Monday, March 1, 2010

Kazakhstan a better credit risk than California

This may be more amusing than instructive, but here goes. This chart shows 5-year credit default swaps on bonds issued by the State of California and the government of Kazakhstan. As Bloomberg's Chart of the Day notes, California would be ranked as the world's eighth-largest economy, while Kazakhstan's economy is only one-sixteenth as large. Yet the market is saying that California's bonds are 50% more risky than those of Kazakhstan.

In case you're wondering, similar credit default swaps on Greek government bonds are trading at 364 bps (only slightly higher than California's 303). Iceland 524, Portugal 163, Spain 130, and Italy 128.

The governments of California and Greece are in the same pickle: government spending is out of control and must be reined in, starting with public sector salaries and benefits. The market is saying that's going to be very difficult to accomplish. I'd like to think it's fairly easy: just say "no."


Benjamin Cole said...

BTW, investor solon Charlie Munger ran a piece in Salon about 10 days back, worth reading.

Takes some hard whacks at government denbt--but also unregulated financial speculation.

What is the SG reaction?

Scott Grannis said...

Can you give me the link? I'm having trouble finding it.

septizoniom said...

this is one of your weakest posts ever. mocking the market's judgment based solely on economy size. then you leave that dangling. poor.

Scott Grannis said...

I did start the post with "this may be more amusing than instructive." It was not really my intention to mock the market. I don't know, for that matter, whether the market in sovereign credit default swaps is mature and liquid enough to trust implicitly. So I think there is more entertainment value here than real wisdom.

Benjamin Cole said...

My mistake--the Munger piece is on Slate,

Munger does not like debt and derivatives....

Scott Grannis said...

I have great respect for Charlie Munger and I think he is one of the world's most brilliant investors. I heard him speak not too long ago, and I cherish my copy of "Poor Charlie's Almanack." I would highly recommend it to anyone:

But not all great investors are also good economists, and Charlie is a good example of one who isn't.

He doesn't understand derivatives, and he is a mercantilist who doesn't understand trade.

Understanding derivatives is not easy, and he is pretty old, so he has a good excuse. It took me the better part of a decade of working with derivatives to come to an understanding of what they are, how they work, and what hidden risks they carry.

Charlie loves to hate derivatives, and he blames them for a host of problems. But he unfortunately ignores the problems caused by countless government interventions which distort free markets and render self-correcting forces inherent in markets inoperable.

Benjamin Cole said...

Well, if we are lucky, we will all get so old.

Wisdom in years, perhaps.

Benjamin Cole said...

Derivatives do not owrry about leveraged debt, as in 100-to-1- bets?

I worry that investor-speculators are tempted to leverage up--why not?

If you lose, you lose, but then debtor's prisons are no longer around. Corporation law limits recourse to the corporation, not personal assets.

If you win, it is Fat City for life, baby.

I gotta tell you--in the same shoes as many, I would also leverage 100 to one.

And Munger's larger point is still valid--is not the purpose of capital markets to tranfer savings to productive enterprises?

Scott Grannis said...

Derivatives are not the gambling casino that you might think. They are elaborately structured to minimize counterparty risk and to limit speculation. Derivatives that have a great deal of leverage are not really as risky as they sound. To begin with, for every buyer of a derivative there must also be a seller. For every winner there must be a loser. Collateral is typically required of both buyer and seller. Accumulated gains in derivative positions are typically segregated to protect the winning party. These are just some of the many details about derivatives that you don't read about in the typical derivatives story. I would urge anyone who thinks derivatives are a big casino to invest some time and effort to understand them.