How To Waste Money
from Peter Radford
Just a very quick note today. We have a long holiday weekend ahead of us here in the US. But I couldn’t pass this up.
You all remember those notorious credit default swaps? Those nasty little, or not so little, pieces of paper that the boys and girls on Wall Street play with. Like matches near gasoline. In the right hands they appear very sensible and so, so, safe. Sometimes they end up in the wrong hands, and blow up in our faces. The idea is that a CDS is a piece of insurance against another piece of paper. So if a bond I own becomes worthless I collect on the CDS – insurance – and am none the worse for wear. It’s even more fun if you can buy insurance on something you don’t own. That way you collect cash and have no offsetting loss. That was made illegal centuries ago in life insurance, it offends simple ethics, but on Wall Street anything goes. They love cheating. They do it all the time. It’s called being innovative. It’s why our factories have no up to date equipment. All our capital is being sucked out so the traders can play games. But, let’s ignore that for the moment.
Here we are all atwitter about the impending end of the earth. Judgement day is upon us. No, not that judgement day. The other one. The one that arrives when the US hits its debt ceiling. On that day, plus one, the US has no cash to pay back its debt – this is hypothetical – and so the potential for default rears its ugly head.
So, what do the boys and girls do?
They buy CDS insurance against US treasury default. Yes. Even though the US treasury has defaulted there will be US banks, presumably more secure than the Treasury, left who can make good on the insurance. Forget that these banks rely on the Treasury to survive – that spoils the story the boys and girls tell each other.
OK. Stop laughing. Here’s the problem:
The US can’t default on its debt. Not unless it wants to for some obscure reason. Read that again. It is not possible for the US to default. As is: it cannot happen. Never. Never. Not ever.
Now I may sound a little sure of myself there, so I owe you an explanation. Let’s go through what happens:
Judgement day: the US hits the so-called debt ceiling. Whoops.
J-Day +1: Bond holders ask for payment. Double whoops. Tim Geithner looks around. He cannot issue more debt, since that would violate the law. He shakes his wallet. It’s empty.
So what does he do?
He gets on the phone.
Tim: “Is this the print shop”
Printer: “Yes it is. Hi Tim, how are you?”
Tim: ” Hey, I have a bit of a problem. I need to pay off some bonds and have run out of cash. Could you help me out here?”
Printer: “Sure. How much should I print?”
Tim: ” I’m not sure. There are a lot of these bonds. You’d better run the press non-stop.”
Printer: ” No problem Tim. You’re a good guy. The press is all yours.”
Tim: “Thanks. You’re terrific. Such a patriot too.”
And that’s it.
You see, any country that owns its own printing press cannot default. You simply swap bonds for freshly minted cash. The only time a country can default is when the bonds it owes money on are not denominated in its own currency. This is basic stuff.
Now, back to those geniuses buying those CDS’s.
What about the above conversation do they not understand?
I don’t know. But they sure look stupid.
Why do they persist in this pointless exercise?
Traders are paid to churn portfolios. Their bonuses depend on volume, not intelligence. Which is good, because that is in short supply.
In fact, given the last three years I think you could make a fortune shorting Wall Street’s collective IQ.
Then again, how can you be bearish about something already rock bottom?