Best of the Week
Most Popular
1. The Trump Stock Market Trap May Be Triggered - Barry_M_Ferguson
2.Why are Central Banks Buying Gold and Dumping Dollars? - Richard_Mills
3.US China War - Thucydides Trap and gold - Richard_Mills
4.Gold Price Trend Forcast to End September 2019 - Nadeem_Walayat
5.Money Saving Kids Gardening Growing Giant Sunflowers Summer Fun - Anika_Walayat
6.US Dollar Breakdown Begins, Gold Price to Bolt Higher - Jim_Willie_CB
7.INTEL (INTC) Stock Investing to Profit From AI Machine Learning Boom - Nadeem_Walayat
8.Will Google AI Kill Us? Man vs Machine Intelligence - N_Walayat
9.US Prepares for Currency War with China - Richard_Mills
10.Gold Price Epochal Breakout Will Not Be Negated by a Correction - Clive Maund
Last 7 days
Has Next UK Financial Crisis Just Started? Bank Accounts Being Frozen - 21st July 19
Silver to Continue Lagging Gold, Will Struggle to Overcome $17 - 21st July 19
What’s With all the Weird Weather?  - 21st July 19
Halifax Stopping Customers Withdrawing Funds Online - UK Brexit Banking Crisis Starting? - 21st July 19
US House Prices Trend Forecast 2019 to 2021 - 20th July 19
MICROSOFT Cortana, Azure AI Platform Machine Intelligence Stock Investing Video - 20th July 19
Africa Rising – Population Explosion, Geopolitical and Economic Consquences - 20th July 19
Gold Mining Stocks Q2’19 Results Analysis - 20th July 19
This Is Your Last Chance to Dump Netflix Stock - 19th July 19
Gold and US Stock Mid Term Election and Decade Cycles - 19th July 19
Precious Metals Big Picture, as Silver Gets on its Horse - 19th July 19
This Technology Everyone Laughed Off Is Quietly Changing the World - 19th July 19
Green Tech Stocks To Watch - 19th July 19
Double Top In Transportation and Metals Breakout Are Key Stock Market Topping Signals - 18th July 19
AI Machine Learning PC Custom Build Specs for £2,500 - Scan Computers 3SX - 18th July 19
The Best “Pick-and-Shovel” Play for the Online Grocery Boom - 18th July 19
Is the Stock Market Rally Floating on Thin Air? - 18th July 19
Biotech Stocks With Near Term Catalysts - 18th July 19
SPX Consolidating, GBP and CAD Could be in Focus - 18th July 19
UK House Building and Population Growth Analysis - 17th July 19
Financial Crisis Stocks Bear Market Is Scary Close - 17th July 19
Want to See What's Next for the US Economy? Try This. - 17th July 19
What to do if You Blow the Trading Account - 17th July 19
Bitcoin Is Far Too Risky for Most Investors - 17th July 19
Core Inflation Rises but Fed Is Going to Cut Rates. Will Gold Gain? - 17th July 19
Boost your Trading Results - FREE eBook - 17th July 19
This Needs To Happen Before Silver Really Takes Off - 17th July 19
NASDAQ Should Reach 8031 Before Topping - 17th July 19
US Housing Market Real Terms BUY / SELL Indicator - 16th July 19
Could Trump Really Win the 2020 US Presidential Election? - 16th July 19
Gold Stocks Forming Bullish Consolidation - 16th July 19
Will Fed Easing Turn Out Like 1995 or 2007? - 16th July 19
Red Rock Entertainment Investments: Around the world in a day with Supreme Jets - 16th July 19
Silver Has Already Gone from Weak to Strong Hands - 15th July 19
Top Equity Mutual Funds That Offer Best Returns - 15th July 19
Gold’s Breakout And The US Dollar - 15th July 19
Financial Markets, Iran, U.S. Global Hegemony - 15th July 19
U.S Bond Yields Point to a 40% Rise in SPX - 15th July 19
Corporate Earnings may Surprise the Stock Market – Watch Out! - 15th July 19
Stock Market Interest Rate Cut Prevails - 15th July 19
Dow Stock Market Trend Forecast Current State July 2019 Video - 15th July 19
Why Summer is the Best Time to be in the Entertainment Industry - 15th July 19
Mid-August Is A Critical Turning Point For US Stocks - 14th July 19
Fed’s Recessionary Indicators and Gold - 14th July 19
The Problem with Keynesian Economics - 14th July 19

Market Oracle FREE Newsletter

Top AI Stocks Investing to Profit from the Machine Intelligence Mega-trend

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

© 2005-2019 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

6 Critical Money Making Rules