Thursday, November 27, 2008

A Couple Thoughts on Liquidity, Lehman and Sovereign Risk

On the after-effects of Lehman’s collapse:

…money fund investors responded to the “breaking of the buck” issue at the Reserve Fund by withdrawing funds from “Prime” funds and placing most of those proceeds in Treasury or Government-only money market funds. That’s the 21st century equivalent of a “bank run,” and its consequences contributed to the severe freezing up of interbank lending in September and October.

From a random trader;

The volumes are dire, a lot of this is on-screen pricing, its not being moved. But to be honest, if you believe there are people with deep pockets out there who believe sovereign CDS trades offer good value then why aren’t they selling protection and compressing spreads? On the UK there are 100 basis points you can pick up, then you should be writing contracts, offering protection and compressing spreads down on UK CDS.

No one can arbitrage this (expensive CDS's on sovereign debt) at the moment. Those days seem to be gone. We seem instead to be entering this forbidding sort of environment where governments are having to do everything in their power to stabilise the system, to the point of risking (their) own funding. If you are in that situation you can’t expect sovereign spreads to come in.

A Prayer

Let us not forget that we have been deep in a debt ponzi scheme for nigh the last decade plus. Peter borrows to buy Paul's company, then the company borrows to buy overpriced assets. Neither is well covered by the underlying cash flows and both can't get refinancing (illiquidity) and therefore can't repay loans (insolvency). Wash, rinse, repeat.


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