How markets attacked the Greek piñata

A sobering piece about some of the perverse incentives credit default swaps have created. This article provides a glimpse of one of the more important pieces of the current financial crisis.

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How markets attacked the Greek piñata

Wall Street loves a piñata party - singling out a company or country, making it the piñata, grabbing their sticks and banging it until it breaks. As in the child's game, the piñata is left in shreds. Unlike the child's game, in the Wall Street version the piñata is stuffed with money for the bankers to scoop up with both hands, instead of sweets. We see this game being played today, with Greece as the piñata.

Investors trying to understand why their portfolios have begun to melt down for the second time in five years are becoming experts in the fiscal policy of Greece. A look at the piñata party might make things clearer.

Greece's travails are often measured by reference to the market in credit default swaps (CDS), a kind of insurance against default by Greece. As with any insurance, greater risks entail higher prices to buy the protection. But what happens if the price of insurance is no longer anchored to the underlying risk?

When we look behind CDS prices, we don't see an objective measure of the public finances of Greece, but something very different. Sellers are typically pension funds looking to earn an "insurance" premium and buyers are often hedge funds looking to make a quick turn. In the middle you have Goldman Sachs or another large bank booking a fat spread.

Now the piñata party begins. Banks grab their sticks and start pounding thinly traded Greek bonds and pushing out the spread between Greek and the benchmark German CDS price. Step two is a call on the pension funds to put up more margin, or security, as the price has moved in favour of the buyer. The margin money is shovelled to the hedge funds, which enjoy the cash and paper profits and the 20 per cent performance fees that follow. How convenient when this happens in December in time for the annual accounts, as was recently the case. This dynamic of pushing out spreads and calling in margin is the same one that played out at Long-Term Capital Management in 1998 and AIG in 2008 and it is happening again, this time in Europe.

Eventually the money flow will be reversed, when a bail-out is announced, but in the meantime pension funds earn premium, banks earn spreads, hedge funds earn fees and everyone's a winner - except the hapless hedge fund investors, who suffer the fees on fleeting performance, and the unfortunate inhabitants of the piñata. What does any of this have to do with Greece? Very little. It is not much more than a floating craps game in an alley off Wall Street.

This is where the idea of CDS as insurance breaks down. For over 250 years, insurance markets have required buyers to have an insurable interest; another name for skin in the game. Your neighbour cannot buy insurance on your house because they have no insurable interest in it. Such insurance is considered unhealthy because it would cause the neighbour to want your house to burn down - and maybe even light the match.

When the CDS market started in the 1990s the whiz-kid inventors neglected the concept of insurable interest. Anyone could bet on anything, creating a perverse wish for the failure of companies and countries by those holding side bets but having no interest in the underlying bonds or enterprises. We have given Wall Street huge incentives to burn down your house.

Let's be clear, public finance in Greece is a mess. Statistics have been fudged, government pensions have been inflated and reckless borrowing has been the norm. Drastic remedies are required. But the crisis is manageable, and Europe has sent clear signals that they will take care of their own house without help from China, America or the International Monetary Fund. Unfortunately, a measured response does no good to the dealers in CDS, who require volatility and even panic to make their game a profitable one. If contagion spreads in uncontrollable ways, so much the better for the traders in volatility, never mind the collateral damage.

Until the CDS market is confined to buyers who have an underlying interest in the risk being covered, and sellers who are regulated as insurance companies with adequate reserves, this market will remain a reckless enterprise bent on arson. Serious issues of sovereignty and stability are at stake. Regulators have to stop ignoring the piñata party and start providing adult supervision.

Getting a job just got a little easier

http://money.cnn.com/2010/02/09/news/economy/job_openings/index.htm

This month on average, 5.9 job seekers are competing for each job opening, down from 6.4 the previous month. And it's the first time the ratio of job seekers to jobs dipped below 6:1 since June of last year.
Good news!

France, Germany Weigh Rescue Plan for Greece

This article goes over the possibility of the EU (mainly France and Germany) lending a hand to Greece in-order to repay some of their national debt. Greece's debt last year was around 13% of GDP and the S&P down graded their credit rating in December and world markets have been in a frenzy over concerns about the countries debt. It would be interesting to see the reaction from countries outside of the EU if Greece is bailed out and whether or not a one-time bailout for Greece would be enough. The article mentions that there was public outrage from the announcement of cuts in government spending (on public service wages).

Nasdaq Chief: U.S. Can't Curb Bank Trading

BY JACOB BUNGE

The head of Nasdaq OMX Group Inc. cast doubt on the ability of U.S. regulators to carve out some bank-trading activities as part of a broad overhaul of the financial system.

Bob Greifeld, chief executive of the trans-Atlantic exchange operator, said it appears "impossible" to separate banks' proprietary trading activities from customer and hedging positions.

Mr. Greifeld's comments on a post-earnings conference call are the loudest call to date from the exchange industry for a rethink of the proposals made to the Obama administration by former Fed chairman Paul Volcker.

U.S. Consumer credit fell for 11th straight month

This article talks about how people are not borrowing as much money like they used to before the start of the recession. This may seem smart from the consumer stand point but it makes an economic recovery much harder to achieve. Since people are borrowing less money they are also spending less money which is not good in a recession. the article also talks about how unemployment is effecting peoples rate of borrowing money

The burger and beverage recession

This article is interesting because it observes the recovery of the economy from a consumer's standpoint. By identifying normals goods as indicators such as Coca-Cola, McDonald's and Coors beer, the article states that consumer confidence still has not recovered. Especially compared to foreign demand for these goods which continue to show increasing trends, spending in the United States has not matched such levels. For all three companies, losses were still experienced in the United States however fortunately for these multinational companies, international growth is making up for the losses. This article is slightly concerning because it is difficult to lift the economy out of its hole without consumer spending and the continued reluctance, especially for normal goods that have been staples of American society for decades, may show that the recovery of the economy is still unconvincing enough to persuade consumers to spend.

U.S. Consumer Confidence Falls

This particular index is now 1.7 points below its 12month average of 48.5 and only 2.4 points above its reading in Dec. 2007 (44.4) when the recession began.

The inevitable fix for the deficit

Good article on possible ways to fight the US deficit (eventually national debt). The author talks about the idea of VAT (Value Added Tax) which basically is a tax on goods that falls heaviest on the consumer. The article goes deeper into explaining what VAT is and how it could cure the projected $1 trillion dollar annual deficits up to 2020.

Is It Time to Extend Unemployment Insurance??

This article discusses the need for Congress to extend the social safety net programs, that provide unemployment insurance, in the stimulus package because millions of people nationwide will lose unemployment benefits in the coming months. According to new statistics without congressional intervention, nearly 5 million jobless workers will lose benefits by June. The article concludes with, "Congress needs to act now and extend these benefits", however, as mentioned in class the longer a worker is eligible for unemployment insurance, the longer the duration of the average spell of unemployment. So what should Congress pursue?

Next in line for a bailout: Social Security

For the first time in 25 years, Social Security is taking less taxes than it is spending on benefits. US government may need to bailout for social security in the near future.

More debt heading our way

The government has decided to increase our debt, basically borrowing 40 cents on every dollar. The House voted for the budget to increase 1.9 trillion dollars deeper, which is an increase of 6,000 per person. The budget is close to 4 trillion dollars more than last year's budget. The programs that a lot of this money are helping include: food stamps, Medicacaid, and Social Security.

America's Biggest Rip-offs

American's Biggest Rip-offs

http://money.cnn.com/galleries/2010/news/1001/gallery.americas_biggest_ripoffs/index.html

It's interesting to see how things as small as text messages and pop-corns can have markups as high as 6500% and 900%.

Zimbabwe Prices Fell 7.7% in 2009 From Hyperinflation (Update1)

Prices in Zimbabwe fell by 7.7 percent last year after abolishing national currency and switching to dollars to decrease the inflation rate of hundreds of millions. Zimbabwe started using US dollars in december 2008. Inflation peaked to more than 500 billion percent before the government switched to US dollar.

Consumer credit falls for 11th straight month

Consumer credit has declined for the 11th straight month. Total borrowing has declined approximately $10 billion in the month of December. For all of 2009, consumer credit has dropped 4%. Experts think the decline will stop around June, and they believe there will be a strong rebound in 2010. All of this is making it very tough for people to obtain credit.

Jobless Report Encouraging Sign for Market

this article talks about how the recent decline in unemployment is a good sign but its not a great sign. it is always a good sign to see unemployment drop but with our economy still cutting thousands of jobs a week it may be a while until we see unemployment at a reasonable rate. one thing the article did not talk about was if this decrease was because people found jobs or if people stopped looking for jobs. If it as because people stop looking then that would cause the rates to drop but that would only mean that our economy is still in a lot of trouble. hopefully in the future we can see a significant drop in unemployment so that we may see a strong recovery.

A long awaited job

Even though unemployment numbers decreased to 9.7%, the lowest it has been for months , a typical worker is unemployed for just over seven months. This just adds to the fustration for the adults in this awful economy. Unemployment benefits usually last for around 26 weeks and with six people for every job opening this just creates a very tough time for people looking for anything that will come their way.

The Labor Department is reporting 20,000 job losses, a higher number than many expected. Since the start of the recession, there has been around 8.5 million job losses. There are 11.5 million Americans that are receiving some sort of unemployment benefits however some of those are going to be cut by March.

Google Facing Europe

Google has had a problem in China. But it may have bigger headaches in Europe and now may have a bigger fight in Europe with various issues such as privacy, copyright protection and the dominance of Google’s Internet search engine, the company is clashing with lawmakers, regulators and consumer advocates. The consequences with the issues in Europe outweigh the situation in Asia because Google’s operations in Europe are much larger and more lucrative

Italy has proposed a law making online video services like YouTube liable for invasions of privacy, violations of copyright and other transgressions that occur in user-generated content

The minister of justice for Germany, Sabine Leutheusser-Schnarrenberger, complained recently about Google’s instinct for “pressing ahead” and its “megalomania.” She said the company was tearing down privacy protections. She also said this in an interview, "On the whole, I see a giant monopoly developing, largely unnoticed, similar to Microsoft."

It will be interesting what has to come with Google and it's issues with privacy and monopolization correlating with it's new products and plans.

Bank Failures

The total of bank failures has hit 16 for 2010, in 2009 there was 140, which was the highest since the early nineties. This is a huge number and hopefully there will be a brighter future for banks. These numbers are astronomical and it must stop because it also causes many people to become unemployed.

Toyota's Recall

Toyota is planning on announcing early this week on recalling at least 311,000 of its 2010 Prius hybrid models after the complaints about the vehicle's brakes intensified. This decision comes after Toyota's recall of about eight million cars worldwide over gas pedals that could possibly stick or catch a hold on floor mats. Toyota's slow response to the brake's imperfection has caused a furry of question on the business's ethics.

Toyota will be reviewing and looking into the two other hybrids with the same braking system, the Lexus HS250h and a model sold in Japan, the Sai, to determine whether they are at risk.

Invested Interests

This article talks about the state of Asian nations and how low growth might not be caused by the misconception that people in Asian nations save more than they consume. While it is true in China people largely save more than they consume, other countries seem to be the opposite. In fact, their consumption might be the problem. In underdeveloped countries it is better to invest than to consume (in order to promote economic growth). Consuming too much today causes the next generation to be poorer while investing will build infrastructure and depending on marginal product of capital make labor more efficient. This leads to more consumption in the future which, while not beneficial to us now, will eventually become valuable. The article concludes saying that while higher consumption suits the West's interests, more investment is in Asia's interest.

Concern about the US economy and debt problems in Europe lead to large falls in many stock markets, while oil prices also drop.

-Stock markets in the United States and Europe fell - the U.S. it's worst in 9 months, and the overall European by 2%, Spain and Portugal by 5%.
-Analysts believe this to be a reaction to the sharp drop in crude oil prices (almost $4 a barrel).
-Anaylasist lost hope for a recovery in Greece and Portugal without a bailout because the public is not interested in buying their goverment's bonds.

Obama plan to tax large financial firms designed to pay for TARP losses

This article is about President Obama proposing a new tax that would tax the companies responsible for the nation’s economic crisis. The tax would estimate to bring in $90 billion dollars over the next decade. Obama believes that firms are now financially healthy enough to reimburse the government for their economic rescue efforts.

Markets: Shaky after the slump

This article points out the slump that the market has suffered over the past three weeks. This week, investors could either help the market out of the slump or make it worse by still not investing. One of the main causes of the market fall last week was the fear of Greece defaulting its debt. Although in a slump, Phil Orlando points out that the better than expected fourth quarter earnings is a sign that the economy is continuing to stabilize.

So far, 63% of the S&P 500 companies have reported their results for the past year. If the rest of the 186 companies stay consistent with the first 63%, there will have been a rise of 206% in earnings.

Is The Market Priced for Perfection“Investors have already priced in everything we can hope for in terms of an economic and profit recovery,”

The article discusses how the rapid recover in the stock market from March through December of last year will probably not continue this year. “Investors have already priced in everything we can hope for in terms of an economic and profit recovery,” This is the reason for a lack of confidence in the outlook of a rapidly recovering economy. James W. Paulsen, chief investment strategist in Minneapolis, for Wells Capital Management, said that “when the market gets extended and optimism emerges, a sense of vulnerability develops.” In this case, the market was vulnerable to what Mr. Paulsen described as “government volatility.”

Debt fears rattle market

This article discusses the impacts of the recent debt crisis on many markets including the Wall Street. This crisis caused the ratio of dollar to euro to increase to seven month's highest and in consequence increased the price of dollar based commodities such as gold and oil. In the current economic conditions where the labor market is so tight, this is aother big blow for many economies. Hope this article has something that can be useful in keeping track of the economic woes of the world.

Obama proposes measures to shore up small businesses

Obama says that the key to boost the economy out of the recession is to make sure that small businesses are going to be successful. Small businesses make up a large percentage of the economy it is essential for them to be successful.

Obamas plan is to take 30 billion dollars out of the Trouble Asset Relief Program (TARP) which was originally designed for bailing out Wall Street Investment banks and create new small business lending fund that will help provide capital for banks on main street. Also originally Obama was said to allow for 47,000 loans to small businesses so that entrepreneurs and business owners can start business and help finance current businesses from being shut down. Finally, a new tax credit for more than one small businesses that hire new workers or raise wages. Hopefully, this plan will help spark the economy and allow small businesses to prosper in a weak economy.

Companies Boost Productivity and Put off Hiring

This article talks about how companies are pushing their current employees to do more so that they don't have to hire more people. Firms are scared to hire a lot more people now because even though the economy is starting to look up, you can never be sure. American workers are very overworked, especially now. It seems to be, either you have a job and are fighting for your life to keep it, or your out of luck and can't find work anywhere.

Obama Optimistic on Growth

Even though a considerably large number of Americans are unhappy with the Results of the President's plans for the economy President Obama revealed his optimism on Sunday. In 2009 there was improvement in the job market with the unemployment rate 10 to 9.7 %. The Economy as a whole grew by almost 6 % in the fourth quarter of 2009. As we have all learned before we can look at the economy in two different ways , the long run and the short run. The way in which things are being taking care of will show results in the long run. Unemployment which is the biggest problem in my mind will not go back to its natural rate within the year. I do think that the economy continues to be run the way it is being run with the use of taxes to control inflation from getting to high the situation could completely turn around in the future bringing us into the upside of the business cycle.

I Stopped Looking for Work

This is just a brief story of a woman who has become a discouraged worker. This along with seven other stories all talk about how each one of them are giving up on looking for work. This is quite disheartening to read but it is the truth of what our country is dealing with right now. It is hard for us as college students to look at these kinds of articles and hear about the job market in the "real world".

Inflation Risks in Asia

This article deals with inflation and the current speculations that some Asian countries may have to deal with increased inflation in the near future. Last year the central banks in Asia were flooding their markets with currency to stimulate growth, but now they are fearing they are growing too fast and may see increased inflation. Robert Subaramen, the cheif economist in Hong Kong says, " the biggest risk facing Asia was that of an unexpected increase in commodity prices driving up inflation." Central banks in Asia could fix this problem by decreasing the amount of money they are putting into the system or increasing interest rates, but since the U.S. Federal Reserve is unlikely to raise interest rates until later this year the Asian central banks will probably keep their interest rates low until the U.S. changes fearing the loss of speculative money from other countries. Instead of raising interest rates India and China have experimented with other methods such as increasing the reserve requirment of their banks, and the Phillippines have raised the rate on short term lending. Both of these stragegies keep the interest rate the same, but some economist fear this will not be enough to keep inflation from rising.

Rebuilding a shattered economy, $50 at a time

This article concerns on how to help Haiti people rebuild their home; it narrates a number of viewpoints of economists or bankers, who are dedicated to restructuring Haiti. First, Neil deMause, the writer, points out that Haiti’s labor market was already plunging in a severe trouble before the Earthquake; it estimated that the unemployment rate was as high as 70%. Therefore, the task of rebuilding Haiti is quite tough and imminent especially after the Earthquake.

It reports that International aid groups have been focused on supplying food and shelter. And, Microlending has gained a more and more important role to help poor areas like Haiti to create a new hopeful life. For example, Fonkoze has already lent microloans to 50,000 in Haiti. According to Hari Srinivas, an expert of the Global Development Research Centre, this activity (microloans) would have a disproportionate effect. And the rest of this article discusses how to make good use of limited cash grants, and help Haiti’s people get sustainable loans, which is a fundamentally solution of Haiti’s big problem.

Wages and the Recession

This article discusses how wages are no longer determined by productivity. The author states that usually productivity growth and wage growth move together, but that this is not currently happening. During the recovery process, companies are cutting costs wherever possible. Wages are obviously one way to do this. Many have moved jobs overseas where labor is cheap. The rise in health care costs have also made it difficult for firms to increase wages substantially. The short run outlook is not very rosy, and neither is the long run according to this article. Wages have seemed to level-off.