The Zimbabwenomicsts Say Do Nothing Naked

by Johnny Debacle

Zimbabwenomic forces are following up last year’s smashing success in banning short-selling in certain financial firms with new legislation aimed at effectively scrapping the entire CDS market.

House of Representatives Agriculture Committee Chairman Collin Peterson of Minnesota circulated an updated draft bill yesterday that would ban credit-default swap trading unless investors owned the underlying bonds. The document, distributed by e-mail by the committee staff in Washington, would also force U.S. trading in the $684 trillion over-the-counter derivatives market to be processed by a clearinghouse.

It’s about time that someone put together a way to stop the CDS market cold in its tracks. The instrument’s ability to provide hedging for companies’ debt, improved liquidity in names, and more accurate information about the health of issuers is not only dangerous, but it’s overtly capitalistic (they might as well be called Credit Default Ronald Reagans), which we now know to be a mistake. A healthy economy doesn’t need an unfettered free market system — what it needs is a regulated command economy that ensures that houses (and everything else) are always affordable, especially for people that can’t afford them and that politicians are always in control of all economic and financial processess.

This particular zimbabwenomic reform comes from the chairman of one the most progressive committees in the house, and hopefully he and fellow zimbabwenomicist Barney Frank can push forward appropriate regulation of all markets, specifically, regulation that will prevent them from going down.

As much as 80 percent of the credit-default swap market is traded by investors who don’t own the underlying bonds, according to Eric Dinallo, superintendent of the New York Department of Insurance. Dinallo last year proposed outlawing so-called “naked” credit-default swap trading. He shelved the proposal in November because of progress by federal regulators on broader oversight of the market.

More generally, we think one of the effects of the Great Regression will be that everything naked will take a hit. Naked trading, naked shorting, naked greed, naked people and naked CDS positions were the excesses that got us into this mess. The lesson? We, as a society, need to do it with our clothes on, whatever “it” is.

Recommendation: We recommend an unhedged short on naked trading, naked shorting, and naked CDS positions, basically anything naked. Putting clothes on all such actions ensures that nothing is able to go down. Now is a perfect time to bone up on dry humping in expectation of the new regulatory paradigm.

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Comments

  1. Cory
    January 29th, 2009 | 12:49 pm

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    Excellent post!!!

  2. Pleb
    January 29th, 2009 | 1:59 pm

    See, I think you just haven’t gotten the proper dose of hopenchange yet. How could increasing the budget by 30% annually while cutting marginal taxes (low end marginal taxes) possibly fail? When TARP II makes it out of committee, you’ll get a chance to see how wrong you are. Like Nigel Tufnel’s amplifier, the fact that Congress is passing these bills means they’re a good idea. If we need more money, we’ll just crank up the money copying machine to 11.

  3. Brad
    January 29th, 2009 | 3:12 pm

    This goes to show how legislators just don’t understand. The problem with the CDS market were traders selling protection thinking defaults are incredibly unlikely (take AIG’s explanation of how they ended up selling so much protection as an example). Forcing those traders to hold the underlying bonds is even worse! Now they lose on the bond when it defaults and then they have to also pay their CDS counterparty because of the default too. Think of it this way, it would be like buying a car and then letting someone else buy insurance from you on your car. When they crash the car, you lose the car (its wrecked) and you have to pay the insurance payout to the guy who has been feeding you premiums. That is double the downside risk, not a hedge! Mr. Petersen, learn about how the market works before you try to fix it, then maybe you can do things to help, rather than hurt!

  4. Straight Cash Homie
    January 29th, 2009 | 2:42 pm

    Ref Mr. Soros FT article.
    The entire premise based upon the benefit of being on the short side of a CDS all but totally ignores in the OTC market there are not market makers that must become a counterparty to maintain orderly markets for that security. Hence, those who take the long side do so at their own risk knowing full well they are under no obligation to do so. It sound more to me like he is pissed about missing the opportunity and maybe a little jealous of JP. Fact is JP’s use of CDS and other shorts is being hailed as genius and rewarded handsomely, where as George Soros is still derided for imploding the bank of London and causing the Asian economic crisis in the 1990’s…. I think we can all agree it’s completely unfair.

  5. AKAL
    January 31st, 2009 | 1:56 pm

    Where can I get these Ronald Reagans? Would you suggest going long dead presidents not on bills or coins? Long on Ron?

  6. Dave
    February 4th, 2009 | 12:03 pm

    If it were true that more than 50% of CDS issued could be redeemed, then they would actually help the market, improve liquidity, and convey information. Also, gambling would be fun again.

    Once the ratio falls below 50%, then liquidity, information, and solvency of the market fall below where they would be without the CDS.

    Current experience suggests that only about 10% of CDS can be redeemed according to the contract. The percentage that are backed by a company with the promised credit rating is zero. But even if both numbers were 49%, then they still deserve to be killed off.

    If a randomly chosen insurance policy on my car only had a 49% chance of paying, then the government would be doing me a favor by eliminating the insurance business completely. (If people just paid for damages as they happen, that would also pass risk to the appropriate party.)

    If I were buying insurance policies on someone else’s car, then that transaction deserves to be killed off even if the insurance company is still solvent. CDS went so far down this path that the SEC allowed transactions that the Nevada Gaming Commission had previously outlawed.

    If you think this is “Socialism”, then you need to re-think the proper role of “police” in society. If a policeman arrests you for robbing people in a numbers game, is the cop restraining trade? Is the government trying to run your life? Or is the policeman simply implementing the risk/reward inherent in a life of crime?

    CDS are even worse than a numbers con: There actually are innocent parties here. This may not fit in your world view, since you appear to be an investment manager.

    Our local government issued bonds to build roads that are actually worth LESS money because they are “insured” by a monoline. If you have a solution to this insanity besides “more of the same”, then please step forward and be recognized.

  7. SAWells
    February 13th, 2009 | 5:30 pm

    I think we’re not so much worried about “The instrument’s ability to provide hedging for companies’ debt, improved liquidity in names, and more accurate information about the health of issuers” as we are about its ability to suck all the money in the world into a deep pit and set fire to it.