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How The Teamsters Beat Goldman Sachs


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Another example of how the market (or certain parts of it) are working entirely counter to the interests of companies, their employees and the countries in which they operate.

http://www.counterpunch.org/andrew01082010.html

Among the causes of the ongoing financial meltdown, many experts cite the Commodity Futures Modernization Act, smuggled through Congress late on a December evening in 2000. The law exempted Credit Default Swaps (CDS) which are essentially bets on the value of securities from all regulation, including state gambling laws. This allowed Wall Street to conclude that any risk could be hedged with a bet. The result, of course, was disaster, with economic consequences that we will be feeling for a very long time.

....

In recent weeks the 30,000 employees of YRC Worldwide, one of the nation’s largest trucking companies, discovered that they had unwittingly been drafted as chips in the casino. The company, built up through a series of misguidedly overpriced takeovers in the years of the credit bubble, had hit a financial wall thanks to the fall off of business in the recession. Unless investors holding the company’s bonds could be persuaded to swap their debt for equity, the company would go bankrupt and its employees thrown out of work.

...

In response, the union made it clear that they were prepared to name names. “We would make it our mission to hold people accountable,” says Gold. Following advice from Greenberger on strategy, Teamster President James Hoffa wrote to relevant Senators, Congressmen, State Attorneys General and regulators detailing how “Certain financial firms, have been or are marketing and/or underwriting a strategy where bonds in YRCW would be bought by investors with the intent of voting against the exchange, thereby triggering a bankruptcy that would pay the investors and possible other financial firms huge profits from the high CDS payments which would be triggered by a YRCW bankruptcy or liquidation. The profit from the YRCW CDSs would far outweigh losses from the failed YRCW bonds.”

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Another example of how the market (or certain parts of it) are working entirely counter to the interests of companies, their employees and the countries in which they operate.

http://www.counterpunch.org/andrew01082010.html

Among the causes of the ongoing financial meltdown, many experts cite the Commodity Futures Modernization Act, smuggled through Congress late on a December evening in 2000. The law exempted Credit Default Swaps (CDS) which are essentially bets on the value of securities from all regulation, including state gambling laws. This allowed Wall Street to conclude that any risk could be hedged with a bet. The result, of course, was disaster, with economic consequences that we will be feeling for a very long time.

....

In recent weeks the 30,000 employees of YRC Worldwide, one of the nation’s largest trucking companies, discovered that they had unwittingly been drafted as chips in the casino. The company, built up through a series of misguidedly overpriced takeovers in the years of the credit bubble, had hit a financial wall thanks to the fall off of business in the recession. Unless investors holding the company’s bonds could be persuaded to swap their debt for equity, the company would go bankrupt and its employees thrown out of work.

...

In response, the union made it clear that they were prepared to name names. “We would make it our mission to hold people accountable,” says Gold. Following advice from Greenberger on strategy, Teamster President James Hoffa wrote to relevant Senators, Congressmen, State Attorneys General and regulators detailing how “Certain financial firms, have been or are marketing and/or underwriting a strategy where bonds in YRCW would be bought by investors with the intent of voting against the exchange, thereby triggering a bankruptcy that would pay the investors and possible other financial firms huge profits from the high CDS payments which would be triggered by a YRCW bankruptcy or liquidation. The profit from the YRCW CDSs would far outweigh losses from the failed YRCW bonds.”

This seems like pee pee. Are we supposed to ban shoert selling because we are not allowed to acknowledge that a company is FUBAR?

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This seems like pee pee. Are we supposed to ban shoert selling because we are not allowed to acknowledge that a company is FUBAR?

This isn't about short selling so much as CDS.

I am not sure it would be legal to take out insurance on your house burning down, and then to actually burn your own house down. This is the exact analogy in this case.

I take an interest in a companies debt, i then insure myself for 5 times that debt for the event of that company failing. Company gets into a bit of an issue that could normally be renegotiated, but I decide to bring the company down so I can collect on my bets.

Frankly the insurer should be able to Foxtrot Oscar to the investor with the claim on the CDS. Its AIG all over again and why and how Goldman Sachs got secretly bailed out.

Goldman will be investigated and closed down at some point not too far away.

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This isn't about short selling so much as CDS.

I am not sure it would be legal to take out insurance on your house burning down, and then to actually burn your own house down. This is the exact analogy in this case.

I take an interest in a companies debt, i then insure myself for 5 times that debt for the event of that company failing. Company gets into a bit of an issue that could normally be renegotiated, but I decide to bring the company down so I can collect on my bets.

Frankly the insurer should be able to Foxtrot Oscar to the investor with the claim on the CDS. Its AIG all over again and why and how Goldman Sachs got secretly bailed out.

Goldman will be investigated and closed down at some point not too far away.

"This isn't about short selling so much as CDS. "

Why differentiate

"I take an interest in a companies debt, i then insure myself for 5 times that debt for the event of that company failing. Company gets into a bit of an issue that could normally be renegotiated, but I decide to bring the company down so I can collect on my bets."

And what about all the other players in the market? back to my point again. Are you supposed to stop a company going under even though it deserves to?

"Its AIG all over again"

It is completely different.

"I take an interest in a companies debt, i then insure myself for 5 times that debt for the event of that company failing. "

Why bother taking an interest in the first place and not just buy CDS protection?

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"This isn't about short selling so much as CDS. "

"I take an interest in a companies debt, i then insure myself for 5 times that debt for the event of that company failing. "

Why bother taking an interest in the first place and not just buy CDS protection?

You take an interest so you can bring the company down - then collect on the insurance.

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snip

Why bother taking an interest in the first place and not just buy CDS protection?

who would insure a company thats LIKELY to go bust?

an insurer would only provide insurance for an event that was NOT evident at the time the insurance was taken.

likewise, why would another banker take on a CDS from another banker?

The idea of CDS was to make a borrower more highly rated for a given investor, say a pension fund...the fund may have a policy to lend only to AAA rated borrowers....to protect, rightly, its pensioners.

if an entity didnt have AAA rating, it couldnt borrow.

a banker WITH an AAA rating could look at the borrower, and decide, that for x %, he could take the risk of the default...he would have priced the risk based on the likelyhood of default.

he therefore takes his premium and the loan is now guaranteed to the pension fund by an AAA rated firm, so the loan is now made to the lower rated entity but with a AAA rating.

this is good.

it IS insurance....but they made laws to say its NOT insurance.

Now you can buy CDS even without having an interest...thats where it all goes wrong.

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The difference between CDS's and conventional insurance is that one does not need an interest in the asset being insured. You could go to an insurance company and buy a policy against your house burning down, you could not buy such a policy on someone else's house. If your house were to burn, you would only recover your loss, yet if you could insure someone else's house, you would profit. This would give you a hue incentive to seek to burn their house down.

You can buy CDS's against, say, the UK government defaulting on its bonds, or any other large issuer, without owning any guilts. Thus it is not insurance but speculation. You load up on a companies CDS's then seek its demise. The players are not so reckless as to burn down that companies factories. They are however able to buy its shares and vote it into oblivion. The losses made by the shares collapse being lower than the CDS pay out.

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This isn't about short selling so much as CDS.

I am not sure it would be legal to take out insurance on your house burning down, and then to actually burn your own house down. This is the exact analogy in this case.

I take an interest in a companies debt, i then insure myself for 5 times that debt for the event of that company failing. Company gets into a bit of an issue that could normally be renegotiated, but I decide to bring the company down so I can collect on my bets.

Frankly the insurer should be able to Foxtrot Oscar to the investor with the claim on the CDS. Its AIG all over again and why and how Goldman Sachs got secretly bailed out.

Goldman will be investigated and closed down at some point not too far away.

Who sold the CDS insurance?

Surely whoever sold it should be buying the same debt, and voting for an equity swap to prevent a bankruptcy. Actually to prevent two bankruptcies if you include their own.

Makes you wonder who would be daft enough to sell CDS insurance, given that it seems possible to burn your house down and claim ten times the value of the house. I would love to know who has been doing the underwriting?

Come to think of it, most of the underwriting is probably written against our pension funds, and the taxpayer.

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I wonder if the James Hoffa mentioned in the OP is any relation to the famous Teamsters Union boss of the 1970s 'Jimmy Hoffa'. He was allegedly in bed with the Mafia and was apparantly 'dissapeared' by them in 1975. I remember talking to some US ex colleagues from Detroit about him a few years back. They joked that he was interred somewhere in the concrete of a motorway flyover nicknamed 'the Jimmy Hoffa Memorial Freeway'! LINK

Edit to add; "Jimmy Hoffa Memorial Freeway" was a Googlewhack when I tried it! It won't be anymore though, as I presume HPC is googled?

Edited by newp
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Who sold the CDS insurance?

Surely whoever sold it should be buying the same debt, and voting for an equity swap to prevent a bankruptcy. Actually to prevent two bankruptcies if you include their own.

Makes you wonder who would be daft enough to sell CDS insurance, given that it seems possible to burn your house down and claim ten times the value of the house. I would love to know who has been doing the underwriting?

Come to think of it, most of the underwriting is probably written against our pension funds, and the taxpayer.

When CDS were created and first traded, they were physically settled. That is, to collect on the CDS payout, you had to have the underlying bonds the protection was written on to exchange them for the cash. Then 6-7 years into the market ISDA changed the protocols to cash settlement to expand the market. Previously, the market could only be as big as the outstanding bonds, you could only insure your house that physically existed at that point to borrow the analogy. By moving to cash, you didn't have to own the bond to either buy or sell protection, now you could leverage your bet on the creditworthiness of a company manyfold. This is where it went wrong. Before, it didn't make sense to buy the bonds and CDS protection at the same time, vote to reject a debt for equity swap and bankrupt the company. You would lose money, for each bond you held you would be made whole but you would have paid out the cost of protection.

The CDS volume went parabolic after this change as you would expect. Goldmans and the other banks gamed this new environment to their advantage, also not unexpected given they invented CDS to circumvent regulatory capital requirements and allow them to leverage their bets. We have police and laws because we know if people left to their own devices will take advantage of the weaker and uninformed. The victims thought the regulators had any dubious practices covered, instead they were both oblivious in some of its quarters and enthusiastic supporters in others.

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who would insure a company thats LIKELY to go bust?

an insurer would only provide insurance for an event that was NOT evident at the time the insurance was taken.

likewise, why would another banker take on a CDS from another banker?

The idea of CDS was to make a borrower more highly rated for a given investor, say a pension fund...the fund may have a policy to lend only to AAA rated borrowers....to protect, rightly, its pensioners.

if an entity didnt have AAA rating, it couldnt borrow.

a banker WITH an AAA rating could look at the borrower, and decide, that for x %, he could take the risk of the default...he would have priced the risk based on the likelyhood of default.

he therefore takes his premium and the loan is now guaranteed to the pension fund by an AAA rated firm, so the loan is now made to the lower rated entity but with a AAA rating.

this is good.

it IS insurance....but they made laws to say its NOT insurance.

Now you can buy CDS even without having an interest...thats where it all goes wrong.

Correct except for the bit I bolded. That is also true but is a consequence, rather than the reason. CDS were invented by banks to circumvent capital adequacy ratio rules. A bank makes either a direct loan or buys a bond in company A. This is considered an asset on balance sheet, risk unadjusted when first made. It is also capital tied up and not in reserve. Depending on the type of loan and who the borrower is, it has a proportional weighting when considered as capital than can be liquidated to meet a liability. A bank has to maintain a minimum capital reserve as a ratio of it's assets which are mainly loans. A CDS allowed the bank to say to the regulator, look this bond I have in Ford, I can buy CDS protection on that bond so if Ford defaults I can only lose the tiny CDS premium I paid (relative to size of the bond) max so that shouldn't count as at risk capital and I now should be able to use that money to make another loan. Regulator goes duh yeah ok, that sounds good and runaway leverage and risk taking by banks is born. Because of cash settlement, risk is not symmetric, counterparty risk becomes THE risk and hence the credit crunch when it blows up. That some investors perceived the risk on a bond as safer because they could buy CDS protection on it and therefore bought lower rated debt than they would have was another consequence of this regulatory failure, rather than the driver behind their invention which actually was more sinister in its original intention. ;)

Edited by moneyscam
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Surely CDS are a valid defence against nasty communist unions who try to blackmail you?

Union: "Give us free money by taking a haircut on your bond holdings. Otherwise we'll destroy the Company and you will get nothing"

CDS Holder: "No. Work harder and pay back what you borrowed."

vs.

Union: "Give us free money by taking a haircut on your bond holdings. Otherwise we'll destroy the Company and you will get nothing"

Unprotected Bondholder: "You win, here's 10 million dollars!

Union: "ha ha ha. We'll keep half for ludicrous salaries and wasteful industrial practices. The other half we'll spend on helping elect a Socialist government opress you."

I prefer option one.

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who would insure a company thats LIKELY to go bust?

an insurer would only provide insurance for an event that was NOT evident at the time the insurance was taken.

likewise, why would another banker take on a CDS from another banker?

The idea of CDS was to make a borrower more highly rated for a given investor, say a pension fund...the fund may have a policy to lend only to AAA rated borrowers....to protect, rightly, its pensioners.

if an entity didnt have AAA rating, it couldnt borrow.

a banker WITH an AAA rating could look at the borrower, and decide, that for x %, he could take the risk of the default...he would have priced the risk based on the likelyhood of default.

he therefore takes his premium and the loan is now guaranteed to the pension fund by an AAA rated firm, so the loan is now made to the lower rated entity but with a AAA rating.

this is good.

it IS insurance....but they made laws to say its NOT insurance.

Now you can buy CDS even without having an interest...thats where it all goes wrong.

"who would insure a company thats LIKELY to go bust?"

Who would sello CDS protection on a company that is likely to go bust for a premium that doesn't reflect that risk?

"it IS insurance"

This is opinion, not fact. Unless you are a derivatives lawyer and haven't told us, you cheeky bugger!

"The idea of CDS was to make a borrower more highly rated for a given investor, say a pension fund...the fund may have a policy to lend only to AAA rated borrowers....to protect, rightly, its pensioners."

Who told you that? Are you confusing with CDO?

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"who would insure a company thats LIKELY to go bust?"

Who would sello CDS protection on a company that is likely to go bust for a premium that doesn't reflect that risk?

snip

I agree...how then, is it possible, like bankers have done, to pass the risk on by selling chunks on? anyone later in the chain MUST charge less than the risk premium, otherwise, passing it on makes no sense.

according to past posts, all this balances out...AIG proves it doesnt, and cannot.

and as for the lawyers...why does it need a lawyer to discern what IS insurance and what is not?....the golden rule in court is one of reasonableness...what would the man on the detroit omnibus think had occured?

an insurance is a bet on a possible outcome...a CDS is a bet on a possible outcome. whats the difference?

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Correct except for the bit I bolded. That is also true but is a consequence, rather than the reason. CDS were invented by banks to circumvent capital adequacy ratio rules. A bank makes either a direct loan or buys a bond in company A. This is considered an asset on balance sheet, risk unadjusted when first made. It is also capital tied up and not in reserve. Depending on the type of loan and who the borrower is, it has a proportional weighting when considered as capital than can be liquidated to meet a liability. A bank has to maintain a minimum capital reserve as a ratio of it's assets which are mainly loans. A CDS allowed the bank to say to the regulator, look this bond I have in Ford, I can buy CDS protection on that bond so if Ford defaults I can only lose the tiny CDS premium I paid (relative to size of the bond) max so that shouldn't count as at risk capital and I now should be able to use that money to make another loan. Regulator goes duh yeah ok, that sounds good and runaway leverage and risk taking by banks is born. Because of cash settlement, risk is not symmetric, counterparty risk becomes THE risk and hence the credit crunch when it blows up. That some investors perceived the risk on a bond as safer because they could buy CDS protection on it and therefore bought lower rated debt than they would have was another consequence of this regulatory failure, rather than the driver behind their invention which actually was more sinister in its original intention. ;)

much obliged for the clarification...I was, however, trying to paint a broad brush overview...your detail has started to fill it out nicely.

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You can't insure someone else's house, but you can get a CDS on someone else's company.

you can certainly buy insurance on the life of someone else. this is good for tax planning i gather.

Edited by Bloo Loo
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I agree...how then, is it possible, like bankers have done, to pass the risk on by selling chunks on? anyone later in the chain MUST charge less than the risk premium, otherwise, passing it on makes no sense.

according to past posts, all this balances out...AIG proves it doesnt, and cannot.

and as for the lawyers...why does it need a lawyer to discern what IS insurance and what is not?....the golden rule in court is one of reasonableness...what would the man on the detroit omnibus think had occured?

an insurance is a bet on a possible outcome...a CDS is a bet on a possible outcome. whats the difference?

"I agree...how then, is it possible, like bankers have done, to pass the risk on by selling chunks on? anyone later in the chain MUST charge less than the risk premium, otherwise, passing it on makes no sense."

My point was in reference to the particular article. It makes no sense. Are you sure you are not getting confused with CDOs here - the market for CDS is reasonably liquid (in most names), so you would buy/sell protection at the market rate

"according to past posts, all this balances out...AIG proves it doesnt, and cannot."

Eh? We are talking about something completely different - we've done that one to death

"and as for the lawyers...why does it need a lawyer to discern what IS insurance and what is not?....the golden rule in court is one of reasonableness...what would the man on the detroit omnibus think had occured?"

Because I personally don't know enough about the legal side of it. I'm happy to listen to someone that has both (relevant) derivative and legal experience

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"I agree...how then, is it possible, like bankers have done, to pass the risk on by selling chunks on? anyone later in the chain MUST charge less than the risk premium, otherwise, passing it on makes no sense."

My point was in reference to the particular article. It makes no sense. Are you sure you are not getting confused with CDOs here - the market for CDS is reasonably liquid (in most names), so you would buy/sell protection at the market rate

"according to past posts, all this balances out...AIG proves it doesnt, and cannot."

Eh? We are talking about something completely different - we've done that one to death

"and as for the lawyers...why does it need a lawyer to discern what IS insurance and what is not?....the golden rule in court is one of reasonableness...what would the man on the detroit omnibus think had occured?"

Because I personally don't know enough about the legal side of it. I'm happy to listen to someone that has both (relevant) derivative and legal experience

I seem to recall YOU saying CDS is infallible...it ALL cancels out...AIG just didnt get it...

so, to balance out, potential losses need to be laid off...so you sell a CDS against BlooLoo Ltd defaulting on a loan of 1bn from Noel Bank.

you charge your rate say 1m.

you are on the hook for 999m.

are you saying you dont lay off some of this risk?

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Who sold the CDS insurance?

Surely whoever sold it should be buying the same debt, and voting for an equity swap to prevent a bankruptcy. Actually to prevent two bankruptcies if you include their own.

Makes you wonder who would be daft enough to sell CDS insurance, given that it seems possible to burn your house down and claim ten times the value of the house. I would love to know who has been doing the underwriting?

Come to think of it, most of the underwriting is probably written against our pension funds, and the taxpayer.

Its the old collecting pennies in front of a steam roller. Most of the time you make a good and steady income selling CDS, but once in a while you get your heal stuck in a drain and the roller gets you.

Funnily enough this is whay AIG did. AIG was bailout out in a secretive fashion in order to save Goldman Sachs. The treasury should have let AIG go down and then watched as Goldman burned.

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Its the old collecting pennies in front of a steam roller. Most of the time you make a good and steady income selling CDS, but once in a while you get your heal stuck in a drain and the roller gets you.

Funnily enough this is whay AIG did. AIG was bailout out in a secretive fashion in order to save Goldman Sachs. The treasury should have let AIG go down and then watched as Goldman burned.

PLEASE STOP MENTIONING AIG WHEN WE ARE TALKING ABOUT SOMETHING COMPLETELY DIFFERENT

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I seem to recall YOU saying CDS is infallible...it ALL cancels out...AIG just didnt get it...

so, to balance out, potential losses need to be laid off...so you sell a CDS against BlooLoo Ltd defaulting on a loan of 1bn from Noel Bank.

you charge your rate say 1m.

you are on the hook for 999m.

are you saying you dont lay off some of this risk?

Why don't you arrange an HPC London derivatives drinks and we can debate this at length?

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I wonder if the James Hoffa mentioned in the OP is any relation to the famous Teamsters Union boss of the 1970s 'Jimmy Hoffa'.

He's the only son of Jimmy Hoffa, if you can credit Wikipedia. He has degrees in economics and law and a sister who is a judge.

An outstanding example of that fine Yankee tradition of hereditary positions. Like the Kennedy and Bush clans, and half of Washington and Hollywood and Manhattan and... oh, pretty much everyplace where there's serious money and influence.

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Why don't you arrange an HPC London derivatives drinks and we can debate this at length?

And in further news on London Today . . . . .

The riot squad had to be called out to a meeting of the HPC London derivatives drinks, when a serious disturbance broke out amongst attendees over "how much is the actual cost of 'free' bar peanuts"?

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