the __earthinc – Page 102 – By Hafiz Noor Shams

[2515] Watch out for those CDS

Post author By Hafiz Noor Shams
Post date Tuesday, March 6 2012
No Comments on [2515] Watch out for those CDS

For those who have been following the Greek crisis, they know that March 8 is the deadline for the bond swap that is essential in ensuring an orderly default of Greek bonds. Just 12 days later, Greece is due for repayment that without any haircut to its bondholders, there would be a chaotic default.

The bond swap plan is essential in keeping Greek public finance under control, however arbitrary the preferred debt-to-GDP ratio is. According to the Debt Sustainability Analysis paper dated February 15 leaked during the Greek debt negotiation, a 5% reduction in bond swap participation will increase the debt-to-GDP ratio by 2%. And the baseline assumes 95% take-up rate to reach 129% debt-to-GDP ratio. The magic number is 120% and in order to achieve that ratio, the take-up rate has to be high.

Here is the problem. Some bondholders may have bought credit default swaps in anticipation of a technical default some time back. It is in their best interest to not participate in the Greek bond swaps and trigger the CDS. Participation in the swap will not trigger the CDS.

The deal with the CDS is tricky. I myself am a bit unclear if holding the precarious Greek bonds until maturity and default will actually trigger the CDS. A broker told me just now that there are so many CDS with varying conditions that it is impossible to know just which CDS will trigger. Ultimately, what is unclear is which is better: the haircut bonds or the payout from the CDS?

I am betting some will in event of plain old default and that will be the reason for some to reject of the bond swap deal. Big enough a rejection and we will find ourselves in a financial whirlwind all over again.

Tags credit default swaps, default, European Financial Stability Facility, Greece

Politics & government

[2514] Koch’s betrayal

Ceciro spoke eloquently,
against Catiline’s betrayal,
will libertarians protest fully,
against Koch’s betrayal?

Tags Cato Institute, Charles Koch, libertarianism

Economics

[2513] Minimum wage and the money illusion

Post author By Hafiz Noor Shams
Post date Monday, March 5 2012
3 Comments on [2513] Minimum wage and the money illusion

In the short run when (nominal) prices are not so flexible, there will be a trade-off between (nominal) minimum wages and unemployment rate. The mechanics is simple. If businesses cannot change the price they charge their customers, they will optimize their cost. Since a person’s real wage theoretically equals the person’s marginal product of labor (or in English, productivity), businesses will try to maintain workers whom are reasonably productive with respect to the wage paid. In reality, this could mean either tighter selection of workers or even firing of unproductive workers. More often than not, it would likely only lead to tighter worker selection criteria. Regardless, with labor population growth, it would lead to lower hiring compared to pre-minimum wage and then immediate creating greater unemployment among the labor force, with all else being constant.

In the long run when prices finally adapt, the relationship between minimum wage and unemployment can be rendered impotent. Prices adapting means erosion of minimum wages by inflation. The more prices adapt, the less productivity is required given the equivalent fixed minimum wage level. This thus opens up more space for less productive workers to have a shot at employment in sector which the minimum wage law covers and in turn, applies a downward pressure on the unemployment rate.

Unless, of course, if the minimum wage level is updated in line with some measure of inflation. In that case, the negative relationship within minimum wage and unemployment rate will be sustained.

There is one important point that I wish to highlight if it is not so apparent already. While the negative relationship between minimum wage and unemployment will weaken over time in the face of inflation and non-update of the law, the effect of unemployment is real due to sticky prices in the short run.

With a real minimum wage, the effect is permanent.