Phorgy Phynance

Archive for the ‘Cash bonds’ Category

More on CDS, implied corporate leverage, and default rates

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The interesting discussion continues over on Nuclear Phynance. Here is my latest:

Hi Cheng,

My opinion on CDS has nothing to do with what is going on in subprime. In my opinion, subprime is just the first “zit” appearing on the face of a pubescent teen’s face who has been eating nothing but junk food for the past 10 years and is about to have a massive breakout.

I’ve heard economists blabber about how strong corporate balance sheets are as they have decreased leverage since 2000-2001, but these same economists have absolutely no clue about CDOs and other avenues for off balance sheet implied leverage. In my opinion, the only thing holding default rates down was the availability of easy credit, not some increased sense of corporate responsibility. I think we will find that most corporations are more highly leveraged than balance sheets would suggest. Now that spreads are widening with a return of risk premium (plus some for good measure), the availability of easy credit, especially in high yield, is quickly disappearing.

A logical next step following reduced easy credit is going to be increased default rates. This I think is going to severely test the CDS market (again nothing to do with subprime), especially when a default occurs on a company whose outstanding CDS protection exceeds the outstanding cash debt by factors of 10 or more. Even if the CDS is not settled physically, the cash needs to come from somewhere. Where will that be? What happens when the person you bought protection from defaults?

Regarding treasuries, close to 50% of all outstanding US government debt is held outside the US.

US financial watchdog says economy at risk from ‘non-ally’ bondholders

David Walker, the US comptroller general, indicated that the huge holdings of American government debt by countries such as China, Saudi Arabia and Libya could leave a powerful financial weapon in the hands of countries that may be hostile to US corporate and diplomatic interests.

Mr Walker told The Times that foreign investors have more control over the US economy than Americans, leaving the country in a state that was “financially imprudent”.

He said: “More and more of our debt is held by foreign countries – some of which are our allies and some are not.”

Mr Walker, who heads the Government agency that is responsible for auditing the national accounts and is also the arm of Congress that scrutinis-es spending by the Administration, said that the US has been forced to rely on foreign investors more because Americans are saving so little.

Don’t get me wrong though, I’m not all gloom and doom. There are certainly investment opportunities galore even if what I am preaching does occur. For example, oil is going no where but up. Food prices are going no where but up. Gold is going nowhere but up. Call me crazy, but I think land, i.e. physical land, not necessarily structured paper, is going to go up.

Wild times


Written by Eric

July 26, 2007 at 5:36 am

Economy at risk from ‘non-ally’ bondholders

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I’m halfway through

Financial Armageddon: Protecting Your Future from Four Impending Catastrophes

and will give a review when I’m done. So far, it is awesome. I’m also a big fan of Panzner’s Financial Armageddon blog. This morning, he points to a very interesting article in the Times Online.

Walker Understands the Golden Rule

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Written by Eric

July 24, 2007 at 8:28 am

Cash versus synthetic

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Been away for a while with traveling, preparing for the new job, etc. There is a pretty good (in my opinion) discussion going on over at NP:

Will there be a financial market contagion caused by ABS CDO woes?

This morning, there is a discussion of disparities between cash and synthetic (CDS) bond markets. Here is my take on the subject:

Investors in cash versus traders in cash/CDS are in many cases from two different planets and in some cases do not even speak the same language. My expectation is that cash will soon follow CDS, but for a time, cash will be artificially inflated as real money investors with significant “dry powder” who do not necessarily understand CDOs are mistakenly seeing bargains when HY widens 30 bps. Once that powder is gone, cash will soon tank as well.

Written by Eric

July 24, 2007 at 7:46 am