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mdman

Credit Derivatives Supergrowth 2007-09

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From the Congressional Oversight Panel report on TARP released today:

Credit derivatives on sub-investment grade assets create large amounts of unregulated exposure to potential defaults on lower quality loans, amplifying the effect of defaults. Similar to past due securitization assets, credit derivative exposure for subinvestment grade assets experienced a significant uptick in the same period. Sub-investment grade credit derivative exposure for the 19 largest BHCs grew from $1.6 trillion in year end 2007 to $8.9 trillion in the first quarter of 2009 as a result of downgrades. (Page 32, main report)

What does this mean in relation to the health of the big banks and global financial system? Denninger is as usual doomy about this. Here is his interpretation:

These banks thought they could "hedge" their risk with credit derivatives and as the risks became more apparent they radically increased their reliance on these instruments. Unfortunately the counterparty almost certainly does not have the money to pay ($8.9 trillion?!) and as such these so-called "hedges' are probably worthless.

Is it possible for this growth in credit derivative exposure to be associated with less risk? What sort of series of contracts would make this possible? (Or are we all doomed?)

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From the Congressional Oversight Panel report on TARP released today:

What does this mean in relation to the health of the big banks and global financial system? Denninger is as usual doomy about this. Here is his interpretation:

Is it possible for this growth in credit derivative exposure to be associated with less risk? What sort of series of contracts would make this possible? (Or are we all doomed?)

It's probably bad but doesn't necessarily have to be. A huge majority of these crazy numbers are all actually offsetting. I.e. AIG owes Goldman which owes Barclays which owes UBS which owes some Hedge Fund which owes RBS which owes.... and so on. No net exposure but gross exposure.

Gross exposure and gross notionals are meaningless in derivatives. This does however explain why CDS are going to be traded on exchange.

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It's probably bad but doesn't necessarily have to be. A huge majority of these crazy numbers are all actually offsetting. I.e. AIG owes Goldman which owes Barclays which owes UBS which owes some Hedge Fund which owes RBS which owes.... and so on. No net exposure but gross exposure.

Gross exposure and gross notionals are meaningless in derivatives. This does however explain why CDS are going to be traded on exchange.

This has been the usual reply, and the Lehman credit event seems to confirm this. But I wonder why the growth from 2007 - 09? What was the point?

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It's probably bad but doesn't necessarily have to be. A huge majority of these crazy numbers are all actually offsetting. I.e. AIG owes Goldman which owes Barclays which owes UBS which owes some Hedge Fund which owes RBS which owes.... and so on. No net exposure but gross exposure.

Gross exposure and gross notionals are meaningless in derivatives. This does however explain why CDS are going to be traded on exchange.

So if I had some of this and collapsed another bank/FI vendor then i'd be owed trillions?

Moral hazard ftw!

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It's probably bad but doesn't necessarily have to be. A huge majority of these crazy numbers are all actually offsetting. I.e. AIG owes Goldman which owes Barclays which owes UBS which owes some Hedge Fund which owes RBS which owes.... and so on. No net exposure but gross exposure.

Gross exposure and gross notionals are meaningless in derivatives. This does however explain why CDS are going to be traded on exchange.

sorry, AIG defaulted....course, it all balanced out....but wait...oh no it didnt... cos AIG owed Goldmans 10bn and Paulson arranged a bailout.

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