« Janet Tavakoli Warns Of A Gold Super Spike: "Congress must act immediately to abolish credit default swaps on the United States" »
Originally appeared at the Huffington Post >>
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Congress should act immediately to abolish credit default swaps on the United States, because these derivatives will foment distortions in global currencies and gold. Failure to act now will only mean the U.S. will be forced to act after these "financial weapons of mass destruction" levy heavy casualties. These obligations now settle in euros, but the end game is to settle them in gold. This is so ripe for speculative manipulation that you might as well cover the U.S. map with a bull's-eye.
Credit default swaps are not insurance. If you buy fire insurance on your home, you must own the house. If you buy credit protection on the United States, however, you do not need to own U.S. Treasury bonds. If your protection gains value after you buy it -- not because the U.S. defaults, but because of market mood changes -- you can resell that protection and make a profit.
Lower credit risk means a lower price for protection. Zero implies zero risk. The higher the basis points, the higher the implied risk. When U.S. credit default swaps were first introduced, the price of protection was around two basis points. According to Bloomberg, the price for five-year protection was around 38 basis points (per annum) on Friday. But the price in the over-the-counter market -- where this stuff actually trades -- was almost double or around 75 basis points.
Since most traders in U.S. credit default swaps don't think the U.S. will default any time soon, why are they trading U.S. credit default swaps? They are speculating on price movements the way a day trader buys and sells stocks to speculate on stock price movements.
Volume in U.S. credit default swaps is relatively small, but it can explode rapidly, just as volume expanded rapidly for credit default swaps on mortgage debt in 2006 and 2007.
Speculators Want U.S. CDS Payoffs in Gold
Remember AIG? When prices moved against AIG on its credit default swap contracts, AIG owed cash (collateral) to its trading partners. AIG paid billions of dollars and owed billions more when U.S. taxpayers bailed it out in September 2008.
U.S. credit default swaps currently trade in euros. After all, if the U.S. defaults, who will want payment in devalued U.S. dollars? The euro recently weakened relative to the dollar, and market participants are calling for contracts that require payment in gold. If they get their way, speculators on the winning side of a price move will demand collateral paid in gold.
The market can create an unlimited number of these contracts very rapidly. The U.S. wouldn't have to ever default to trigger a major disruption in the gold market. Spreads (or prices) on the credit default swaps could simply move based on "news," and demand for gold would soar.
If this speculation drives up the price of gold, and the available gold supply becomes limited, are you willing to post your children as collateral? I am pushing the point so that we put a stop to this before it is too late.
Global Disaster in the Making
More than a year has passed since former Treasury Secretary Henry Paulson went to Congress in September 2008 to plead for special powers and TARP money to bail out U.S. financial institutions. Yet there has been no meaningful financial reform.*
The European Union has its own challenges. German Chancellor Angela Merkel recently called for limits on credit derivatives on Greece, since the European Union is concerned about misuse of credit derivatives for speculation. Chancellor Merkel did not go far enough.
World leaders shouldn't merely ask for limits on sovereign credit derivatives. They should demand a ban on all sovereign credit default swaps.
*This video explains how cheap money, wide-spread bad (often predatory) lending, phony securities, credit derivatives, and Wall Street banks' massive over-borrowing led to our current financial crisis. Yet there is still no meaningful reform. Explanation of credit derivatives begins at 8:00.
Tuesday, March 9, 2010 at 2:14PM
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Reader Comments (9)
Washington Must Ban U.S. Credit Derivatives as Traders Demand Gold
http://dailybail.com/home/washington-greece-geeks-and-grifts.html
But, Ms. Tavakoli hasn't explained why a CDS rate impacts the sovereign debt issuer. If the government itself is selling the swaps, they could be exposed, but that's not the case presumably. I'm not aware that increasing US CDS rates has driven up the cost of US government borrowing. Greek CDS rates rose dramatically because concerns arose about Greece's ability to service, or roll over their debt, but the swaps did not cause those concerns. The cause was the Greek people and their governments' propensity to spend more than they earned.
Maybe Ms. Tavakoli is suggesting that CDS's are potentially damaging for large financial entities who use them unwisely. That's certainly the case with any form of leverage, but it misses the real issue. The main problem is that we have decided failed institutions, must be bailed out by governments, therefore no risky behavior can be permitted because of risk to society. It's not that difficult to understand the eventual outcome of this process of socialization of risk, but Friedrich Hayek spells it out very eloquently in "The Road to Serfdom".
Anything good for the Taxpayer or the Country see below.
Send your lobbyist and your campaign fund donation to my office and we'll talk it over. May take a few more donations and a year or two but I think we can go forward with this.
Translation - Unless I get some real dough to spread around it will end up in committee and never see the light of day.
i have searched an everything seems to finds its way back to ms Tavakoli. it is a very bold statement, yet appears to have little basis. as for banning CDS i agree, not because of the risk, but if you need "insurance" to lend money, it is plain to see it should not be lent. CDS take away the risk,and have we not had enough of that? risk is important and calculating the risk is equally as important.
It is what could happen, not what will happen. It could happen if we keep going down the road of destroying our currency. She is sounding a warning. If I am wrong, then yes, she needs to be more clear.