How Wall Street Wins Its No-Lose Trades

8 | By Shah Gilani

The madness of the manipulation machinery on Wall Street knows no bounds.

Remember credit default swaps (CDS)? They’re the risky financial derivatives traded among Federal Deposit Insurance Corp. (FDIC)-insured banks that, during the 2007-’08 financial crisis, took down Lehman Bros. and almost bankrupted giant insurer AIG Inc. (NYSE: AIG).

Well, they never went away. And now they’re making a comeback, and Wall Street is using them in ever more maniacal ways.

They’re back partly because the recently passed federal spending bill reversed a Dodd-Frank rule that said big gambling banks had to separate CDS into units not guaranteed by the FDIC (aka taxpayers).

While I may come back to that, I’m not writing about Congress‘ latest gift to Wall Street today.

Today, I’m going to show you how Wall Street manipulators are using CDS and a false front of “activism” to make huge profits from troubled companies – and why that’s becoming routine.

Good Idea Gone Bad

This is about outright, legitimized (as in it’s not only legal – it’s business as usual) manipulation.

Think of CDS as a kind of insurance. Companies issue debt, and investors buy their obligations to collect interest and expect their principal to get paid back at maturity.

But sometimes debtors get into trouble. CDS sellers offer the holders of debt insurance against the debtor defaulting.

That’s not a bad idea. In fact, it’s a good product.

But, Wall Street being Wall Street, that good idea became a great way to gamble. That’s because there’s no limit on how many “insurance policies” can be written on any company’s debts.

For example, RadioShack Corp. (NYSE: RSH) has about $1.4 billion in outstanding debt (bonds and loans), and so the storied retailer is in trouble. Speculators betting on RadioShack defaulting, however, have bets that add up to about $23.5 billion.

That’s like everyone in your neighborhood taking out fire insurance on your house. These gamblers would be hoping your house burnt down so they could collect.

Sooner or later, someone might toss in a match to light the pile of potentially profitable bets.

Of course, that’s happening on Wall Street.

The RadioShack story is complicated. To keep it simple, today I’m going to let you know about a less known but less complex example of CDS manipulation.

When Debt Is a Bad Bet

In 2013, the Spanish gambling company Codere SA (BME: CDR) was in financial trouble.

Moreover, its managers didn’t know that GSO Partners, the debt-trading arm of Blackstone Group LP (NYSE: BX), had amassed a pile of CDS, betting that the company would default. Then, Codere received an offer of help, in the form of a desperately needed loan, from another Blackstone unit.

That’s weird, right?

Not if you’re the Blackstone Group.

The loan came with a provision. For Codere to get the loan, it first had to default on its outstanding debt.

That’s right: Codere got a loan from a Blackstone unit to avoid default. However, to get the loan, Codere first had to agree to delay interest payments on its other debts. Not paying that interest constituted a default. That made the CDS bets winners.

In other words, “activist” investors are now targeting companies and playing them like pawns.

Another such deal saw a trio of hedge funds buy CDS protection on a company’s debts and, at the same time, buy enough shares so they could vote down a plan the company had to merge with a stronger company.

How’s that for manipulation?

The company outsmarted the hedge funds by setting up a poison pill, so it could sell itself.

Now, with Dodd-Frank being eviscerated, we’re going to see many more of these bets. It’s another way to make money – and Wall Street loves to make money.

I warned about CDS back on September 25, 2008, before the credit crisis reached its zenith. CDS were a big part of what caused the credit crisis. Of the 15 points in my How to End the Credit Crisis at No Cost to Taxpayers, No. 4 was:

    Only allow issuance of credit default swaps up to the actual outstanding dollar value of corporate debts and loans outstanding. This will ensure legitimate hedging and eliminate undue pressure on outstanding debt issuers.

It’s that simple.

Then again, it’s just as simple for Wall Street and its moneymaking madness to manipulate Congress, the White House and the financial regulators.

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8 Responses to How Wall Street Wins Its No-Lose Trades

  1. Robert in Vancouver says:

    The Democrats still control which bill gets passed, at least until Republicans gain control in the new year. And President Obama will still has his power of veto over any bill.

    So this change to Dodd-Frank was passed because Democrats wanted it passed, and it wasn’t vetoed so that means President Obama wanted it passed.

    Easy to see who is at fault for giving the crooks on Wall Street another chance to rake in billions of dollars at the expense of the little guy.

  2. David Jaworski says:

    So in a nutshell……..all of the money that is being paid out on CDS protection when a company defaults comes from the American taxpayer? Do I understand this correctly? If so then the fix for this is to limit the CDS protection purchase value to be the same as the actual real debt amount.

    How can we the people change this type of stuff once and for all or is there a way?

  3. Kevin Beck says:

    I completely agree. The first principle of insurance is that the person buying the policy must have an insurable interest. My neighbor does not have an insurable interest in my house; therefore, no legitimate insurance company would write such a policy.

    There is no legitimate way that there is an insurable interest of $23.5 billion in the debts of a company that only has outstanding debts of $1.4 billion (from the Radio Shack example quoted above). If bankruptcy occurred, then the purchasers should only be limited to collecting based upon the total amount of the company’s default, and each policyholder would be limited to about 6% of the amount of their “policy.” That’s making the rather generous assumption that such business is legitimate.

    However, I like your 2008 solution better.

  4. Edouard D'Orange says:

    Common sense from Mr. Gilani. It’s so simple, not complicated law like Dodd-Frank that the anti-business demoncraps favor. It’s not (exactly) restricting, strangulating restrictions, red tape, big government interference and anti-capitalism as the Wall St. manipulators, and some Republicans (like the paid off RINO) claim. It’s just prudent, straightforward protection for the financial system. And we need to re-institute a simple Glass-Stegall banking law.

  5. sheldonross says:

    These guys who call themselves business people or credit and debit gamblers should be put in jail and not a white collar jail for fraud (defrauding the American people. About 7 yrs. should do it.

  6. Buffalo Bill says:

    The crooks at the top , with all the money , with all the power , with all the connections to make the rules to benefit them financially forever . To hell with the vast majority of people who are looking for a fair shake in life . You jerks will all burn in hell when your miserable lives are over .

  7. David Allen says:

    Who sells CDS insurance? Being a complete novice in financial matters there are a lot of issues I don’t completely understand. Another one being why inflation is considered a .desirable thing. It can only hurt all us “little” people.

  8. Lefty says:

    Who are the fools that underwrite these credit default swaps? Don’t they have enough sense to limit their exposure to the ratio of their insurance to the total of all insurance written times the potential loss? Are those writing these CDSs insured by the taxpayer? If Congress does not insure that such risks cannot be over insured then we have fools or parasites for Congressmen.

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