Sunday, 1 June 2008

First Comes the Swap. Then It’s the Bad Journalism

Continuing a long tradition of dissing something you don't understand, Gretchen Morgenson has an ill-informed article in the NYT on a dispute between UBS and a hedge fund over a CDS. Let's start with the errors:
INVESTORS don’t often get a peek inside the vast, opaque and unregulated world of credit default swaps, those privately traded insurance contracts that essentially allow participants to bet on or against a debt issuer’s financial condition. (Remember, these are the same instruments that played such a pivotal role in the collapse of Bear Stearns.)
Plain wrong. Lack of liquidity played a pivotal role in the collapse of the Bear. CDS had little to do with it.
There is no central market where investors can watch credit default swaps trade and see their prices. Each transaction is conducted away from regulators’ prying eyes.
Again wrong. Regulators have the right to look at all transactions, OTC or otherwise. FSA for instance has a legal right to demand any document at any time: the FED is similarly engaged with its firms' OTC deals. If UBS's regulators can't see its CDS exposure that has much more to do with Swiss Banking law than with CDS. As I pointed out earlier, just because something is on exchange does not mean that price discovery are reliable: in many ways CDS levels are more readily available and liquid than most exchange traded single stock options.

The article does then make a not-entirely-terrible job of explaining the dispute between UBS and the fund. It appears an MD at UBS (who I am assuming is a sales person) assured the fund, Paramax, that UBS's collateral calls would not be based on aggressive marks. The court papers apparently claim he:
assured Paramax that mark-to-market risk was low... Paramax contends in the filing, it was informed ... that “UBS set its marks on the basis of ‘subjective’ evaluations that permitted it to keep market fluctuations from impacting its marks.” ... [the salesperson] was responsible for all marks on UBS’s super senior positions and that he could justify ‘subjective’ marks on the Paramax swap because of the unique and bespoke nature of the deal.”
Again, _if_ this is true, it has nothing to do with CDS. It could happen in any market. If it happened, it would be a dramatic failure of segregation of duties, but nothing about CDS makes this more or less likely.

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