The role of speculative capital in the creation of the credit derivatives market cannot be overemphasized. Speculative capital is the conceptual rainmaker of this market, its underwriter. It brings the credit to the trading arena and ensures its staying power there by “grooming” it in accordance with the needs of the market.
The most outstanding handicap of credit in the new environment is the long time horizon. The traditional credit analysis is “through the cycle,” extending 5 to 7 years in the future to allow for the evaluation of an entity during a business cycle. Speculative capital would have none of it.
Having brought credit into its orbit, it trims its horizon to mere months. Credit, thus shortened and thrown into the market, seeks the confirmation of its price in the most short-term, readily available and actively traded instrument: stock. In this way, stock price comes to play a role in setting the price of credit. Traditional credit rating agencies are forced to take account of the development. They, too, shorten the time horizon of credit analysis.
A realization takes shape: if the stock price is an immediate measure of credit, perhaps credit and market price are more closely related than previously thought. This phenomenon plays out at the wholesale level as well, when corporations discover that they could sell their liabilities – and accounts receivable assets – in the market. So the tried and true concept of mortgage-backed securities (MBS) is extended to all forms of debt to create collateralized debt obligations (CDO), collateralized loan obligations (CLO) and, in case of accounts receivable, asset backed securities (ABS).
The rise of credit derivatives is the latest qualitative change in the evolution of finance capital that brings together its market and credit “dimensions.” We are currently witnessing the early stages of this development. But armed with the theory of speculative capital we could see what is happening, i.e., what is changing. We could also discern the cause, pattern and characteristics of the change. So while for others credit derivatives are the risk-diversifying, need-fulfilling products of an innovative Wall Street, for us they are the footprint of speculative capital on its march towards systemic crisis. The march, driven by the profit-seeking, inherently self-destructive movement of speculative capital, creates financial entropy on its path, one manifestation of which is closing the longest running, most structural arbitrage opportunity of all: between the credit price and the market price. But the ensuing state of inert uniformity cannot be tolerated; speculative capital cannot sit by idly and will not go gently into that good night. It must disrupt the equilibrium to create profit opportunities anew. That brings about the systemic risk.
Tuesday, 24 June 2008
An Excerpt from Vol. 3 of Speculative Capital
The following is an excerpt from the last page of Vol. 3 of Speculative Capital: The Enigma of Options. The book came out in 2006. The lines were written in the late '05 or early '06.