China's Central Bank Eliminates Margin T…

19-01-2017 Hits:182 BoomBustBlog Reggie Middleton

China's Central Bank Eliminates Margin Trading of Bitcoin

There have been rumors that the Chinese Central Bank (PBoC - People's Bank of China) would limit or eliminate margin trading in Bitcoin. It is now official, sort of...

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Is Donald Trump Truly Successful or Born…

18-01-2017 Hits:320 BoomBustBlog Reggie Middleton

Is Donald Trump Truly Successful or Born With A Silver Spoon? An Analysis

In social media and mainstream media, I often hear Donald Trump quoted (by himself, and others) as an extremely successful, self-made man. As an entrepreneur for nearly all of my...

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As I Promised, EU Is Colliding Into Prac…

17-01-2017 Hits:759 BoomBustBlog Reggie Middleton

As I Promised, EU Is Colliding Into Practical Confines of NIRP, Bank Hemorrhaging Up Next

Nearly a year ago, I warned subscribers of consequences stemming from the ECB's negative interest rate program. Here's an exceprt from our resarch report titled European Banking Macro Issues for March...

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Is Bitcoin Too Risky? Whenever the Bitco…

12-01-2017 Hits:1378 BoomBustBlog Reggie Middleton

Is Bitcoin Too Risky? Whenever the Bitcoin is Mentioned in Financial Pop Media, Ignorance Ensues

I hate to be the one to break bad news to you, but most of the pop media/mainstream media financial pundits that I hear and see opine on bitcoin have...

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What Happens When Rates Rise While the S…

10-01-2017 Hits:786 BoomBustBlog Reggie Middleton

What Happens When Rates Rise While the S&P 500 Relies on Cheap Credit To Boost EPS?

So, the stock market, bond market and real estate markets are all at all-time highs. Everything is Awesome! You know better than that. You see, when the bond market wakes...

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Debt Encumbered Oil, Sovereign Soil, Toi…

10-01-2017 Hits:602 BoomBustBlog Reggie Middleton

Debt Encumbered Oil, Sovereign Soil, Toil & Trouble: Can't You Hear Seems Cracking in the OPEC Empire?

@WSJ reports Libya Ramping Up Oil Production, Threatening OPEC (supposed) Plans to lift global oil place by artificially limiting supply. This would be in violation of federal antii-trust laws in the...

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Ten Years Since BoomBustBlog Was 1st Pub…

09-01-2017 Hits:918 BoomBustBlog Reggie Middleton

Ten Years Since BoomBustBlog Was 1st Published & That Initial Research Still Relevant Today

We have looked into insurance companies' performance last month in regards to our bearish real estate thesis. A small comederie of companies are suffering losses and/or declining profits as we've exected....

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The Macro Truth About The Big Bitcoin Po…

07-01-2017 Hits:1087 BoomBustBlog Reggie Middleton

Bitcoin has dropped precipitously, and as is usual, we have the cacophony of instant digital currency pundits cackling about as if they had a clue. This is the inaugural post...

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To Bust or Not To Bust: Are We In A Real…

04-01-2017 Hits:774 BoomBustBlog Reggie Middleton

To Bust or Not To Bust: Are We In A Real Estate Bubble?

Banks are showing thin NIM, yet many of the big banks are able to boast stable if not slightly improving credit metrics. This doesn’t make sense considering the explosive growth...

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What Happens To Real Asset Lending Banks…

03-01-2017 Hits:622 BoomBustBlog Reggie Middleton

What Happens To Real Asset Lending Banks When the Real Funding Rate Appears? We're About to Find Out

During the financial crisis of 2008, money market funds who subjectively agreed to hold their NAV (net asset value) unit prices at $1 “broke the buck”. That is, the unit...

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Stress Test on Banks’ Earnings Facing th…

30-06-2014 Hits:44743 BoomBustBlog Reggie Middleton

Stress Test on Banks’ Earnings Facing the Veritaseum UltraCoin Value Transaction Platform

My last post on the topic of disintermediation during a paradigm shift was Wall Street Should Be First To Invest In Reggie Middleton's UltraCoin, Much Of It Won't Be Here In...

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Introducing the "Unbreakable Promis…

09-06-2014 Hits:39539 BoomBustBlog Reggie Middleton

Introducing the "Unbreakable Promise" As a Method Increasing Efficiencies and Decreasing Risk

Continuing on the margin compression theme originally laid out in Margin Compression Is Coming in the Payment Processing Space As $100 Million Pours Into Startups, I illustrate mathematically how the bit...

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I've been preaching about the risks the CDS market poses to the financial system for some time now. Since the monolines faux business model has been laid bare, we will start seeing some real action in this arena. For those who don't want to take my anecdotal quips as gospel, I actual go in depth through Reggie Middleton on the Asset Securitization Crisis Series - The Next Shoe to Drop: Credit Default Swaps (CDS) and Counterparty Risk - Beware what lies beneath!. A worth read for those not familiar with the Credit Default Sucker's market.

Now, to the point of the post. UBS is in a lot of hot water these days. Despite being eyeballs deep in rapidly disintegrating, highly leveraged trash assets they are also often in hot water. Reference the financial times:

In depth: UBS - Apr-01

UBS faces civil charges over securities sales - Jun-26

 
 

The growth in CDS market in the last few years has outstripped that of the US equity and bond markets

The credit derivatives market has grown at a remarkable pace as reflected from the tremendous increase in total notional amount outstanding over the last few years. The total notional amount of credit derivatives as of June 2007 increased to US$42.6 trillion, an increase of 109% over the US$20.4 trillion reported in June 2006. This has been driven by both the rise in single name CDS and the multi name CDS instruments. The significant rise in the multi name CDS (traded indices) has notably surpassed the growth in single name CDS. Single name CDS’ total notional amount outstanding has increased from US$7.31 trillion in June 2005 to US$24.2 trillion in June 2007 while the multi name CDS has grown from US$2.9 trillion in June 2005 to US$18.3 trillion in June 2007.

 

image002.jpg 

Source: Thomson Research

 

The CDS market has outstripped the growth in every other US market reaching US$45 trillion in notional amount outstanding volume. According to ISDA, the notional amount outstanding of credit derivatives grew 32% in the first six months of 2007 to $45.46 trillion from $34.42 trillion. The annual growth rate for credit derivatives is 75% from $26.0 trillion at mid-year 2006 surpassing the US stock markets at US$21.9 trillion, the mortgage security market at US$7.1 trillion and the US treasuries market at US$4.4 trillion. The ability to bet on the financial health of the company directly in the CDS market (go long or short by buying or selling insurance protection) and the rise in speculative interest saw the rise in the CDS volumes.

 

Creation of colossal US$45 trillion CDS market may unfold into trouble larger than subprime crisis

The creation of the massive US$45 trillion CDS market in the last few years, which faces some unique problems, can unfold into a massive bubble collapse that would easily dwarf that of the subprime crisis. The CDS are supposed to cover the losses of banks and bondholders in the event of default by companies. However, the CDS market has evolved from being primarily a means to hedge credit risk to a speculative and trading platform for a large number of banks and hedge funds. If the corporate defaults surge in the coming quarters (as Reggie Middleton, LLC expects them to) or there is default in payments of coupon and principal amounts, this could lead to a crisis far worse than what we have seen so far in the current “asset securitization crisis” and quite possibly in the recent history of the financial system. The high yield default rate has increased significantly (125%) in the last few quarters from 0.4% in 1Q 07 to almost 0.9% in 1Q 08. In addition, the monolines which are under considerable stress and play the role of both counterparty as well as the reference entity in the CDS market could spell major trouble for the market participants.

 

Spectacular growth of credit risk transfer instruments 

  image003.jpg

1 In trillions of US dollar. 2 Of BIS reporting banks; cross-border and local foreign currency claims. 3 Annualised. 4 Sum of cash tranche sizes by pricing date; includes only cash and hybrid structures. Hybrid portfolios consisting mainly of structured finance products different from cash CDOs are excluded. 5 Covers about 80% of index trade volume, according to CreditFlux Data+.

Source: IMF, CreditFlux Data, ISDA ; National Data; BIS Calculations

One of my recent favorites illustrates how UBS CDS foibles are starting to unfold. Excerpted from FT.com:

UBS asked Paramax Capital International to sell it protection on $1.3bn of the most highly rated slices of a CDO made up of subprime residential mortgages that the UBS investment bank underwrote. In general, by hedging the risk fully through the credit derivatives market, banks can remove such exposures from their balance sheets and do not have to set aside capital...

Paramax claims that, from the beginning, the UBS hedge was cosmetic. In May 2007, when the original agreement was signed, the terms were a fraction of the market rate. Why agree to such thin terms? You put yourself at risk, no? Also, Paramax had only $200m under management and its agreements with its own investors limited it to commit no more than $40m to any single deal. Thus, it could never compensate UBS fully for any meaningful loss in value of the $1.3bn UBS was trying to insure, it claims. So, Paramax must be in the monoline insurance biz Sealed. I know, that was a low blow...

 

Paramax also claims that UBS told it that the bank would employ “subjective valuation methodologies” that meant it would not record any loss in value that could trigger calls for additional margin from Paramax... You set yourself up for this one fellas! Paramax also claims that UBS promised that if the lender needed a “real” hedge, it would tear up the agreement... I can't wait for this to be defined in court and made precedent. Let's repeat that again, " A "real" hedge"! I'll paraphase a huge part of the article for you. The market turned to shit, and the banks started to pretent that they had "real hedges" in place.

Now UBS is taking Paramax to court, seeking to compel it to pay up as the securities drop in value, alleging breach of contract. Paramax in turn is charging UBS with negligent misrepresentation. UBS said the bank was confident in the merits of its case. A lawyer for Paramax said its allegations were supported by both written and oral statements. The combination of subjective valuation and hedges that may not be real because counterparties cannot or will not pay goes way beyond UBS and Paramax. Oh boy, does it. Monolines, investment banks, commericial and mortgage banks, homebuilders mortage finance arms, leasing and consumer finance companies. I can really go on. Remember these posts, ya'll:

 

Remember, these CDS were used as hedges, and often support other positions. For instance, I buy a CDO, hedge it with Paramax (instead of a "real hedge"), then take the freed up (should have been reserved) capital from the hedge and do another nonsense leveraged deal with it using less than optimal capital because it was "hedged"with a Credit Default Sucker" (sorry about that, I meant swap). I then keep going on until I have maxed out my leverage, which is only indicated at 20 to 35x on my 10Q, but the actual leverage is much more when you consider my use of Credit Default Suckers! Again, reference Banks, Brokers, & Bullsh1+ part 2 for how quickly this can build up. 

For example, in one case the seller of credit protection discovered that the final agreement on insuring a portfolio of collateralised debt obligations had never been signed, either by it or a French bank which in this case was buying protection. Now, with the meltdown in that market, the seller has returned all the premium payments to the buyer and torn up the agreement, saying that because it was never signed, it has no legal obligation to pay up...

No need to fret, Paulson and a bevvy - I mean a plethora - of financial CEOs state that the worst is behind us...  If you want to see leverage, risk and overvaluation - that is actually lauded and applauded by both the press and Wall Street, stay tuned for my next post on the Golden Boys...