STOCK MARKET WATCH -- Friday, 1 November 2013

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27. How to Make Money for Nothing Like Wall Street

http://www.theatlantic.com/business/archive/2013/10/how-to-make-money-for-nothing-like-wall-street/280825/

***SNIP

But even with these financial shock absorbers, there are still lots of clever-and-probably-legal-but-ethically-dubious ways to game CDS. Here are the two most devious.

1. Buy CDS on a bond, and then bribe the borrower to temporarily default. This is like taking out insurance on your neighbor's car and bribing him to get in an accident. You get the insurance, and then you kick some money back to him to upgrade his car.

Sound far-fetched? It's not. It's essentially what a unit of the Blackstone Group did with the Spanish gaming operator, Codere SA. First, Blackstone bought insurance on Codere’s bonds, so it stood to make a nice bit of money if Codere missed an interest payment. But how do you make a company miss an interest payment? Well, Blackstone took over one of Codere's revolving loans, as a hostage, and told the gaming company: "We'll force you to pay back this entire revolving loan unless you kindly miss the next interest payment on your bonds." It was a clever ransom. And guess what? The clever ransom worked. The interest payment came late. Blackstone made $15.6 million from its CDS. And as for Codere, they turned out fine, too. Blackstone agreed to restructure its bonds, and reward the company for good behavior with another $48 million loan.

2. Sell so many CDS on a bond that you can pay to keep it from defaulting. This is like selling insurance to as many people as possible on a car that was obviously falling apart — and then paying to fix it before it could get in an accident.

Now, imagine some crappy bonds. Some really crappy bonds. You know they're crappy. I know they're crappy. And Wall Street definitely knows they're crappy. They're so crappy that everybody wants to buy, and nobody wants to sell CDS on them.