Time to Unravel the Knot of Credit-Default Swaps (How bad is this problem?)

nytimes. ^ | January 24, 2009 | GRETCHEN MORGENSON

[dennisw]

Any honest assessment must include the role that credit-default swaps have played in this mess: it’s the elephant in the room, the $30 trillion market that people do not want to talk about.

C.D.S.’s have already figured prominently in taxpayer bailouts. The $150 billion rescue of the American International Group, for example, came about because of swaps the insurer had written on mortgage securities. And the $100 billion taxpayer backstop handed to Bank of America on Jan. 16 had a good bit to do with soured credit-default swaps that the bank inherited when it acquired Merrill Lynch.

“Credit-default swaps written on companies that were presumed not to be in danger of collapse but that are now on the brink — that is the overhang on the financial markets,” said Sylvain R. Raynes, a mathematics professor at Baruch College in New York and an expert in structured finance at R & R Consulting. “The financial system is frozen largely because of credit-default swaps.”

C.D.S.’s have introduced other economic burdens as well. Christopher Whalen, managing partner at Institutional Risk Analytics, argues that speculators who use credit protection to bet against financial institutions add instability to the system and cause the cost of taxpayer bailouts of the banks to escalate.

But the ill effects of a bankruptcy are magnified if billions of dollars in insurance must also be paid out by companies that wrote protection on a beleaguered company’s debt.

While the amount of credit insurance outstanding is around $30 trillion, Robert Arvanitis, chief executive of Risk Finance Advisors in Westport, Conn., says he believes fully half that amount isn’t problematic because it consists of winning and losing stakes that offset each other.

But that still leaves $15 trillion worth of contracts that may be in need of triage.

[dennisw]

How bad is the credit default swap problem? Can they be unwound with minimal bailout money and minimal damage?

[dennisw]

ping

[familyop]

Last year, the Bank for International Settlements (meeting of the world’s central banks in Basel with Ben Bernanke on the Board) said that the world’s credit derivatives amounted to $596 trillion at that time.

[Leisler]

It ought to be the private concerns of private parties, but since we live in such a corporatist/fascist state, the burdens will fall on individuals that did not participate.

Now that governments are so big, and people are so crazed as they always are, governments now run around putting out fires, picking up costs, and distributing the costs via taxes.

Eventually, if not already, a significant portion of citizens will see government as nothing but as an extraction machine. I already feel that most modest people feel a little like Medieval peasantry ridden over by wealth destroying political armies of the Democrat and Republican royalty.

[familyop]

Here’s the link for that.

http://www.bis.org/publ/otc_hy0805.pdf

“The over-the-counter (OTC) derivatives market showed relatively steady growth in the second half of 2007, amid the turmoil in global financial markets. Notional amounts of all categories of OTC contracts rose by 15% to $596 trillion at the end of December (Table 1), following a 24% increase in the first half of the year.1”

[djf]

I have a pack of matches.

I agree to sell it to you for one million dollars.

You give me a note (iou) for the one million dollars and I give you the matches.

Now we both walk around and we have created two million dollars of assets.

And with a little creativity, we can magnify that amount ten times or more.

Imagine this scheme multiplied 50,000 times or more.
That’s how bad it is.

[Ken H]

And with a little creativity, we can magnify that amount ten times or more. Imagine this scheme multiplied 50,000 times or more.

[Neidermeyer]

I just said it in another post , these are illegal insurance contracts in most cases as there is no “insurable interest” on the part of the buyer, jail the seller and declare the contracts null and void , the only exception being if the contract was against a bond/debt issue that the buyer had an interest in.

[Buckhead]

Do any state insurance regulators have the nads to declare these things illegal insurance contracts?

[Dinah Lord]

I doubt it, Buckhead.

bttt

[boomstick]

The number you’re showing is for all OTC derivatives, including interest rate swaps (the largest category). Only about $30 trillion, or 5%, are credit derivatives.