a $15 million insurance payment.


Sound less than kosher? Oh, don’t worry. It’s perfectly legal.

“The Daily Show” team pointed out that this behavior isn’t illegal but maybe should be, and that the media didn’t cover it at all and maybe should have.

But there’s something they missed, and it’s even more frightening.

Here are the details…

Last year Spanish gaming company Codere SA was in deep doodoo. They still are. They had a bunch of outstanding bonds (over one billion euros worth) that they were likely going to default on.

So, in comes GSO Capital Partners LP, a credit investing unit of the world’s biggest private equity firm, Blackstone Group LP (NYSE:BX). GSO buys up a package of Codere’s outstanding debt and CDS (credit default swaps) on the same debt.

Credit default swaps are derivatives. They are a type of insurance. Say you invested in Codere’s bonds and you’re afraid they might default and you won’t get paid your interest or principal. You can buy CDS from, most likely, hedge funds or banks, and pay them premium money payments, just like you would on any insurance policy. If Codere defaults, you get paid and are made whole.

Well, GSO bought Codere’s debt and CDS insurance on that debt. Makes sense, right?

GSO also bought out a syndicated revolving line of credit for up to 100 million euros that several banks had set up for Codere. GSO then went to Codere and said, “Hey we now control whether you’re going to get any money out of this loan facility. And we’ll loan you what you need to make payments on your outstanding debt, so you don’t default.”

But that wasn’t the whole deal.

They also said to Codere, “We want you to make your next payment two days after it’s due, so you technically default. Then we’ll loan you the money to make your interest payment.”

And that’s what happened. Codere had a deal to get the money it needed to pay the interest due on its debt. But GSO wanted it to technically default by not making the next payment on time. That’s because GSO wanted to collect on the insurance it bought on Codere defaulting.

Nice game, huh?

Again, Jon Stewart and his crew at Comedy Central covered this story last week. (Google “Daily Show Blackstone Codere” to watch it.)

But the situation is a little more complicated than Stewart makes it out to be.

Here’s the rest of it.

Yes, GSO made Codere default so it could get paid on its default insurance (if you’re a hedge fund or bank that sold them the insurance, trust me, you’re pissed off). There were plenty of other investors who owned debt that were going to get paid on their CDS insurance too.

The game wasn’t just to collect the insurance.

The $15 million insurance payment GSO got was nice, and it was nice for other investors who got paid too. But the cleverness of the deal was that GSO forced the company’s creditors to the debt negotiating table to restructure their debt once they defaulted. Without the default, the insurance wouldn’t have gotten paid, and there was a chance creditors would have renegotiated to keep the company going in hopes it eventually would pay off its debts.

GSO bought the debt to be in a better position holding it after it got paid on the insurance and after it forced a debt renegotiation on the other creditors.

That’s the power of derivatives in the hands of Masters of the Universe.

Were others burnt on the deal? Sure, but who cares if you’ve got the smarts, muscle, and capital to rig the game to your benefit?

Derivatives are weapons of mass destruction. You may not think these little derivative dust-ups affect you, and maybe they don’t – at least not directly. But there are some players in the business who don’t know what they don’t know, and that’s scary for all of us. It’s the players who didn’t know how the backdoor game could be played who really suffered. That will be a lesson they won’t forget.

Speaking of forgetting… Things are all quiet on the derivatives front after the credit crisis that was grossly aided and abetted by derivative weapons of mass destruction, right?

Wrong.

One of the dangers of derivatives is that they’re “bilateral contracts,” meaning they’re private, two-way trades that aren’t exchange traded and therefore are not transparent.

Dodd-Frank sought to remedy that by making certain U.S. traders in certain derivatives trade them on exchanges called swap execution facilities (SEF). But there’s a problem with that solution.

You see, U.S. regulators can’t make other traders in other parts of the world follow U.S. rules if they don’t do those trades in the U.S. or with U.S. entities as counterparties.

Of course that’s not a problem for U.S. banks and derivatives traders. They’re just setting up foreign subsidiaries (if they don’t already have them, which most do) in London and Hong Kong and elsewhere to do business outside the U.S. so as to avoid doing their business in the open on SEFs.

You can see where this is going, can’t you? Just like with the CDS trade deal above, which isn’t illegal, U.S. companies were given a carve out to set up foreign entities to do derivatives trades away form the very same swap execution facilities they were supposed to do their trades on because some or any transparency is better than none.

It’s getting bad. Now, not only are more derivatives trades (by U.S. entities) being done away from prying eyes in places where regulations are far more lax than in the U.S., by spreading their trades around traders are splitting markets. That “fragmentation” is going to undermine liquidity and “netting” that’s an absolute must when stresses in the derivatives markets cause the whole dance floor to shimmy and shake.

So what’s the moral of the story?

The derivatives dance is a dangerous waltz. Pick your dance partners well, and when enough punch is spilled on the dance floor, realize that that ain’t a new dance derivatives traders are doing, it’s probably the electric slide… as in slide off a cliff.

Shah

Source :http://www.wallstreetinsightsandindictments.com/2013/12...

Money Morning/The Money Map Report

©2013 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in