The Sting, Part 3  

Posted by Big Gav in

I was pleased to see over my break that the WSJ has picked up the story about the CDS timebomb awaiting the world's widows, orphans and local councils (see here and here for background) - Synthetic CDOs hit local councils on other side of world.

ALAN McCormack, the general manager of the Parkes Shire Council in the central west of NSW has a big headache. The council is poised to lose millions of dollars if more US companies succumb to a deepening recession.

More than 16,000 kilometres away, at New York investment firm ICP Capital, hedge fund manager William Gahan is reaping big gains on McCormack's predicament.

The fortunes of the two men are connected through an investment known as a "synthetic collateralised debt obligation".

Between 2005 and 2007, the Parkes council put more than $13.5 million of its savings into synthetic CDOs. The investments offered an attractive income and a gold-standard credit rating -- in return for providing a sort of insurance on the debt of hundreds of mostly US companies.

Now, though, if even a handful of those companies renege on their debts, Parkes will have to cough up as much as $12 million to honour the insurance commitments it made. That has been a boon for Gahan, who used financial products to place bets against many of the same companies.

But it would deprive Parkes of a big chunk of the money it needs to rebuild its water supply amid an enduring drought. "It is going to be a long, hard ride," says 60-year-old McCormack, who has run the council for 18 years.

The linkage between McCormack and Gahan demonstrates how far a vast superstructure of credit derivatives such as synthetic CDOs, built up over the past decade, has spread the risk of lending to US companies -- and how far the pain is likely to reach. They are called derivatives in part because they do not entail any direct investment into companies. Instead, they are more like side bets on the companies' fortunes.

Global investors have already lost billions of dollars on derivative investments tied to US sub-prime mortgages, but many more -- including towns, charities, school districts, pension funds, insurance companies and regional banks -- put money into synthetic CDOs that insure the equivalent of trillions of dollars in mostly US corporate debt.

Synthetic CDOs are vulnerable at this stage in the financial crisis because of the way they work. They generate income by selling insurance against bond defaults, typically on a pool of 100 or more companies. One way they do so is by entering into contracts known as "credit default swaps". Investors, such as Parkes council, receive regular payments from buyers of the credit default swaps, which are usually banks or hedge funds.

In return for the income, investors agreed to make huge payments in what was seen as a highly unlikely event: a wave of corporate defaults greater than any experienced in the previous two decades. Now, though, as financial firms implode and a slump in consumer spending hits retailers and manufacturers, that event is starting to happen.

As a result, synthetic CDO deals are poised to trigger a massive transfer of wealth from investors such as Parkes council to hedge funds and the trading units of big US investment banks. By various estimates, the amount of money set to change hands could be anywhere from tens of billions to hundreds of billions of dollars.

0 comments

Post a Comment

Statistics

Locations of visitors to this page

blogspot visitor
Stat Counter

Total Pageviews

Ads

Books

Followers

Blog Archive

Labels

australia (619) global warming (423) solar power (397) peak oil (355) renewable energy (302) electric vehicles (250) wind power (194) ocean energy (165) csp (159) solar thermal power (145) geothermal energy (144) energy storage (142) smart grids (140) oil (139) solar pv (138) tidal power (137) coal seam gas (131) nuclear power (129) china (120) lng (117) iraq (113) geothermal power (112) green buildings (110) natural gas (110) agriculture (91) oil price (80) biofuel (78) wave power (73) smart meters (72) coal (70) uk (69) electricity grid (67) energy efficiency (64) google (58) internet (50) surveillance (50) bicycle (49) big brother (49) shale gas (49) food prices (48) tesla (46) thin film solar (42) biomimicry (40) canada (40) scotland (38) ocean power (37) politics (37) shale oil (37) new zealand (35) air transport (34) algae (34) water (34) arctic ice (33) concentrating solar power (33) saudi arabia (33) queensland (32) california (31) credit crunch (31) bioplastic (30) offshore wind power (30) population (30) cogeneration (28) geoengineering (28) batteries (26) drought (26) resource wars (26) woodside (26) censorship (25) cleantech (25) bruce sterling (24) ctl (23) limits to growth (23) carbon tax (22) economics (22) exxon (22) lithium (22) buckminster fuller (21) distributed manufacturing (21) iraq oil law (21) coal to liquids (20) indonesia (20) origin energy (20) brightsource (19) rail transport (19) ultracapacitor (19) santos (18) ausra (17) collapse (17) electric bikes (17) michael klare (17) atlantis (16) cellulosic ethanol (16) iceland (16) lithium ion batteries (16) mapping (16) ucg (16) bees (15) concentrating solar thermal power (15) ethanol (15) geodynamics (15) psychology (15) al gore (14) brazil (14) bucky fuller (14) carbon emissions (14) fertiliser (14) matthew simmons (14) ambient energy (13) biodiesel (13) investment (13) kenya (13) public transport (13) big oil (12) biochar (12) chile (12) cities (12) desertec (12) internet of things (12) otec (12) texas (12) victoria (12) antarctica (11) cradle to cradle (11) energy policy (11) hybrid car (11) terra preta (11) tinfoil (11) toyota (11) amory lovins (10) fabber (10) gazprom (10) goldman sachs (10) gtl (10) severn estuary (10) volt (10) afghanistan (9) alaska (9) biomass (9) carbon trading (9) distributed generation (9) esolar (9) four day week (9) fuel cells (9) jeremy leggett (9) methane hydrates (9) pge (9) sweden (9) arrow energy (8) bolivia (8) eroei (8) fish (8) floating offshore wind power (8) guerilla gardening (8) linc energy (8) methane (8) nanosolar (8) natural gas pipelines (8) pentland firth (8) saul griffith (8) stirling engine (8) us elections (8) western australia (8) airborne wind turbines (7) bloom energy (7) boeing (7) chp (7) climategate (7) copenhagen (7) scenario planning (7) vinod khosla (7) apocaphilia (6) ceramic fuel cells (6) cigs (6) futurism (6) jatropha (6) nigeria (6) ocean acidification (6) relocalisation (6) somalia (6) t boone pickens (6) local currencies (5) space based solar power (5) varanus island (5) garbage (4) global energy grid (4) kevin kelly (4) low temperature geothermal power (4) oled (4) tim flannery (4) v2g (4) club of rome (3) norman borlaug (2) peak oil portfolio (1)