When Greece Defaults, the Credit Default Swap Dominoes Fall (February 4, 2012)
A default by any other name is still a default. When Greece defaults, the inter-connected chains of credit default swaps will fall like dominoes.
For your Superbowl half-time reading, here is a brief summary of the situation in Europe:
1. Greece is poised to default, the end-game everyone anticipated in 2011. It is not a matter of if but when.
2. That default will trigger credit-default swap contracts, derivatives known as CDS that protect the owner from events such as default.
3. This will implode the shadow-banking system and the visible banking system, as those who sold the CDS (financial institutions) do not have enough cash or assets to pay the owners of the CDS.
4. The general idea is that sovereign default is very unlikely, so you can sell protection (CDS) against that possibility for a low premium, and cover that bet by buying your own protection from another player.
5. If that player (counterparty) can't pay you off, then you can't meet your obligations on the CDS you originated and sold.
6. So the failure of one counterparty can trigger a systemic failure akin to a row of dominoes being toppled by the fall of one domino.
7. To avoid such a CDS-triggered collapse, the European Union and its proxy agencies (European Central Bank, etc.) are attempting to call a default by Greece something other than "default."
8. This will theoretically keep the first domino--a credit-default swap--from falling. In other words, if we call a default by some other name, then it isn't a default.
9. Those absorbing the losses caused by a Greek default (and let's stipulate that this references owners of Greek debt who bought CDS as insurance, not speculators who leveraged CDS at 30X the actual bond value) will want to cash in their insurance, i.e. the CDS they own against a Greek default. They have every incentive to demand a default be recognized as a default. If they accept the official plan to avoid calling a default a default, then all the losses will be theirs and none will fall to the counterparties who sold them the CDS.
10. How is this fair?
11. The official response of avoiding default is focused on self-preservation, not fairness, justice or the rule of law.
12. The system can be likened to a pool of $100 bets leveraged off $5 in cash. If every bet is covered perfectly, then it's somewhat like $95 in bets being paid by passing $5 around--much like the famous email that depicts all debts in a small town being paid by the same $5.
13. In the real world, somebody's bets and insurance will not be perfect and their obligations will exceed their cash on hand. In other words, they will end up with $3 and owe $5. They will default and the dominoes will start falling as everyone down the line doesn't receive their $5 counterparty payoff.
14. Empires tend to fall when the interests of their Elites diverge. We are at such a point in the global financial Empire.
15. "Extend and pretend" has "worked" for almost 2 years. If Greece defaults and it is recognized by even one player as a default, then the system will quickly unravel and cash/dollars will be king until the deleveraging runs its course.
If this recession strikes you as different from previous downturns, you might
be interested in my new book
An Unconventional Guide to Investing in Troubled Times (print edition)
Kindle ebook format. You can read the ebook on any
computer, smart phone, iPad, etc. Click here for links to Kindle apps and Chapter One.
The solution in one word: Localism.
Of Two Minds Kindle edition: Of Two Minds blog-Kindle
"This guy is THE leading visionary on reality.
He routinely discusses things which no one else has talked about, yet,
turn out to be quite relevant months later."
NOTE: contributions are acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency.
Or send him coins, stamps or quatloos via mail--please request P.O. Box address.
Subscribers ($5/mo) and contributors of $50 or more this year will receive a weekly email of exclusive (though not necessarily coherent) musings and amusings, and an offer of a small token of my appreciation: a signed copy of a novel or Survival+ (either work admirably as doorstops).
At readers' request, there is also a $10/month option.
The "unsubscribe" link is for when you find the usual drivel here insufferable.
All content, HTML coding, format design, design elements and images copyright © 2011 Charles Hugh Smith, All rights reserved in all media, unless otherwise credited or noted.
I would be honored if you linked this essay to your site, or printed a copy for your own use.
|Survival+||blog fiction/novels articles my hidden history books/films what's for dinner||home email me|