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The International Swaps and Derivatives Association ruled yesterday that the Greek debt restructuring deal will trigger about $3 billion in credit default swaps, a tiny fraction of the total CDS insurance on the loans. This makes the debt swap a partial “credit event,” or default.
Billions of dollars are to be paid out in insurance-like instruments as Greece on Friday pressed ahead with the largest ever sovereign debt restructuring. In a test case for markets, the International Swaps and Derivatives Association, the derivatives trade body, announced there would be a pay-out, or credit event, for holders of credit default swaps.
It means there will be a net pay-out of about $3bn on CDS contracts, according to the data warehouse Depository Trust & Clearing Corp, in a boost for the relatively new market in sovereign debt protection that could also benefit eurozone debt markets amid worries that a failure to trigger could have undermined an important hedging instrument for holding government bonds. However, there was a long delay over the decision by the ISDA determinations committee, which is made up of 15 global banks and investment funds, that annoyed some investors. Uncertainty still hangs over the CDS market as an auction process to decide the amount of pay-outs may not take place for another week.
Bill Gross, who runs the world’s biggest private bond fund at Pimco, warned that CDS had been undermined by the saga. “The rules have been changed here,” he said in a radio interview. “The sanctity of their contracts is certainly lessened.”
But Robert Pickel, chief executive of ISDA, said: “I think the CDS market will come out well from this because we stayed to the letter of the contracts. The key thing was that a credit event could not be triggered until it was binding on all holders of the bonds. It would have been premature to trigger a credit event before now.”
I actually think the ISDA is correct in the sense that they held off on calling the situation a credit event until bondholders were told they would receive less on the dollar for their loans (through the collective action clause in their bond contracts), rather than agreeing to participate. In fact, under North American rules, Felix Salmon notes, restructuring wouldn’t have counted as a credit event at all.
Yet Bill Gross is right as well. The rules have changed. Only a portion of the CDS market got paid out. The ISDA never had to confront the default of a sovereign country like Greece before, and they did sort of make it up as they went along. They achieved their desired result in a stumbling manner. And Felix writes that this could end up fatal to the CDS market:
Going forwards, then, I can’t imagine that investors will have much if any confidence that CDS will really perform the hedging function they’re designed for. My feeling is that if you look at the numbers for total single-name CDS outstanding, they’ll decline steadily from here on in. Because you ultimately can’t trust them when you really need them.
I certainly hope so! Because CDS are completely dangerous. What’s more, as we saw with the AIG debacle, if the market fails, governments will come in and pay off the CDS at par, so they become just another part of the Too Big to Fail apparatus. Loosely regulated side markets that reach into the trillions of dollars might be good for the people who service the contracts and take a commission, but their value for the world is dubious.
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Good post. The fallout will interesting.
The whole CDS, MBS, CDOs are paper gambling. 700 Trillion in black market. Risking the global economy on the whims of gambler is insane.
Taking large risks is one thing. Especially if its with your own money. This however is just stupid. By giving them a form or insurance and telling them ‘Don’t worry, you won’t lose your shirts because someone is watching your back.’ they take worse and worse risks. We’re the idiots that have to pay for their ‘fun’.
If nasty to think this because of the pain for the innocent that will occur but I hope the whole damn system comes down. I may be conservative but even I know we can’t go on as is. Let it fall and use the pieces to build something better.
The money “game” is going to collapse, tps, damaging civil society and many essentially innocent human beings beyond our imagining.
Frankly, however, there does not appear any way in which the economic “system” and the “legal” and “political”, contingent “systems”, which the politcal-economy, to use an archaic term, has quite corrupted, may right themselves. The clear intent of what Adam Smith called “the Masters” is to create an overarching neo-feudal system, resulting in serfdom for the many and with the destruction of the Rule of Law, unlimited power and unfettered greed for the elite, “astute”, few, as well as endless, everywhere, warfare.
If you are a true conservative, of the old school, then you will, likely, find warm welcome and shared viewpoints among many here.
I do not recognize your “handle” and therefore assume that you are “new” to the lake.
DW
CDSs are a totally unregulated, private contract “dark market”. Why ANY government or central bank would want to backstop this mess is beyond belief.
No doubt there will be some pain letting this $700 trillion whirling ball of shit die, but maintaining it on the backs of the world’s 99% is even worse. After all I have yet to meet one person who was affected by the Lehman implosion (and I do ask).
With this crapping on the bond holders, from several directions, who will they get to finance “sovereign debt” in the future from the deadbeats-in-waiting (Spain, Portugal, Italy, and others from the Euro poodles kennel?
As Argentine and Russian defaults have shown, the same folks will be back to buy more debt as they either chase a risk premium or they finance the sale into the country of a controlled by the rich in their country company’s goods (as Germany did with Greece – financing German sales into Greece when Greece could not afford them – heck Germany is now pissed that they can’t sell old navy ships that should be scrapped into the Greek naval defenses).
While not a person, I am aware that the City of Vacaville Cailifornia had to write off 2 million dollars in 2009-10 (fiscal years) of Lehman Bros. Investments.
Why, yes (in case you were wondering), they have, and continue to ask for deep employee concessions since 2008.
Union contracts have been broken time and time again. Never heard Gross whine about those contracts.
Just shows you the banksters will screw anyone and everyone, including a fellow bankster!
Risk spreading is very convenient for non-conspirator impoverishment.
From “Seeking Alpha” about one year ago:
“”"”"”Ben Bernanke is a stooge and a fraud, but he is at least partially honest in his explanations of why he wants to keep printing money. The reason is to try to keep interest rates low. Granted, he’s failing miserably at this, but at least he understands the goal.
Of course, Bernanke tells the public and Congress that the reason we need low interest rates is to support housing prices. He doesn’t mention that $188 TRILLION of the $223 TRILLION in notional value of derivatives sitting on the Big Banks’ balance sheets is related to interest rates.
Yes, $188 TRILLION. That’s thirteen times the US’ entire GDP, and nearly four times WORLD GDP.
Now, of course, not ALL of this money is “at risk,” since the same derivatives can be traded/spread out dozens of ways by different banks as a means of dispersing risk.
However, given the amount of money at stake, if even 4% of this money is “at risk” and 10% of that 4% goes wrong, you’ve wiped out ALL of the equity at the top five banks.
Put another way, Bank of America (BAC), JP Morgan (JPM), Goldman (GS), and Citibank (C) would CEASE to exist.
If you think that I’m making this up or that Bernanke doesn’t know about this, consider that his predecessor, Alan Greenspan, knew as early as 1999 that the derivative market, if forced into the open and through a public clearing house, would “implode” the market. This is DOCUMENTED. And you better believe Greenspan told Bernanke this.
In this light, all of Bernanke’s monetary policies and efforts are focused on doing one thing and one thing only: trying to shore up the overleveraged, derivative-riddled balance sheets of the Too Big to Fails, or Too Bloated to Exist, as I like to call them.
The fact that the bank executives taking this money and using it to pay themselves and their employees record bonuses only confirms that these folks have NO interest in taking care of shareholders or their businesses. They’re just going to take the money and run for as long as this scheme works.
I don’t know when this will come unraveled. But it WILL. At some point the $600+ TRILLION behemoth that is the derivatives market will implode again. When it does, no amount of money printing will save the Too Bloated To Exist banks’ balance sheets.
At that point, it’s game over for Wall Street and the Fed.”"”
Makes you see the whole phoney keep interest rates low for the homeowner “thing” in a whole different light doesn’t it???
I would guess that this admission comes after months of feverish calculations aimed at divining the likely results of the netting process that it is hoped will leave all the CDS sellers still capable of remaining in business.
Keep in mind that the ‘about $3 billion’ figure surely represents an optimistic estimate of liability after settlement of contracts representing a much higher total notional value.
If the assumed payout turns out to be 5% of the total notional value of contracts outstanding, this would mean that there were $60 billion in wagers related to the Greek default, but we have no way of knowing what was bet because the CDS market is not transparent.
I would guess that the eventual payout is not quite as predictable as some would like to paint it, and so there’s more than a few fingers crossed.
Some of these TBTF banks that have been selling CDS contracts may not have been as good at hedging their own positions as others and so what we’re seeing may well be considered a real-life stress-test.
Will the netting process result in a 2% payout on the notional value, or will it be 5-10%, and which bank made a mistake in their risk calculations?
Some people around here keep saying the numbers don’t mean anything because what we’re talking about is ‘only’ notional value.
I’d like to remind tham that a payout of ‘only’ 10% of notional value of that $600-1000 TRILLION is more than the world GDP, and as you say would make all those TBTF banks go extinct in a NY second as you point out.
Now somebody is going to say they’ll never have to payout anything near 10%, to which I reply, even a 1% payout would be enough to end their game.
And guess what, anybody stupid enough to build this sort of risk into their business model is obviously too stupid to achieve even a 99% hedge.
The only problem with CDS’s is the possibility that those who sold them will not be able to pay out some or all of the claims. And it should be the buyers’ responsibility to ensure that they seller can pay. And that goes for any kind of insurance. Everyone should be vigilant about what their insurance policies are able and willing to provide.
What can be said about this sort of thinking?