| Fitch says 50% Haircuts would Constitute Default; No Official Ruling from ISDA Yet; Wrong Decision Could Kill CDS Market; How Will Setup be Resolved? Posted: 28 Oct 2011 09:34 AM PDT The yield on 10-year Italian bonds is back over 6% following a weaker than expected bond auction. Who wants to load up on Spanish, Portuguese, or Italian bonds if they cannot hedge with credit default swaps? No ISDA Ruling YetEveryone is acting as if the International Swaps and Derivatives Association (ISDA) has issued a ruling on on whether 50% haircuts forced at gunpoint are "voluntary", but there is no official ruling yet, only hints. Please consider Voluntary or forced? The important word games of debt defaultWhen is a default not a default?
Investors struggled with that question Thursday after European officials outlined plans that would see owners of Greek bonds take a 50 per cent loss on the face value of their holdings.
The International Swaps and Derivatives Association, an industry group that oversees the CDS market, says the Greek deal probably won't trigger default clauses in CDS contracts because the 50 per cent "haircut" is voluntary.
That view is starting to roil the $25-trillion market for credit default swaps because it calls into question the fundamental reason for purchasing insurance against losses on bonds. If investors can no longer count on being able to hedge against the possibility of a loss, they may start demanding higher yields as compensation for increased risk.
"I would think [such a ruling by the ISDA] would be quite a negative for the market," said Lawrence Chin, director of research at the Cundill division of Mackenzie Financial. "You could get hit on the debt, but you don't get the insurance [payout]."
"Based on what we know it appears from preliminary news reports that the bond restructuring is voluntary and not binding on all bondholders," the ISDA said on its website Thursday. "As such, it does not appear to be likely that the restructuring will trigger payments under existing CDS contracts."
But things can be confusing, even at the ISDA. In a version of the Q&A dated July 8, the ISDA asks, "Does it matter whether the event is 'voluntary' or 'mandatory' "? Answer: "The CDS Definitions do not refer to a distinction between voluntary and mandatory events, though it does come up indirectly."
Then there's the matter of just how voluntary the latest agreement really is. Banks may have agreed to take a 50 per cent loss on their Greek debt holdings to avoid an even worse deal.
David Geen, general counsel for the ISDA, acknowledged in an interview on Bloomberg Television that there was likely some "coercion" of banks by European officials. "There's been a lot of arm twisting," he said, but asserted that while the deal may have been "borderline." it still fell short of being a default.
The Determinations Committee of the ISDA will make a final decision on whether the Greek deal triggers CDS payouts "when the proposal is formally signed, and if a market participant requests a ruling from the DC," the association said in its Q&A.
"If you can't hedge your position, you shrink your position," said Steven Tananbaum, managing partner and chief investment officer at GoldenTree Asset Management. Fitch says 50% Haircuts would Constitute DefaultJust to muddy the waters further, Fitch says acceptance of 50% haircuts on Greek debt would constitute default. Bloomberg reports ... If it's accepted, "the 50 percent nominal haircut on the proposed bond exchange would be viewed by the agency as a default event under its Distressed Debt Exchange criteria," Fitch said in a statement today. The accord is " a necessary step to put the Greek sovereign's public finances on a more sustainable footing."
This week's rise in the euro "shows expectations were very low for what would come out of the meeting," said Geoff Kendrick, head of European currency strategy at Nomura Holdings Inc. in London. "I am relatively skeptical about how long this will last because I think it was just another plan for a plan." Kendrick expects the euro to weaken to $1.30 by year-end.
Italian Prime Minister Silvio Berlusconi conducted the first test of investor enthusiasm for Europe's debt since the summit's plan was announced, selling bonds today at euro-era record borrowing costs.
Italian Sale
The Treasury in Rome sold 7.93 billion euros, less than the maximum 8.5 billion-euro target, of four different bonds today. The yield on Italy's benchmark 10-year bond rose 11 basis points, or 0.11 percentage point, to 5.98 percent. Fitch vs. ISDAWe come to the very real possibility that Fitch rules one way and the ISDA another. Voluntary "No Default" Decision Could Kill CDS MarketThe Wall Street Journal reports Default Insurance Market Takes Hit Under the broad deal reached this week to stem the euro-zone's financial crisis, holders of credit-default swaps on Greek government bonds aren't expected to receive any payout, even though a preliminary agreement between financial institutions and European policy makers would recognize just half the face value of some Greek debt.
The decision not to trigger the swaps raises questions about the value of the insurance-like contracts and exposes the limitations of the hedging strategies that banks and investors have come to rely on. The swaps are widely used by bondholders and major banks to defuse a wide range of risks, and by traders to bet on market trends. If the swaps don't pay out when bonds default, banks and funds that bought the insurance may face losses they thought they had hedged.
"You need the real money guys, the banks, to view [credit-default swaps] as a viable contract for CDS to be a real market," said Adam Fisher, chief investment officer at hedge fund Commonwealth Opportunity Master Fund Ltd., and a trader of sovereign credit-default swaps. The deal reached Thursday, he said, could "kill off the market."
"If you owned a sovereign bond and you got scared because you bought CDS thinking it would pay out, you'll realize you would have been better off just selling your bond—and you'll just get rid of everything," said Ashish Shah, co-head of credit at AllianceBernstein.
The biggest U.S. lenders don't stand to lose much on the Greek "haircut." A bigger issue is exposure to economies such as Portugal and Ireland, and much bigger countries such as Spain, Italy and even triple-A-rated France. I Predict a Surprise Default Ruling by ISDAThe WSJ implies a "decision not to trigger the swaps" has been made. Piecing together various reports, I don't think it has. Here is the setup. There is only $3.7 billion in CDS contracts on Greek bonds vs. €350 billion ($496 billion) government debt. Will the ISDA be willing to risk the CDS market on sovereign debt for a lousy $3.7 billion? I believe it won't if the "Derivatives King" (JP Morgan) and a few of the other big boys decide it is in their best interest to take a small hit now to prevent killing a lucrative market. Thus I am going to go out on a limb and predict the ruling will be a default, possibly triggering massive buying of CDS contracts on Portuguese, Spanish, and Italian debt to the huge benefit of the "Derivatives King" and other big players. Just don't expect the same result next time if the big boys go on an insurance selling spree. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com
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| Shanghai Homeowners Smash Showroom in Protest of Falling Prices; Developer Warns on Price Drops; "Twilight Zone" of Phony Accounting and Shadow Money Posted: 28 Oct 2011 12:51 AM PDT The property bubble in China has finally burst. Denial has turned to anger as Shanghai Homeowners Smash Showroom in Protest Over Falling PricesA group of around 400 homeowners in Shanghai demonstrated publicly and damaged a showroom operated by their property developer after the company said it cut prices. Home buyers had wanted to speak with the developer to refund or cancel their contracts but were unsuccessful, according to local media. One report said the price cuts exceeded 25% per square meter.
The local media reports said an unspecified number of people were injured.
Chinese media separately reported that another group of Shanghai homeowners gathered on Saturday to speak with Longfor Properties Co., after it dropped asking prices to 14,000 yuan per square meter from 18,000 yuan per square meter at a residential development in the city's Jiading district.
The Shanghai property-owner demonstration found little support on China's Internet, where most still expressed worries that housing prices are too high. 22% Drop OvernightThe drop from 18,000 to 14,000 yuan is a 22% overnight drop and that is just a down payment on the carnage that is coming. Housing Math in China- 18,000 Yuan per square meter is about $2,835 per square meter
- One square meter = 10.7639104 square feet
- Cost per square foot = ($2,835 ÷ 10.7639104) = $263.38
In downtown Shanghai, the price is 48,000 yuan per square meter or roughly $696.77 per square foot. I am told these are for roughly finished units (no carpeting, appliances, etc), just stark bare units. For more on absurd Downtown Shanghai property prices, please see Property Developers Hurting in China; New Homes Sales Down 50% in Shanghai; Preposterous Prices Won't Last; Commodities to be Hit in Building SlumpProtests Hit China as Property Prices FallYahoo! Finance has additional protest details in Protests hit China as property prices fallHundreds of angry home buyers launched a series of protests in China's commercial hub of Shanghai this week, as owners decried falling prices for their properties, state media said Thursday.
In the latest incident, some 200 home owners on Wednesday besieged the sales office for a project of leading developer Greenland Group, demanding refunds.
"We require a refund because the loss we are suffering now is too great for us to afford," the Shanghai Daily quoted a protestor as saying.
He paid 17,000 yuan ($2,678) per square metre last year and claimed the developer had cut the price by around 30 percent to boost sales.
In a another incident, 30 home owners stormed the sales office of a project of Hong Kong-listed China Overseas Land & Investment Ltd. on Wednesday, the Global Times said, repeating a similar protest from over the weekend.
Demand for apartments has been falling after authorities, fearing a property bubble, banned the purchase of second homes, increased minimum downpayments and trialled property taxes in some cities -- including Shanghai.
At the same time, property developers have been hit by a lack of funds, as the government hiked interest rates and restricted bank lending to rein in surging inflation and bring real estate prices into line.
Ratings agency Standard & Poor's expects China's property prices to fall by 10 percent nationwide over the next year as the measures take effect. S&P 10% Decline Prediction is Hugely UnderstatedPrices in many places are already down 20 to 30 percent and things will get to the 50 t0 70 percent decline mark before this is over. "Twilight Zone" of Phony Accounting and Shadow MoneyMarketWatch says Watch out for China's 'freak' economyTen years ago, homes in Shanghai sold for about six times an average family's income. Today that's 13 times. Shenzhen has gone from five times to 14 times. These are off-the-charts absurd ratios. This is a bona fide mania.
And it works fine until the music stops. Where are we now?
Prices have started falling. Now, fewer than 46 of 70 major cities saw prices stall or decline in September, reports the National Statistical Bureau. As recently as January the number was just 10.
In the past two and a half years, China has witnessed a staggering credit bubble. Total lending has come to about $7.8 trillion.
To put this in context, that is twice the entire net government debts of the European so-called "PIIGS" — the troubled countries of Portugal, Ireland, Italy, Greece and Spain — put together.
An alarming report from Schroders said Chinese banking operates in a "twilight zone" of phony accounting and shadow money and it's all coming apart. "Almost half of all credit creation in China is off balance sheet," wrote the team at Schroders.
They think this situation could unravel "over the next three to six months," producing a huge crisis with international implications. Most Chinese banks, they predict, will end up as "zombie banks." Hard Landing ComingThe Financial Times reports China property developer warns on price fallsChina's largest real estate developer believes the country's property market, a key driver for the economy, has turned and expects conditions to worsen in the coming months as sales prices volumes decline further.
China Vanke, the country's biggest developer by market share, said government efforts over the past year to rein in soaring prices were having a severe impact on the market and developers were being squeezed after sales volume in 14 of the country's largest cities halved in September from a year earlier.
A 30 per cent drop in property prices would precipitate a collapse in fixed investment in China and the country's investment-driven economy would experience a so-called hard landing after years of annual growth above 9 per cent, according to UBS economist Wang Tao.
Property investment accounts for more than 20 per cent of total fixed investment in China and UBS estimates almost 30 per cent of final products in the economy are absorbed by the property sector.
"A property-led hard landing scenario is quite likely in the next few years, even though we do not think the property market is about to collapse now," Ms Wang said.
Debt-laden provincial governments in China rely heavily on land sales for revenue and have poured investment into commercial housing projects in recent years.
These local authorities also account for up to 30 per cent of all outstanding bank loans, many of which are collateralised by land and housing developments, so a collapse in the property market could have a devastating knock-on effect on the financial system. The property bust is underway in China and will spread from city to city just as it did in the US. No city will be immune and commodity prices will be smashed in the downturn. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com
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