Credit Default Swaps

[LenaHuat]

By the time this is really enacted and enforced, the CDS market would have collapsed on its own vomit.

[mocca_com]

CREDIT MARKETS
U.S. sovereign-credit spreads rise sevenfold in year
Risk gauge outpaces measure of corporate-credit risk as U.S. bails out banks
By Laura Mandaro, MarketWatch
Last update: 7:19 p.m. EDT March 10, 2009SAN FRANCISCO (MarketWatch) -- The cost of buying protection against the risk that the United States will default on its mounting debt has surged in the past months, outpacing the rise in corporate-credit costs, now that the government has absorbed more private-sector debt.
The spreads on credit-default swaps for U.S. government debt jumped to 97 basis points Tuesday, nearly seven times higher than a year ago and 60% higher than the end of last year, to a level roughly in line with those of France, according to data supplied by Markit. The spreads also hit a record last week.
In contrast, an index that tracks the cost of buying credit protection against defaults on North American companies with investment-grade ratings -- the Markit CDX.NA.IG index -- has not even doubled in the past year. The index, which includes CDS on blue-chip companies like Altria Group and Bristol-Meyers Squibb Co, has risen 30% this year.
The spreads on credit-default swaps for U.S. government debt are 60% higher than the end of last year, at a level roughly in line with those of France.
Higher spreads on credit-defaults swaps indicate sellers have raised the price of guaranteeing protection because they perceive the likelihood of a default as higher. A spread of 97 means it would cost about $97,000 to buy protection on $10 million in U.S. government debt.
The rise in U.S. sovereign CDS spreads reflects the increasingly active role the United States has played in debt markets, according to Bank of America Securities analysts. In the past year, it's absorbed the toxic assets that led to Bear Stearns' collapse; taken mortgage-backed and asset-backed securities as collateral for loans; and bought commercial paper and agency debt, among other moves.
"Having effectively guaranteed the short-term markets, that risks shifts to the government," wrote Bank of America Securities-Merrill Lynch analysts led by Jeffrey Rosenberg, in a note issued early Tuesday.
Record highs not a good sign
The rising costs to buy credit protection undermine hopes that credit markets are improving -- a turnaround that could set up the U.S. economy and stock market for revival.
Such costs also reflect an increase in money spent buying the type of complicated derivatives that sent American International Group Inc. (AIG) , a seller of credit-default swaps, to ask for several rounds of bailout money last year -- one of the series of shockwaves that have hit the financial system.
The chance that a seller of CDS won't be able to make good on its commitment to cover an underlying entity's debt default, or what's known as counterparty risk, prompted "Black Swan" author and investor Nassim Taleb to describe CDS purchases as tantamount to buying insurance on the Titanic from someone on the Titanic.
Other gauges that track costs of credit protection also have been rising lately.
An index that tracks the costs of credit protection of 14 leading banks and brokerages -- including Bank of America Corp.Citigroup Inc. (CCitigroup Inc, Goldman Sachs Group and J.P. Morgan Chase & Co.-- hit a record high Monday, according to index publisher Credit Derivatives Research. See full story.
Spreads on U.S. sovereign CDS hit a record 100 basis points last week, Markit said.
Records aren't tough to come by in this relatively new market, though. Markit's vice president in credit research, Gavan Nolan, estimates that U.S. sovereign credit-default swaps have been trading with significant volume only in the past year and a half.
Over the past year, U.S. and European central banks have taken unprecedented steps to prop up the financial system.
The U.K. government has nationalized or bought large stakes in struggling lenders Northern Rock, Royal Bank of Scotland (UK:RBS: news , chart , profile ) and Lloyds Banking Group (UK:LLOY: news , chart , profile ) , and is buying government bonds to drive down rates.
Last month, the U.K. Office for National Statistics said the government injections into Lloyds and RBS would drive up the public sector's debt to as much as 1.5 trillion pounds -- or 100% of gross domestic product.
The United Kingdom's CDS spreads have vaulted to about 160 basis points, up 50% from the start of the year. That ranks the cost of buying credit protection on U.K. government debt as the second highest among G7 countries, behind Italy.
Federal Reserve Chairman Ben Bernanke on Tuesday reiterated the central bank's commitment to taking a heavy role in the banking system, saying major financial institutions would not be allowed to fail given the fragile state of financial markets. Read more on Bernanke.
"By effectively transferring the risks underlying the credit crisis to governments, sovereign risk becomes the focal point for credit uncertainty," the Bank of America analysts concluded. "On the road to recovery, now paved with sovereign risk."
Laura Mandaro is a reporter for MarketWatch in San Francisco.

http://www.marketwatch.com/news/story/C ... MidSection

[financecaptain]

Somehow, CDS for US sovereign risk just does not make sense if it is denominatd in US$ and protected amount is also US$. That is because government can never default; US government can always print $ to pay out any debts. It only affects value of US$, not ability of government to reapy.

So if sovereign risk on Franch or Singapore government on US$ repayment may make sense. But on US government ?

[winston]

European Commission To Back CDS Trading Ban As Second Round Of Strikes Cripples Greece;
Greek GDP Now Expected To Miss Worst Case Scenario

by Tyler Durden on 03/10/2010 22:35 -050

The Washington Post reports that the next "Lehman-sized" event may be just around the corner, as the European Commission is now supporting a ban on trading sovereign CDS.

http://www.zerohedge.com/article/europe ... k-gdp-now-

[winston]

Sep 15, 2011

The Markit iTraxx Financial Index of credit-default swaps insuring the senior debt of 25 lenders and insurers fell for a third day, dropping 10 basis points to 275, compared with a closing-price record of 314 on Sept. 12, according to JPMorgan Chase & Co.

The subordinated index declined 19.5 basis points to 498, signaling an improvement in investor perceptions of credit quality.

Source: Bloomberg

[winston]

Credit default swap index

There are currently two main families of CDS indices: CDX and iTraxx.

CDX indices contain North American and Emerging Market companies and are administered by CDS Index Company (CDSIndexCo) and marketed by Markit Group Limited, and iTraxx contain companies from the rest of the world and are managed by the International Index Company (IIC), also owned by Markit.

http://en.wikipedia.org/wiki/Credit_default_swap_index

[winston]

EU parliament bans 'naked' credit default swaps

STRASBOURG - The European parliament voted on Tuesday to ban 'naked' credit default swaps, a controversial financial instrument used by traders to bet on the risk of a country failing to pay off debt.

'For the first time, Europe will ban a financial product used to speculate on a country's debt,' Green group lawmaker Pascal Canfin, a leading negotiator for the legislation, told the parliament before the vote.

'This rule will make it impossible to buy CDS' for the sole purpose of speculating on a country's default,' the French MEP said.

Naked CDS instruments will be prohibited in the 27-nation European Union from December 1 under the rules adopted by an overwhelming majority, with 507 of 641 lawmakers present voting in favour.

The lawmakers also backed restrictions on the practise of short-selling company stocks from 2012. Short selling is defined as when a trader borrows shares that he expects to see fall, sells them, then buys them back when the price is lower to allow him to take a profit before settling the loan.

The parliament reached a deal with EU governments last month after long negotiations on banning naked CDS instruments, which were partly blamed for exacerbating Europe's debt crisis.

A CDS serves as an insurance against the risk of default by a company or a government. In a 'naked' CDS, the investors do not own the debt, betting they can purchase it later at a cheaper price if a default occurs.

Critics say 'naked' CDS allow markets to speculate on a government's chances of defaulting - something Greece has struggled to fend off since May 2010 - driving up pressure on such countries.

'It is only logical that CDS' on government bonds are meant for investors who actually have the respective government bonds,' said Markus Ferber, member of the conservative European People's Party, the parliament's biggest group.

'All else is pure market speculation that can have incalculable effects, as in the case of Greece, and ought to, therefore, be contained.

We need the new provisions to fight the sovereign debt crisis in the eurozone,' he said.

The European Commission presented new rules to better control CDS instruments in September 2010 at the request of French President Nicolas Sarkozy and German Chancellor Angela Merkel.

The European parliament had voted to ban 'naked' CDS on sovereign debt in July but some states including Italy were opposed, fearing that it would make it more difficult to borrow money.

A compromise was reached in the subsequent negotiations, allowing a national authority to lift the ban for up to 12 months, if its sovereign debt market is no longer functioning properly, and possibly extend the decision by six months.

Within 24 hours of a country lifting the ban, the European Securities and Markets Authority (ESMA) would issue an opinion on its website on whether the move is justified.

The Council of EU states is expected to formally approve the new regulation in the coming weeks.

Source: AFP

[winston]

When Greece Defaults, the Credit Default Swap Dominoes Fall

A default by any other name is still a default. When Greece defaults, the inter-connected chains of credit default swaps will fall like dominoes.

http://charleshughsmith.blogspot.com/20 ... fault.html

[kennynah]

talks about greece defaulting is on the table...

[winston]

Has Derivatives Deleveraging Fueled the Stock Rally?

A mad scramble to avoid insolvency as Greek default becomes likely may be driving the rally in equities.

Deleveraging typically means selling assets to raise cash to meet margin calls or pay debts coming due. But there may be another twist to deleveraging that has fueled the manic market rally since late December.

That's how the dominoes topple. Prudent institutions aren't waiting around until the dominoes fall--they're buying the underlying assets so they can meet their CDS obligations. That's the only way not to topple into insolvency when the default causes CDS to be recognized as due and payable.

In this light, it's no wonder stocks have been rising. If even a modest percentage of CDS are tied to stock indices, then those deleveraging their derivatives positions must acquire the underlying assets. They can no longer count on all counterparties paying off as promised, and so they are raising cash and buying the underlying assets needed to make good their obligations

http://charleshughsmith.blogspot.com/20 ... ueled.html