tag:blogger.com,1999:blog-1527766217650773141.post8981016206845500907..comments2023-07-12T06:12:30.772-07:00Comments on Demand Side Transcript: Soros says CDS's "provide a license to kill"Alanhttp://www.blogger.com/profile/07323700324276425194noreply@blogger.comBlogger1125tag:blogger.com,1999:blog-1527766217650773141.post-31233781588039713202010-05-24T08:55:42.575-07:002010-05-24T08:55:42.575-07:00With many countries in a balance sheet recession t...With many countries in a balance sheet recession the problem is how to maintain aggregate demand? The deficit hawks have stopped many governments actually doing that. Now they are suffering substantial drops in GDP, as can be seen in the Baltic countries who are following IMF instructions.<br /><br />World trade has slumped and with companies actively clearing debts and households doing the same the issue is where will demand come from if no one is buying. Japan had the advantage that the rest of the world was still growing. The US and Europe do not have that advantage now. So the GDP will fall because debts are being cleared and activity is falling. The issue will be more of <br /><br />It will only recover once the debts have been brought down to manageable levels. Though what would have stopped the problem in the first place is fixed rules on end users debts. It could be as simple as a maximum of 3.5 times a single borrowers income for a mortgage. That would stop the housing bubble getting out of alignment with wages and reduce the fall out when there is a recession. Rules banning loans with higher loan to values of 90% or less even would also help eliminate the risks for banks and lending institutions. <br /><br />New rules on other lending, and even vanilla products would mean that banking will be less profitable but safer for the state who has to guarantee the financial system. <br /><br />That fails to answer why do you need Credit Default Swaps? Conventionally if you had an investment that was floundering you had the option of selling it. You may have had to take a loss but the buyer would have the option of holding out for better times. <br /><br />One downside to the CDS is that it distorts outcomes when insolvency is an issue. Bond holders no longer have an obligation to take a haircut when a company collapses if they own a linked CDS. They will get reimbursed in full only if there is a total failure. That means that what could have been restructured before no longer will get past bond holders who will want 100% payback via a CDS rather than take a haircut via a restructuring. That places bondholders against all other stake holders in a bankruptcy. <br /><br />Now because of CDS bond holders do not need to trade out of a position. I could understand buying a CDS where the market is very small and illiquid and you do not have an option to sell your holdings but why are government bonds covered by CDS? These are possibly the most liquid of all financial investments. With governments acting as the lender of last resort and backstop to a crisis, it is akin to taking insurance out that an insurer will fail. We have seen how they pervert problems in a company but what if they did the same to a country like Greece or even the US? Maybe they should be banned?David Lazarusnoreply@blogger.com