Credit Default Swaps???
June 23rd 2008 18:48
Credit Default Swaps (CDS) are a $62 Trillion pile of derivatives that are unregulated and non-standard. The pile has grown tremendously since mid-2007's $45 Trillion! Many worry that the danger here is many times higher than the sub-prime mortgage mess.
(Click here for larger image)
There are some who believe that the takeover of Bear Sterns was prompted by the prospect of failure of its CDS and the fear that the whole financial house of cards would crash down..
F. William Engdahl gives the best definition I've read of CDS:
Federal Reserve Vice Chairman Donald Kohn talked about derivatives on Friday, specifically a clearing house to be set up where "credit default swaps" will be traded.
Engdahl says that CDS resemble flood or natural disaster insurance policies, protecting against default of major corporate bonds, yet unlike insurance policies there are no reserves set aside in case disaster strikes.
The CDS written are very complicated and it is not always clear who is on the hook as a counter party.
A central clearing house is not supported by many. They fear that the clearing house will concentrate the risk further and the only entity that could backstop the clearing house would be the Federal Reserve and the American taxpayer.
There are some who believe that the takeover of Bear Sterns was prompted by the prospect of failure of its CDS and the fear that the whole financial house of cards would crash down..
F. William Engdahl gives the best definition I've read of CDS:
Credit default swaps (CDS) are credit derivatives or agreements between two parties, in which one makes periodic payments to the other and gets promise of a payoff if a third party defaults. The first party gets credit protection, a kind of insurance, and is called the "buyer." The second party gives credit protection and is called the "seller." The third party, the one that might go bankrupt or default, is known as the "reference entity."
Federal Reserve Vice Chairman Donald Kohn talked about derivatives on Friday, specifically a clearing house to be set up where "credit default swaps" will be traded.
Kohn said establishing a centralized clearing system for the $62 trillion CDS market would not require action by Congress, but he said it would need regulatory approval.
Engdahl says that CDS resemble flood or natural disaster insurance policies, protecting against default of major corporate bonds, yet unlike insurance policies there are no reserves set aside in case disaster strikes.
The CDS written are very complicated and it is not always clear who is on the hook as a counter party.
In a typical CDS deal, a hedge fund will sell protection to a bank, which will then re-sell the same protection to another bank, and such dealing will continue, sometimes in a circle. Such trades create a huge concentration of risk.
A central clearing house is not supported by many. They fear that the clearing house will concentrate the risk further and the only entity that could backstop the clearing house would be the Federal Reserve and the American taxpayer.
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