[lbo-talk] Realms of the surreal

[Jordan Hayes]

> Just read Liu's piece on JP Morgan. I don't know if he's
> right. But this certainly blew my mind:
>
> "Further, the buyer of a CDS does not even need to own the underlying
> security or other form of credit exposure. In fact, the buyer does not
> even have to suffer an actual loss from the default event, only
> a virtual loss would suffice for collection of the insured notional
> amount.

Not sure why this is so mind-blowing; it's no different than any other 
option.

You don't have to own gold in order to buy a put option that would pay 
off when the gold price crashes.

There are some unique things about CDS -- namely a lack of transparency 
that's outsize to the notional value of the contracts, combined with an 
interesting twist on bankrupcy preference -- but this "nakedness" is in 
no way unique to that market.

The real issue with CDS has been the propensity of *sellers* to misjudge 
the liklihood of default, or rather the correlation risk of their entire 
book defaulting at once, leading to unbounded losses.

*Buying* CDS is just garden variety betting-on-an-uncertain-future 
speculation.

/jordan