Dear,
These days the center of the New Global Crisis is Europe, Mrs. Christine Lagarde made it clear some days ago in a CBS interview.
http://www.cbsnews.com/8301-18560_162-57326856/christine-lagarde-facing-down-worldwide-recession/?pageNum=2
As usual, some interesting remarks from the managing director of the International Monetary Fund.
“Uncertainty fueled by the turmoil in Greece, whose debt crisis threatened to bring down the rest of Europe.”
And also
“Letting Europe down is going to mean, if it was to happen, major consequences and negative consequences on many other economies, including the United States of America”
But Greece is a very small country, with low population (11 million people) and a small economy (GDP around $300.000 billion).
How is possible that the 37th economy of the world is going to be responsible of the new economic disaster?
Weird, isn’t it?
We can learn a lot from history, let’s look some years back and maybe we can find the explanation.
In October 2008, with the Banking crash we saw different approaches in governments’ decisions;
A very important one, Lehmann Brothers was considered expendable and others, like AIG were considered too big to fall.
Why an insurance company could represent a higher systemic risk than a Bank?
The answer comes from a Financial Instrument massively used on the last 10 years and described by Warren Buffet as Financial Weapons of mass destruction; “Over the Counter Derivatives”.
Amongst OTC derivatives, some of the most popular are Credit Default Swaps or CDS’s.
For those of you who are not familiar with derivatives markets let me make a short description.
CDS’s are like insurance contracts, but instead of insuring a house or a car, with CDS’s I can insure another Financial Instrument.
For Instance if I decide to invest in securitized subprime mortgages or CDO’s (collateralized debt obligations), and I want to hedge the risk of a mortgage housing collapse, I can buy CDS’s hedging that risk. In the event that the CDO issuer fails to fulfill its payment obligations the insurance company will cover the losses.
For the moment it sounds an efficient way of risk mitigation.
But we’ll see the danger when we understand that, as a difference of classical insurance business, with CDS’s I also can insure financial instruments that I don’t’ possess.
For instance, if I think that mortgage subprime business is going to collapse, I can buy CDS’s (betting against the housing mortgage business) and if the CDO falls, the CDS’s counterpart will pay me nice premiums.
And that’s not all, for making it worse, due to lack of regulation establishing Capital limitations to the risk exposure; OTC derivatives have the dangerous characteristic of multiplying the risk.
At the end, the whole construction is wasting solvency for generating Gross Domestic Product, in my opinion the energy moving our economic system since the 90’s.
These days CDS’s are becoming sadly popular again, but with some differences to the situation in 2008.
With CDS’s you can insure securitized subprime mortgages, or bet against them, but you also can insure Government Debt, or bet against it.
According to the Bank for International Settlements statistics www.bis.org CDS’s market has grown 8% since 2010, and Sovereign CDS’s 15%.
Why?
For me the answer is obvious, Government Debt is the hottest market these days and speculating on this market with CDS’s is one of the most profitable activities.
Again, we’re wasting solvency for GDP generation.
It sounds crazy but it’s the way it’s worked and the way that still works, but not for long.
Very soon we’ll see the price we’re paying by growing this way, and then new rules for efficient management of Solvency will be implemented. But that will have consequences of course…
Looking forward to read your opinions.
Ferran.
These days the center of the New Global Crisis is Europe, Mrs. Christine Lagarde made it clear some days ago in a CBS interview.
http://www.cbsnews.com/8301-18560_162-57326856/christine-lagarde-facing-down-worldwide-recession/?pageNum=2
As usual, some interesting remarks from the managing director of the International Monetary Fund.
“Uncertainty fueled by the turmoil in Greece, whose debt crisis threatened to bring down the rest of Europe.”
And also
“Letting Europe down is going to mean, if it was to happen, major consequences and negative consequences on many other economies, including the United States of America”
But Greece is a very small country, with low population (11 million people) and a small economy (GDP around $300.000 billion).
How is possible that the 37th economy of the world is going to be responsible of the new economic disaster?
Weird, isn’t it?
We can learn a lot from history, let’s look some years back and maybe we can find the explanation.
In October 2008, with the Banking crash we saw different approaches in governments’ decisions;
A very important one, Lehmann Brothers was considered expendable and others, like AIG were considered too big to fall.
Why an insurance company could represent a higher systemic risk than a Bank?
The answer comes from a Financial Instrument massively used on the last 10 years and described by Warren Buffet as Financial Weapons of mass destruction; “Over the Counter Derivatives”.
Amongst OTC derivatives, some of the most popular are Credit Default Swaps or CDS’s.
For those of you who are not familiar with derivatives markets let me make a short description.
CDS’s are like insurance contracts, but instead of insuring a house or a car, with CDS’s I can insure another Financial Instrument.
For Instance if I decide to invest in securitized subprime mortgages or CDO’s (collateralized debt obligations), and I want to hedge the risk of a mortgage housing collapse, I can buy CDS’s hedging that risk. In the event that the CDO issuer fails to fulfill its payment obligations the insurance company will cover the losses.
For the moment it sounds an efficient way of risk mitigation.
But we’ll see the danger when we understand that, as a difference of classical insurance business, with CDS’s I also can insure financial instruments that I don’t’ possess.
For instance, if I think that mortgage subprime business is going to collapse, I can buy CDS’s (betting against the housing mortgage business) and if the CDO falls, the CDS’s counterpart will pay me nice premiums.
And that’s not all, for making it worse, due to lack of regulation establishing Capital limitations to the risk exposure; OTC derivatives have the dangerous characteristic of multiplying the risk.
At the end, the whole construction is wasting solvency for generating Gross Domestic Product, in my opinion the energy moving our economic system since the 90’s.
These days CDS’s are becoming sadly popular again, but with some differences to the situation in 2008.
With CDS’s you can insure securitized subprime mortgages, or bet against them, but you also can insure Government Debt, or bet against it.
According to the Bank for International Settlements statistics www.bis.org CDS’s market has grown 8% since 2010, and Sovereign CDS’s 15%.
Why?
For me the answer is obvious, Government Debt is the hottest market these days and speculating on this market with CDS’s is one of the most profitable activities.
Again, we’re wasting solvency for GDP generation.
It sounds crazy but it’s the way it’s worked and the way that still works, but not for long.
Very soon we’ll see the price we’re paying by growing this way, and then new rules for efficient management of Solvency will be implemented. But that will have consequences of course…
Looking forward to read your opinions.
Ferran.
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