Wednesday, September 17, 2008

Constructive uncertainty redux

Warning – this post is designed to annoy market fundamentalists and the naked short selling crowd…

The main argument against nationalising failing financial institutions at this point comes down to moral hazard.

This is a short post with the idea of turning that on its head.

Debt markets are currently illiquid and highly skittish.

It is alleged that short-sellers are causing problems – but if they are causing problems its not in the equity markets – its in the debt markets. Relatively small amounts of selling of debt can cause a very wide – and possibly self-fulfilling rise in the spread of some financial institutions.

And if financial institutions are going to be allowed to fail you can short their debt with impunity. Drive the credit spread up. The confidence collapse will make you a killing - at least according to Vanity Fair.

But thanks to Paulson et al you can’t do that any more.

AIG proves the government might make the bonds you shorted whole. Anyone shorting AIG debt just had their ass handed to them.

So if you short debt now – what you face is constructive uncertainty.

It might give the smarties some room for pause.

John Hempton


The Way Rider said...

Could not agree more that Paulson squeezed the AIG, WaMu, MQG et al credit short sellers but why are they smarties? Are they not ultimately looking for the (lack of) value in the underlying and saying it's too expensive. And current events are saying that this is a truism. They, and short sellers took the other side to the trade. If they didn't there perhaps would not be a market, and we can all go home.

John Hempton said...

This post is a tease. However the constructive uncertainty works both ways. All Paulson has to do is make sure it is unclear who he will bail out and he will achieve quite admirable ends.


Anonymous said...

I am surprised by the sophistication of Vanity Fair.

The Way Rider said...

A tease yes, only the current obsession with conspiracy theories gets me worked up, so I fell into the tease trap!

On today's action: the market seems hell bent on carrying out everyone. MQG & Co. are going to get slaughtered today. This has gone beyond anything that is 'normal', and for the first time I'm really starting to worry (bottom anyone? fat chance!).

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