The inside story
We observed in December of last year that “there are tremendous fortunes to be made by short selling the entire financial system.” That has indeed come to pass in the ensuing months. Now the SEC is investigating parts of the $45 trillion unregulated world of credit default swaps, where it is thought that some of antics started to try to sink Morgan and Goldman. WSJ:
The SEC said it will require hedge-fund managers to submit, under oath, their trading activity in financial-company shares and related instruments such as credit-default swaps…The swaps trade directly between institutions, not on exchanges, and many investors believe their prices can be easily manipulated. They have become an increasingly popular way for firms to gamble on the fortunes of financial companies without actually trading securities issued by the firms.
The cost of default insurance for Bear Stearns and Lehman Brothers Holdings Inc. spiked in the days before both Wall Street firms collapsed. In both cases, elevated swap prices fueled worries about the investment banks’ solvency, triggering mass defections among clients and ultimately the companies’ demise. Bear is now part of J.P. Morgan Chase & Co.
In the past week, a jump in the value of credit-default swaps tied to Morgan Stanley and Goldman Sachs Group Inc. set off similar concerns at both firms. On Thursday morning, swap sellers were charging buyers more than $900,000 annually to insure $10 million of Morgan Stanley’s obligations from default over five years, a price typically associated with highly risky or distressed companies. The prices had doubled from Monday and tripled from the week before. On Friday, after the SEC announced its short-selling curbs, the cost fell to $560,000…
prices have often swung sharply ahead of major corporate news events, triggering suspicion that nonpublic information was leaking into the dealer market. Still, the SEC hasn’t brought any big cases involving credit-default swaps. There is a big debate over whether credit-default swaps are securities
Many people think that insider trading is both illegal and uncommon. That is not so. Insider trading “isn’t generally illegal in commodities” markets, for example. And, even in the world of publicly traded securities, financial institutions have an explicit mechanism to protect themselves from litigation in purchases and sales of securities based on insider information.
We remember being told in the heyday of junk bonds that these securities only traded on what the parties believed was inside information. Insider trading is the rule, not the exception, in many markets, even today. Former Treasury Secretary William Simon once told us, “with full disclosure, there are no conflicts of interest.” There’s wisdom in that. Fuller disclosure should be the rule, as far as possible, in all these markets; the lack of transparency has not served us well.
September 21st, 2008 at 7:18 pm
We observed in December of last year that “there are tremendous fortunes to be made by short selling the entire financial system.”
Congratulations. Events proved you correct.
You didn’t say the contrary: that tremendous fortunes might be made by borrowing every penny one could and buying the entire financial system. That underscores your assessment of how the balance of risks stood.
Accordingly, I’m not understanding your vehemence against those market participants who acted on that balance of risks. Aren’t they supposed to act in their own interest (and in their investors’ interests)? If the markets have developed an instability that is not based on economic fundamentals, let’s rectify it as possible; if an emergency has arisen, let’s respond accordingly (a 90% rebound would give little comfort after a 90% drop). But I don’t understand the rationale for the moralistic tone in parts of some of your posts. Maybe I’m misreading them.
The Information Arbitrageur’s deconstruction is worth reading.
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The SEC said it will require hedge-fund managers to submit, under oath, their trading activity in financial-company shares and related instruments such as credit-default swaps…
I’m all for transparency, but…
Under oath?!–thereby deliberating putting them at risk of (felonious) perjury. Sounds like, having cultivated bubbles by omission and commission, the government is now trying to cultivate scapegoats.