Credit Derivatives: Ban speculative Buyers of 'Protection'

News that speculators are betting that municipalities and federal states in the USA may default highlights the urgent need for reform of the credit derivatives market. Not only does the ballooning of outstanding trades create a substantial risk of default by one of the participants in the market it also creates problems in the wider economy by accelerating and exaggerating real or perceived weakness in the credit ratings of various issuers. There is no reason why those without an insurable asset should be allowed to buy 'credit protection' - nothing is 'protected' and it is but a speculation on default. The argument that you need speculators to facilitate a liquid market so that  investors (banks, bond investors) with genuine reasons can protect themselves,  does not hold as you really need only SELLERS of credit protection to satisfy this requirement. So speculators are more than welcome to provide liquidity as sellers of credit protection. Adjusting legislation would mean that derivatives traded outside recognised exchanges would again be unenforceable if they are not hedging against a pre-existing risk.

Goldman most powerful Bank?

Hubris comes before the fall. The headline above illustrates the danger that companies and their managements start to believe what they read in misguided press comments. Already many years ago while we were both working there a colleague of mine said that if Goldman Sachs - or any other bank - would disappear no one would notice any difference after a few days . Markets would carry on as before and would be as serene as the sea after it has swallowed a mighty ship. A single company certainly should not be able to influence the markets - that danger should be addressed by vigilant competition authorities. Unfortunately, these bureaucrats usually at best play catch-up with developments in the markets (otherwise companies like Sky UK, Microsoft, Google and Apple would already have had their wings clipped). A more sinister danger would be if companies can exert power in the political sphere. Here the multitude of links that Goldman Sachs staffers past and present have with the US Government certainly is cause for concern. But this is just another symptom of a defect of the political system in most countries where lobbies, parties or - even worse - unelected authorities (China!) make a mockery of democracy.

Lacking CDO Disclosure: Who is to blame?

It takes two to tango. The present discussion about the alleged lack of disclosure in CDO transactions directs most of the criticism towards the structuring and originating parties in the large investment banks (and their cooperators in hedge funds). While this criticism may well be valid in some - or the majority of the cases - one should not forget that no-one was forced to buy these structured products. Any attempt at regulatory reform would be simplified if the effort would primarily be directed at the buy-side. If the list of permitted transactions would be updated so that structured products are strictly controlled the supply would quickly adjust itself - both in terms of quantity and - even more importantly - in terms of quality of disclosure.