Strange but true.. Credit Default Swaps are Back!

[Joanne98]

With all this reflationary work by the central banks and governments, don't you wonder what the new cash is buying?

Know anyone who's getting a new Porsche? Suezmax tanker? Damien Hirst pickled shark? Semiconductor test equipment?

Didn't think so. Neither do I. But the cash is going somewhere, such as into credit and credit derivative speculation.

A few months ago, you might not have expected to see those words again, outside congressional or parliamentary hearing transcripts. But that's what's been going on since March.

The credit specs are back. After all, if the dictates of style and tax auditors say you have to go easy on conspicuous consumption, and if there's no demand for the products of real capital spending, then you might as well take your cash to the track, or the corner credit default swap dealer.

Credit hedge fund managers, and even the banks' own desks, have uncoiled themselves from their foetal positions, and are back taking advantage of what are either risk-free arbitrages or value traps, depending on how the next few months go.

If I were them, I might be taking the money made in the past two and a half months off the table. But then I don't have to be reaching to get past a high-water mark.

"I am totally mystified by this rally," says one friend of mine in the credit fund trade.

He's made money on both the downside and the upside during the past year, and generally isn't at a loss to describe the parallelogram of forces, as they say in classical mechanics.

"Look, the system has taken out some of its financial leverage, but the economy still has too much excess capacity that will have to be dealt with. If we sit in the muck for five years , then there will be a tremendous number of defaults." That isn't being priced in to credit spreads.

Even after they've been reviled by talking heads and politicians from here to Ulan Bator, credit default swaps are still a very low-cost way of putting on speculative positions, as long as they still trade. And so, thanks to the Geithner Treasury's policy of reform, rather than dissolution, CDS trading has regained a vampiric strength the real economy still lacks.

Some specific credit sectors have done particularly well, such as retailers and chemicals. "They are just too expensive," says a German volatility trader. "JC Penney has gone from 800 or 900 over in the five year down to 190 to 200. That shows not short covering, but people jumping in after that." The consumer-dependent retailers and cyclicals such as the chemical companies still have issues with real-world demand, but the credit market people only see them as sources of cheap beta. For now.

The intrinsic leverage of CDS trades makes it possible to hope the portfolio manager might actually get paid a bonus some day.

For five-year CDS on credits such as those back-from-the-dead names every basis point on a $10m position can be worth $3,500 to $4,000.

Apart from going outright long "cheap" credit, there are, once again, fun games such as the "negative basis trades". That is, you can own a corporate bond, or emerging market sovereign bond, buy default protection on the paper with CDS, and collect interest payments for taking no risk. That's right: because CDS prices are depressed, relative to the comparable bonds, you can collect money for taking no risk.

A couple of years ago, someone might have said there was a risk that a CDS counterparty, such as, hypothetically, AIG, might get into trouble, and you would be unable to count on that leg of the trade. Then a risk-free arbitrage could turn into a money trap.

But thanks to Hank Paulson, Tim Geithner, and the rest of Team USA, that risk is no longer seen to be a problem. So you can now collect a couple of hundred basis points of risk-free money, as long as you have a line of credit with a dealer.

You may not be able to use credit markets to make reliably secured loans to auto companies, but the system can be used to collect more than 100 basis points of fully credit risk-hedged income from 10-year Turkish state bonds.

continued>>>
http://www.ft.com/cms/s/0/c1313f68-4a54-11de-8e7e-00144feabdc0.html?nclick_check=1

[madrchsod]

1. "same as it ever was,same as it ever was,same as it ever was"

the massive swindle continues with the blessing of the obama administration.

[DemReadingDU]

2. Why not? They will get paid with our tax money

when they default