
Debt Market Distortions Go Global as Nothing Makes Sense Anymore - randomname2
http://www.bloomberg.com/news/articles/2015-11-15/debt-market-distortions-go-global-as-nothing-makes-sense-anymore
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JumpCrisscross
Transaction costs. Investors prefer swaps because they carry lower transaction
costs. (When something doesn't make sense in finance, it's almost always
transaction costs.)

Suppose you're a rates dealer. (Rates dealers buy and sell Treasuries and
swaps, amongst other things.) An investor wants to invest at the 10-year rate.
Say they insist on getting this in the form of a U.S. Treasury. You must
either (a) buy a Treasury on the market or (b) pull one from inventory. No
other options. Say, on the other hand, they are open to dealing in swaps. You
could hedge this like a Treasury. You can also hedge with another swap. Two
options instead of one. Makes your life easier, doesn't it?

Dealers always preferred swaps. But investors didn't like taking on the
counterparty risk. Dodd-Frank changed that. Now swaps are mutualized. If you
take out a swap with JPMorgan and they go kaput, other parties will pool
together to make you whole. Less of a difference, in terms of credit quality,
between a swap and a Treasury now. Dodd-Frank also made it more expensive to
hold Treasuries in inventory.

In summary, swaps were always tastier to dealers. Dodd-Frank made them more
attractive to investors. At the same time Treasuries became even less fun for
dealers. Left hand meets right hand and you get lower fees on swaps with a
commensurate shift in net pricing.

~~~
bcohn91
I'm a little confused. Are you saying you can hedge a swap like a Treasury,
but can't do the reverse -- hedge a Treasury like a swap? Why would that be
the case? Or am I misinterpreting you?

~~~
scarletham
He's saying that if the investor wants a Treasury, the only way you can sell
that to him is with a Treasury. If he's open to a swap, you can sell (write)
that contract to him and hedge it with either a Treasury or another swap.

The only way to deliver a Treasury is with a Treasury, which you have to track
down out of inventory or from another dealer. You can write a swap without
having to go through that ordeal. This means lower transaction costs.

~~~
kal31dic
Its not true though. You can sell it to him, receive on a 10 year swap and
borrow the bond from someone else. Or you can buy futures and borrow the bond.
And if you can't manage to borrow the bond, failing for a while to deliver to
your customer is hardly the end of the world, last I checked.

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o_nate
These stories came around a few years ago when swap spreads went negative, and
it seems like the same mistakes in interpretation are being made again.
Negative swap spreads do NOT imply that big banks are more creditworthy than
the US Treasury. That is obviously fallacious. You are comparing apples and
oranges. If you want to do a fair comparison, compare the yield on a Treasury
bond with the yield on a non-callable bank bond of the same maturity. Guess
what? The Treasury yield will be lower. Or if you prefer, look at the CDS
market and compare the CDS spread for protection on the US Government vs the
spread for any major bank. Again, the US government spread is less.

If you want to understand this, you need to think about what kind of arbitrage
trade would profit from this situation and why it's not happening in large
enough size to reverse this. You'll realize that the operative constraints are
not fears about the creditworthiness of the US government.

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vegabook
This is the second time in a week that we're falling all over ourselves
wondering why swaps are through Ts. It's not hard: IRS is collateralized,
Treasuries are not. With IRS every 3 (or 6) months, you have to cough LIBOR in
order to receive the fixed leg. So essentially your maturity commitment is
never greater than that, and indeed, for the vast majority of swaps receivers,
mark-to-market collateral adjustments happen _daily_ , so your credit risk is
24 hours! This is not the case for USTs where if you invest for 10 years, you
have no clue for every single one of those 10 years if your principal will be
repaid, and there is absolutely zero collateral adjustment. Why is this so
hard for people to understand?

Ts are being printed without even the slightest regard for the (old-fashioned)
concept known as fiscal rectitude. Swaps can be printed all day long but if
the rates start moving you get paid/have-to-pay every 24-hours for the assumed
risk. It follows that Ts are now a much riskier bet than swaps, and indeed,
what surprises me, is why it has taken so long for this to be happening.

~~~
carsongross
_Why is this so hard for people to understand?_

Here's why:

> swaps are through Ts

> IRS is collateralized

> cough LIBOR in order to receive the fixed leg

> majority of swaps receivers

> mark-to-market collateral adjustments

Nobody (to a second order approximation) knows what the fuck any of that
means, because, since they are sane people with lives to lead, they don't
delve into the details of advanced finance.

~~~
vegabook
let me make it perfectly clear. Lend money for 24 hours is less risky than
lend money for 10 years. Does that make sense?

On your point about finance being complex. This is Bloomberg writing the
story. They of all people should know. And this is the second time in a week
that they're pushing this stuff.

BTW: for the average finance guy the CS jargon on this site would also qualify
as something to be dismissed by "sane people with lives to lead". Not a valid
argument. And before you tell me that this is a CS site so that is
understandable, I'll ask you why this Bloomberg stuff is making it to Page 1.

~~~
anon4
Wouldn't lending money for 24 hours be more risky, since the debtor has less
time to raise money to pay you back?

~~~
nicky0
On the other hand you gave them the money yesterday so it's pretty likely they
still have it to give back to you.

~~~
anon4
But if they don't spend it, why did they take it in the first place?

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ChuckMcM
I always find these stories interesting but feel like I get lost when they get
into the more arcane levels of derivatives. Here is my question; Given the
experience of the Subprime mortgage debacle, and the inherent difficulty of
understanding who is holding the liability of these derivatives, why doesn't
S&P and Moodys just max out their credit worthiness rating at BBB. Just don't
ever let them be A rated, at any level. Would that not "fix" the inversion if
people are mistakenly believing that counter party interest swaps are "safer"
than Treasuries? I'm really curious about that.

~~~
bradleyjg
It's be better to fix the laws and regulations that treat the rating agencies'
opinions as true facts about the riskiness of assets (e.g. SMMEA, 7 CFR
240.15c3-1, Basel III, many many etc.) than to apply a band-aid patch at the
rating agency level. I'm not even sure the government could legally put in
such a requirement as the rating agencies have asserted in litigation that
their output is protected speech.

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tdees40
The language in this is a bit silly:

"Nowhere is that more evident than in the U.S., where lending to the
government should be far safer than speculating on the direction of interest
rates with Wall Street banks."

You aren't "speculating on the direction of interest rates with Wall Street
banks", you're buying a synthetic rates position that is centrally cleared
with daily variation margin. That's not quite US Treasury safe, but it's
pretty damn safe.

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jbssm
Finance prediction is just a game of pure chance, a random walk.

Thing is, the game is rigged and when the big players loose, we all pay the
bill.

~~~
collyw
No idea why this is downvoted. The financial crash seems to provide evidence
of it happening. And there have been studies showing monkeys being as good as
financial analysts at piking stocks.

[http://www.forbes.com/sites/rickferri/2012/12/20/any-
monkey-...](http://www.forbes.com/sites/rickferri/2012/12/20/any-monkey-can-
beat-the-market/)

------
nugget
The most interesting signal I've seen from the world of finance is a number of
smart hedge fund managers shutting down their funds over the past few years,
stating that fundamental value investing is now impossible as the markets are
too controlled by Government policies and intervention. It doesn't seem like
this is healthy long-term unless the Government can manage a very soft
landing.

~~~
Analemma_
What a wonderfully self-serving explanation. Here's an alternative one: hedge
fund managers are shutting down their funds because people are waking up to
the fact that hedge funds are a terrible investment. After the managers take
their 2-and-20, hedge funds have lagged the market every year, in both market
ups and downs. Funds are trying to slow the rush to the exits by slashing fees
([http://www.ft.com/intl/cms/s/0/693d9b74-73f3-11e5-bdb1-e6e47...](http://www.ft.com/intl/cms/s/0/693d9b74-73f3-11e5-bdb1-e6e4767162cc.html))
to keep more people from going the way of CalPERS, but I don't think it's
going to work. There's just too much freely-available evidence that hedge
funds aren't worth the fees for what you get. Blaming the government as they
turn off the lights is a handy way to get at least something positive out of
it though.

~~~
lintiness
hedge funds on average underperform big bulls and outperform big bears. sharpe
ratios matter. maybe mass fund closures signal something more interesting than
that calpers is run by geniuses (hint: they aren't).

~~~
snowwrestler
It will be interesting to see how Warren Buffett's long bet comes out. Just a
couple more years:

[http://longbets.org/362/](http://longbets.org/362/)

