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I read in a Yahoo Finance article (http://finance.yahoo.com/news/10-Countries-in-Deep-usnews-14971805.html?.&.pf=real-estate - broken link) that it costs $1.8M a year to insure $10M of Venezuela's sovereign debt. That's about 18% of one's investment, per year.
Now, call me silly and naive. But I checked recent market prices for Venezuela and the 2027 sovereign notes with a 5.375% coupon are yielding about 9.9% based on the discount. How is this CDS not overpriced? It automatically results in a negative yield if you buy it. Are there really institutions out there paying $18 to make sure they get $10 that year?
There are guys I work with that know a whole lot more of the details, but in simple terms you are mis-estimating the nature of the buyers of the debt and the buyers of the CDSs. There are really different kinds of buyers of each, and they attempt to maintain a mostly liquid market by trading both the bonds and the debt instruments, as well a whole host of futures and derivatives upon which these are priced.
The tough thing is that in the tightest squeeze of the "global liquidity crisis" the cash used to settle these trades was flat out NOT there and that forced the big banks to have some very tense talks with each other and the government. Which as you probably remember left former Sec. of the Treasury Paulson looking like the grim reaper and Fed Reserve Chairmen Bernacke looking even worse...
No doubt there were some folks that did end up paying "more for less", but this was largely becuase they could not get out of their losing positions fast enough.
Foreign exchange arbitrage is not an arena that one enters without having a great big pile of money to loose...
There are guys I work with that know a whole lot more of the details, but in simple terms you are mis-estimating the nature of the buyers of the debt and the buyers of the CDSs. There are really different kinds of buyers of each, and they attempt to maintain a mostly liquid market by trading both the bonds and the debt instruments, as well a whole host of futures and derivatives upon which these are priced.
I do remember reading that you can buy a CDS without owning the debt it's meant to insure. I didn't realize it got to the point that you don't actually want to own the debt because it costs you too much to do so.
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The tough thing is that in the tightest squeeze of the "global liquidity crisis" the cash used to settle these trades was flat out NOT there and that forced the big banks to have some very tense talks with each other and the government. Which as you probably remember left former Sec. of the Treasury Paulson looking like the grim reaper and Fed Reserve Chairmen Bernacke looking even worse...
Does this mean the "customers" of CDS issuers never actually had to pay them? That they made fictitious payments to, say, AIG which they recorded as income on their balance sheets? Or does it just mean AIG didn't have the money to cover its gambles?
The vast majority of direct participants in the credit derivatives markets have a very good idea what they are doing and what their "end game" is. I have no idea whatAIG's total exposure to that segment of the market, nor do I know if they participate(d) in Latin American currency speculation, but any firm that does has to have a lot of connections to a whole lot of very highly placed sources if they do not want to end up having some very bad things happen to them...
Oh, I have no idea what company might be insuring Venezuelan debt. I just listed AIG as an example because they're the most infamous CDS issuer. And agreed that anyone who wants to get into that market had better watch out for the militias if they want to live to see the results..
I was thinking more of the financial implications given the lack of transparency and capricious nature of federalization of industries, but guys with gun are also a part of the Latin American landscape much more so than in the USA...
The reasons are complex, but fall into a couple of general buckets: the money was NEVER there, as they instead felt that the risk of default was close to zero, the money was levered by other assets -- that moved in the SAME negative direction as the trade and demanded massive liquidation, or the money was tied to an asset that was SUPPOSED to be move in an offsetting direction BUT the unusual confluence of event devalued EVERYTHING at the same point in time.
More transparency and oversight SHOULD have been in place to test out these scenarios / verify the appropriate levels of reserve. Instead that is one of the big things that the US Dept of Treasury is NOW working on with the commercial banks AFTER the cows have been burned in the great barn fire or '08...
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