credit default swaps

CDS = WFMD, An Example Case

I've been catching up to my reading and came across an incredible story in FT which makes a prima facie case for the very strict regulation of credit default swaps. Here's the gist of it:

As the financial crisis virus has swept around the globe in recent months, Kazakhstan’s banking sector has been engulfed in turmoil. This is not just creating a headache for the Kazakh government and Western creditors, but also highlighting issues about the credit derivatives market that extend well beyond those far-flung steppes.

Take the case of Morgan Stanley’s dealings with BTA, Kazakhstan’s largest bank. A few years ago, BTA – like many of its Eastern brethren – was an up-and-coming darling of the capital markets world, with investment bankers furiously competing to float its bonds, provide loans, and much else.

Exchange system approved for Credit Default Swap mess

The government finally approved an exchange for trading Credit Default Swaps. With so many financial institutions, from banks to hedge funds, holding on to these things, the question has been how to finally close out all these trades. A lot of the issuers can meet their obligations on these trades, and a lot of buyers of CDSes tied up a lot of their capital into these instruments. Everyone wants out, but there hasn't been an exit until now.

Frankly, I'm glad we're going to have an exchange, it should have been done this way from the beginning.  Everyone's stuff will be in the open, let the various market participants do this, not the government.  I would rather these folks close out their trades between themselves than having the government buy them and deal with it.  Also, this will open the way for a future Credit Defualt Swap product that would be more fungible.

Casino Swaps

A recent article from reporters Salas and Harrington at Bloomberg pointed to a new dimension in the ever expanding saga of credit default swaps and the enormous damage they have done and continue to do to the economy. The crux of the matter is that bond traders who own swaps have a strong incentive to drive distressed companies into bankruptcy. It’s profitable. In something akin to debt arbitrage, traders buy debt at a fraction of its full value, and buy the swap at a fraction of its payoff value, and if the sum of the two is several points less than the full value of the debt, they profit by either waiting for the difference to narrow or by driving the company into bankruptcy. No wonder Buffett called derivatives weapons of financial mass destruction. But it gets even better. According to the article, a strategist at CreditSights Inc.

ON FDL: Bad Bank or Nationalization: What will CDSs Cost Us?

On FDL, masaccio peers into the financial statements of Citi and Bank of America, to determine Bad Bank or Nationalization: What will CDSs Cost Us?masaccio. Suffice it to say that if the credit default swaps are honored, it's going to cost A LOT of money. Cram down, anyone? I think the answer is discussed in Institutional Risk Analytic's interview, The Big Banks vs. America: A Roundtable with David Kotok and Josh Rosner.

There is one notable quote from masacci, which is actually pulled from a Financial Times article:

Hear Comes the Hearings - Investigations Start on Credit Default Swaps

U.S., Cuomo Open Credit Default Swap Investigation:

The U.S. government and New York Attorney General Andrew Cuomo opened a joint investigation into the $34.8 trillion credit-default swap market, the top federal prosecutor in New York said

Might be a scapegoat witch hunt though for they are targeting short sellers.

New York Times:

Mr. Cuomo and Mr. Garcia are investigating whether investors drove up the price of swaps in transactions that were reported to data providers but never actually completed, according to people briefed on the investigation. If so, that would have helped anybody who sold short financial shares. In a short-sale, investors sell stocks they do not own in the hopes of buying them back later at a lower price.

Cox Wakes Up? - SEC Chair Says Credit Default Swaps Must be Regulated....Now!

Rip Van Winkle
Rip Van Winkle SEC Chairman Cox magically sees the light.

CDSes Must Be Regulated:

U.S. Securities and Exchange Commission Chairman Christopher Cox said Congress should grant authority to regulate the credit-default swaps market amid concern the bets are helping fuel the global financial crisis.

Lawmakers should ``provide in statute the authority to regulate these products to enhance investor protection and ensure the operation of fair and orderly markets,'' Cox told the Senate Banking Committee today at a hearing in Washington.