The Ultimate Moral Hazard Trade

Nice article by Charles P. Wallace in the current Fortune about moral hazard in derivatives, involving European banks.

European banks have written credit default swaps on their host government's bonds. It looks like American banks are counterparties to a significant degree: "Overall, U.S. banks may hold two-thirds of the total euro-debt CDS outstanding," according to the article. The U.S. positions are probably largely hedges, but still, even hedged exposure can be devastating, if your counterparty fails when you were counting on them to offset a loss somewhere else in the portfolio.

"French Bank BNP Paribas has sold $4 billion in protection on French government debt, 12% of the global total," the article continues. "Similarly, Italy's Banca Monte dei Paschi di Siena has sold $3 billion worth of protection on Italian government debt. If Italy, say, defaults on its debt, these banks might not be able to pay their American trading partners. 'It's the ultimate moral-hazard trade,' says Peter Tchir, CEO of hedge fund TF Market Advisors. 'If a country defaults on its debts, these European banks domiciled in the same country will also default on their debts and won't pay out, so why not write the protection now and make lots of money?'"

It's logical for the banks to write these contracts, whether or not they expect to make money on them in the long run. After all, the highly-leveraged banks of Europe will generally not be solvent no matter what they do, if their host countries default on their own debt.

On False Certainty

The best lack all conviction, while the worst
Are full of passionate intensity.

-- William Butler Yeats, "The Second Coming," 1919.

Why go anywhere...

...when you are already there?

Per this CR post, teenage kids today are not as interested in driving cars as my friends and I were in the 1970s. The virtual world seems to be eating up the real world, to some degree. My anecdotal observations match what CR says.

Obviously, the weak economy and restricted licenses, which the post touches on, are part of it...but not all.

The New Normal, and the Para-Normal

Thought-provoking new piece by Bill Gross, of PIMCO.  Download the PDF here.

The multi-decade, debt-financed party is over, or at least, in a very different phase. Obviously the natural tendency from here is deleveraging and deflation, but because of that, central banks are printing a lot of money. So we have two possibilities: deflation caused by the "real" economy, and, at the other end of the bimodal distribution, inflation caused by the response of central bankers (if the medicine works, and the dose is too big, inflation will be the result of the otherwise-deflationary illness).

Keep in mind when you read Mr. Gross that he has a distinct point of view. He runs a bond fund, and tends more than most to see a world of low inflation (i.e., a world not too scary to bondholders). Many would say that he thinks that way because he runs a bond fund. Maybe. But it is also possible that he runs a bond fund because he already thought that way before he started. Doesn't matter too much which, as long as you keep in mind that he has a particular point of view.

On Creativity

I love this clip of the great jazz pianist, Bill Evans. His advice on creativity is about the best I can imagine: deal with reality and essences, not appearances. This applies to serious work in any field, including finance, of course. He was a very special artist and this is a great interview.

Best Economic Chart of the Year

And it's good. From Donald Marron (the younger).

Gloomy but Worthwhile: Kyle Bass Interview

If you want to hear someone make a pretty thoughtful bearish case for Europe, Japan and the U.S., this is worthwhile.