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Credit Swaps - £60 Trillion Debt - Why Is Not Made Of This?


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I remember years ago reading that Warren Buffet was cleaning out all the derivatives from his insurance company. If I remember right he spent a small fortune doing this. He is a flipping genius. They should beg him to be Treasury Secretary.

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CDOs Imperiled by Collapse of Iceland Banks, S&P Says

CDOs Imperiled by Collapse of Iceland Banks, S&P Says (Update1)

By Shannon D. Harrington

Oct. 16 (Bloomberg) -- Iceland's collapsed banks pose a ``substantial'' risk to collateralized debt obligations that made bets on corporate debt, according to Standard & Poor's.

Kaupthing Bank hf, Landsbanki Islands hf and Glitnir Bank hf were included in 376 CDOs worldwide, S&P said. Another 297 made bets on two of the three banks. The CDOs packaged credit-default swaps that pay investors if there is a default, and the government's placement of the banks into receivership triggered a settlement of the contracts.

Because the so-called synthetic CDOs also bet on Lehman Brothers Holdings Inc., which filed for bankruptcy on Sept. 15, and Washington Mutual Inc., the bankrupt holding company of the largest U.S. lender to fail, the ``impact of these exposures is likely to be significant,'' S&P said in the statement yesterday.

KBC Group NV, Belgium's biggest financial-services company by market value, yesterday wrote down 1.6 billion euros ($2.15 billion) on its CDOs. Moody's Investors Service said Oct. 14 that it's reviewing 2.88 billion euros of the Brussels-based lenders' five CDOs linked to Icelandic banks.

Iceland's bank regulator took control of the country's three biggest lenders last week when they couldn't secure short-term funding on their about $61 billion of debt. The nation's benchmark stock index plunged 77 percent on Oct. 14, the biggest decline on record, after trading resumed following a three-day suspension.

Iceland Default Swaps

The cost of hedging against default by the Icelandic government has soared to 948 basis points, according to CMA Datavision prices for credit-default swaps. That means it costs 948,000 euros a year to insure 10 million euros of debt for five years. It compares with 118 basis points for the Czech Republic and 238 basis points for Morocco.

Sellers of credit-default swap protection must pay the buyer face value in exchange for the underlying securities or the cash equivalent after a bankruptcy filing.

Many of the deals also will lose payments and loss cushions from contracts linked to Fannie Mae and Freddie Mac, the mortgage-finance companies seized by the U.S. government last month. The takeovers caused a technical default on the credit swaps.

The CDOs sell notes to investors that are repaid using the proceeds of credit-default swap premiums. Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt.

The cost of protecting corporate bonds from default rose today on investor concern a global recession will sap earnings and companies' ability to repay their debt.

The benchmark Markit iTraxx Crossover Index of 50 European companies with mostly high-risk, high-yield credit ratings jumped 23 basis points to 737, according to JPMorgan Chase & Co. prices at 9:32 a.m. in London. In Tokyo, the iTraxx Japan climbed 23 basis points to 208, Morgan Stanley prices show.

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CDSs are just bets.

I bet you £1000 that Barclays will go bust this year and you offer me odds of 100-to-1 that they wont.

I give you the £1000 and you give me a betting slip.

It's just like being at Ladbrooks betting on the horses.

If Barclays don't go bust, you keep my £1000. If they do, you pay me £100,000.

Some banks and investment/hedge funds have made huge bets that other banks will go bust, and other banks and investment/hedge funds have made absolutely humongous bets that they wont.

WTF supposedly respectable financial institutions were doing taking wagers from each other I'm not sure, but it will all be fine as long as no-one goes bust or defaults...

...you see the banks taking the money and giving out the betting slips saw it as a one way bet... no banks would ever go bust or default... so they didn't need to keep any cash in to cover possible payouts... they just called it "profit" and paid themselve multi-billion pound bonuses.

governments have a bo. of options:

1. they could cancel CDS 'bets' on banks going bust, in the same way they stopped shorting.

2. coupled to this, they could cancel all CDS's placed by anyone that aren't directly associated with the 'benefit' of the business.

3. they could cancel them all full stop.

I've had insurance for things where the insurance company tries to avoid paying out. If they don't I either go to court or write it off as experience. It doesn't make me bankrupt. The same will happen with the CDS market.

Invest in financial law firms. Either as a share or ironically as a CDS.

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I remember years ago reading that Warren Buffet was cleaning out all the derivatives from his insurance company. If I remember right he spent a small fortune doing this. He is a flipping genius. They should beg him to be Treasury Secretary.

Not sure where you read that

http://seekingalpha.com/article/66967-warr...so-a-put-seller

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governments have a bo. of options:

1. they could cancel CDS 'bets' on banks going bust, in the same way they stopped shorting.

2. coupled to this, they could cancel all CDS's placed by anyone that aren't directly associated with the 'benefit' of the business.

3. they could cancel them all full stop.

I've had insurance for things where the insurance company tries to avoid paying out. If they don't I either go to court or write it off as experience. It doesn't make me bankrupt. The same will happen with the CDS market.

Invest in financial law firms. Either as a share or ironically as a CDS.

but the cds's were considered assets and loaned against I believe.

you may not go bankrupt if an insurance company doesn't reimburse you for fire damage to your house, but if you have used that insurance contract as collateral to take out more loans on other assets, it surely could.

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but the cds's were considered assets and loaned against I believe.

you may not go bankrupt if an insurance company doesn't reimburse you for fire damage to your house, but if you have used that insurance contract as collateral to take out more loans on other assets, it surely could.

Yep - and that's the bit that baffles me. How was it made possible for these so called insurance contracts to become tradeable financial paper?

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Yep - and that's the bit that baffles me. How was it made possible for these so called insurance contracts to become tradeable financial paper?

it's the same as if you went to the races and bought a ticket for number 3 to win in the fourth race.

sometime before the race you change your mind and lose all faith in number 3.

your friend, however, is willing to buy the claim check off of you because he still thinks number 3 will win.

the cds's work just the same way.

they have a monetary value since there is a chance that they might pay out eventually.

Edited by Mr Nice
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it's the same as if you went to the races and bought a ticket for number 3 to win in the fourth race.

sometime before the race you change your mind and lose all faith in number 3.

your friend, however, is willing to buy the claim check off of you because he still thinks number 3 will win.

the cds's work just the same way.

they have a monetary value since there is a chance that they might pay out eventually.

Sure, but while the initial insurance contract is a worthwhile and sensible hedge against risk of default, trading the cotracts is pure speculation. We may just as well have tradeable motor insurance policies, hadn't we? That way we can all speculate on who may or may not write-off their vehicle.

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Sure, but while the initial insurance contract is a worthwhile and sensible hedge against risk of default, trading the cotracts is pure speculation. We may just as well have tradeable motor insurance policies, hadn't we? That way we can all speculate on who may or may not write-off their vehicle.

being able to trade the contracts isn't necessarily bad.

say you buy some Ford Motor bonds, an take you some insurance against them as a hedge.

you might very well decide to sell the bonds for whatever reason, and you wouldn't need the contract anymore.

you would just sell it on to someone else that is looking for Ford Bond protection.

theoretically, you could sell your insurance that you had on your vehicle.

say you had paid off the premiums for a year in advance, there is nothing really stopping you from entering into a contract with a friend who thinks you drive poorly that says that if he gives you say 100 pounds now, you will sign over the right to collect on any payout that happens over the next year.

Edited by Mr Nice
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Can the governments not just out-law them as a threat to global stability or something ? Although you would think they would have done this already if it was an option ?

Perhaps a clearer distinction between gambling and banking would have been helpful. The two should have been separate.

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What we are saying is it just about impossible to value a hedge funds exposer to the risks as they take out counter bets on large CDS and use some as collateral to borrow money from banks whilst gambling on the FTSE 100.

Peoples pensions are going to all become worthless as they become scape goats for the banking industry.

Brown you sure as hell have stuffed the public up the a$$ and they don't even know it yet.

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The global economy is valued at 57 trillion dollars.

Out in the world now there is 80 trillion is CDO's / CDS's

Lehman went down and took Iceland down.

The whole world will probably be next.

The USA can't default due to it's position of currency, they'll just print an inflate.

Uk is next in the firing line, but probably the EU will bite.

Would be interesting to see how Asia handles this though.

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Fears of Lehman's CDS derivatives haunt markets

By Ambrose Evans-Pritchard

Last Updated: 12:18AM BST 17 Oct 2008

It is a full week after bankers gathered in New York to start sorting out the derivatives mess left by the bankruptcy of Lehman Brothers. We still do not know who is on the hook for some $360bn of default insurance, or how much they will have to pay.

Lehman Brothers former chief executive Dick Fuld has faced heavy criticism Ominous talk of big names and big sums continues to haunt global markets, thwarting efforts by the US and European authorities to unlock inter-bank lending. Traders have noted with acute interest that insurer AIG - now nationalised - says it will need another $38bn from the US government, on top of the $85bn bail-out it has already received. AIG is the world's biggest underwriter of credit protection.

Those on the wrong side of these Lehman debt contracts - known as credit default swaps (CDS) - must come up with the money by Tuesday, the next D-Day in the ever-fraught calendar of the credit markets. There has been a deafening silence so far.

There is no easy way of finding out who they are, so every bank and insurer is suspect. The $55,000bn CDS market is "completely lacking in transparency and completely unregulated" in the words of Chris Cox, the chairman of the US Securities and Exchange Commission.

The settlement auction on Lehman CDS contracts last week was in itself a bombshell. Creditors retrieved just nine cents on the dollar from the Lehman wreckage. As Naked Capitalism put it, the bank had "vaporised". The biggest players at the auction were Goldman Sachs and Deutsche Bank but they were almost certainly transacting for clients.

The insurers of the debt -- a third are hedge funds -- will have to pay 91pc of the $400bn in contracts.

The Depository Trust and Clearing Corporation says the risks have been exaggerated in headline scare stories, insisting that the total sum to be paid will be closer to $6bn. It says most positions are "netted out".

"That's not credible," says Andrea Cicione, credit chief at BNP Paribas.

"They keep coming up with these number by 'netting' but we think the amount is going to anywhere from $220bn to $270bn. The chain broke in the CDS market when Lehman Brothers went down. We may now see other counter-parties defaulting," he said.

With hindsight, it is now clear the decision to let Lehman Brothers go bankrupt set off a melt-down of the world financial system, forcing North America, Britain, Europe, Australia, and now parts of Asia to rescue their banks. "A dramatic error," said Christine Lagarde, France's finance minister.

US Federal Reserve chair Ben Bernanke said this week that Washington lacked the legal power to take on the vast liabilties stemming from a Lehman rescue.

"A public-sector solution for Lehman proved infeasible, as the firm could not post sufficient collateral to provide reasonable assurance that a loan from the Federal Reserve would be repaid, and the Treasury did not have the authority to absorb billions of dollars of expected losses to facilitate Lehman's acquisition by another firm. Consequently, little could be done," he said. The new legislation passed by Congress "will give us better choices."

In truth, both Congress and the US public wanted a scalp. Treasury Secretary Hank Paulson had to bide his time until it was clear to almost everybody that a domino collapse of the US banking system would lead to catastrophe. The Lehman collapse did the trick.

The list of companies admitting to losses on Lehman investments reveals the global extent of the damage. Dexia held €500m of bonds, which may have caused its own need for a Franco-Belgian rescue days later.

Among the others with declared exposure: Swedbank $1.2bn; Freddie Mac $1.2bn; State Street $1bn; Allianz €400m; BNP Paribas €400m; AXA €300m; Intesa Sanpaolo €260m; Raffeissen Bank €252m; Unicredit €120m; ING €100m; Danske Bank $100m; Aviva £270m; Australia and New Zealand Bank $120m; Mistubishi $235m; China Citic Bank $76m; China Construction Bank $191m, Industrial Commercial Bank of China $152m and Bank of China $76m. Ultimately, some money may be recovered.

These losses are out in the open, but the CDS shoe has yet to drop. Perversely the insured volume is greater than the $150bn total of Lehman debt. Some $400bn of CDS contracts were sold. Many were used by hedge funds to take "short" bets on the fate of the bank. The contracts nevertheless have to be honoured.

Chris Whalen, head of Institutional Risk Analytics, says this creates a huge moral dilemna. Why should taxpayers now responsible for AIG foot the bill for huge windfall transfers to hedge funds?

"We need to shut this whole thing down. The people who don't own the underlying collateral and were just betting should be flushed away. It would be grotesque if the US authorities were now to subsidize speculators. The US political class is waking up to this," he said.

If so, the winners may have more trouble than they realize collecting their prize.

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There are some very clever and very knowledgable people on this site.

Please - you helped me understand less than 2 months ago what these were - please, I'm concerned - how is it that this is being ignored by the government, the press and the public at large when it could implode and cause more problems than the current "credit crunch".

Brown says he'll do anything - but how can he raise £60 trillion of tax payers' money to prevent the banks going bust?

Surely, they ARE going to go bust once this all comes out - how can it not?

Lastnight I heard it mentioned on Newsnight - they did a bit - but didn't go the full length.

Then - it made Channel 4 news - but still - it was just touched on - not made a feature of.

Wasn't on the BBC main news or News at Ten.

Someone hinted on this site here yesterday that if it makes it on the main news programmes - BBC at 6 0'clock or 10-clock and News at Ten - that is the point at which it really is a crisis and it the s**** will really hit the fan.

At the moment talk is of pending recession.

But given the trillions in these Swaps - what potentially could happen to our society when suddenly everyone realises that these are the thing - not subprime that will bring countries down?

Why is so little being talked about on this subject as it seems to me as a layman - this REALLY is the nub of it all and will come out - and best would be to come out sooner rather than later.

Or can they be absorbed into the current mailstrom of banking and financial disaster?

Thanks guys for your opinion.

Heather, may I suggest you find yourself a good book on CDS and immerse yourself in it over the weekend. Maybe visit Markit.com and do some reading there. Then form an opinion.

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being able to trade the contracts isn't necessarily bad.

say you buy some Ford Motor bonds, an take you some insurance against them as a hedge.

you might very well decide to sell the bonds for whatever reason, and you wouldn't need the contract anymore.

you would just sell it on to someone else that is looking for Ford Bond protection.

theoretically, you could sell your insurance that you had on your vehicle.

say you had paid off the premiums for a year in advance, there is nothing really stopping you from entering into a contract with a friend who thinks you drive poorly that says that if he gives you say 100 pounds now, you will sign over the right to collect on any payout that happens over the next year.

Okay, but why not just go for a return of premium if the insured asset is sold on and the insurance is no longer required? That's what generally happens, isn't it? Apart from credit default insurance, that is.

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Heather, there's some useful info (well I found it useful) on this blog: http://infoproc.blogspot.com/2008/09/notio...-our-enemy.html

As I understand it and I could be very wrong here, investments in debt-based stuff that were rated as poor (BBB etc) by the credit rating agencies require substantial (to the order of 350%) capital to be held by the investor (Bank). In order to avoid setting aside such amounts, the current Basel regulations allow them to "hedge" using these type of instruments, which improves the credit rating of the debt-based stuff, to say AAA and reduces the required set-aside capital, to something considered much more reasonable (like 10%). So, I suspect cancelling them would make a few more bankers choke on their latte's.

Edited by espada
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