Credit Default Swaps

Joint probe of CDS market underway

Jim Kim — Mon, 20 Oct 2008 07:51:54 -0400

In a collaboration that the New York Times calls unusual, New York state and federal prosecutors are joining forces to investigate possible manipulation in the market for credit default swaps. The focus seems to be on whether dealers artificially boosted the price of CDS on some bonds by reporting trades that never really happened. Data has been sought from Markit, the DTCC and Bloomberg. We'll see where this goes. The view seems to be that the market is so sprawling that joint action is the only way to go. Recall there's been some tension between the two camps, back when Eliot Spitzer regularly upstaged his federal counterparts. This could get interesting and just might fuel the movement to transition the market to an exchange.

For more:
- here's the article

Is the U.S. a suspect credit risk now?

Jim Kim — Wed, 01 Oct 2008 15:02:57 -0400

One good thing about the maligned credit default swaps market is that it allows people to make targeted bets--or buy specific insurance--on just about any bond that trades. It thus offers a barometer of strength that now rivals the stock market in terms of influence. Lehman Brothers and Bear Stearns were done in by the CDS market, as well as the stock market. Which brings us to Treasury debt. No one really thinks the U.S. is going to default, but Fortune notes that prices of CDS on Treasuries really spiked this week, hitting a record 31.3 basis points--compared to as little as 7.5 basis points in January (CMA DataVision). So now we have a barometer of what Wall Street thinks about the on-going efforts to bailout troubled banks.

For more:
- here's the Fortune article

The future of AIG?

Jim Kim — Wed, 17 Sep 2008 13:42:08 -0400

AIG survives, but it will be a shell of its former self. Which may not be a bad thing. In agreeing to to an $85 billion bridge loan from the government, the insurer basically gave up operational control. The Federal Reserve could end up owning as much as 80 percent of the company, reports Fortune. The deal also requires AIG to sell businesses to raise capital, and to repay the debt. One unit that is toast: AIG's Financial Products unit, once hugely profitable thanks to the insurance guarantees it sold on credit default swaps tied to mortgages. Most people are guessing assets will be sold at fire sale prices. Just look at Lehman's pitiful deal for its investment bank. AIG competitors will be forced to take a hard look at some assets. You can bet jobs will be at stake.

For more:
- here's the article

Related Article:
Regulators change tune, bail out AIG

CDS spreads continue to widen

Jim Kim — Wed, 17 Sep 2008 09:30:29 -0400

The Lehman Brothers news, the AIG fiasco and the Merrill Lynch deal offer up quite a cocktail for the markets to digest. It's fair to say that there's a lot of acid in stomachs out there, still. Credit Derivatives Research's Counterparty Risk Index, which tracks credit default swaps on 15 leading financial firms, has been soaring. As you would expect, spreads on AIG CDSs soared thousands of points. The fear is palpable. In addition, the two remaining independent investment banks, Morgan Stanley and Goldman Sachs, have also seen their spreads widen a bit. The gut-wrenching turn of events may create some lasting uncertainty. It's hard to see what will offer any real salve in the immediate future.

For more:
- here's the article from MarketWatch

Bank to tie hedge fund lending to their own CDSs

Jim Kim — Mon, 18 Aug 2008 18:34:53 -0400

The Financial Times reports that Morgan Stanley and Goldman Sachs have developed systems that tie their lending commitments to hedge funds to the value of their own credit default swaps. As the price of CDS "insurance" grows, the amount they are willing to commit declines. Goldman Sachs already has a similar arrangement in place that ties lending to its bond prices. This is certainly an understandable outgrowth of that. Presumably, there will be a high level of transparency, such that all funds know when various triggers are being reached--to facilitate an orderly unwind. CDSs can really whip around when sentiment shifts. The FT suggests also that the move toward using CDSs instead of bonds is yet another indication that derivatives markets have replaced rating agencies as measures of creditworthiness.

For more:
- here's the FT article

The greatest short bets of all time

Jim Kim — Mon, 11 Aug 2008 10:06:29 -0400

When John Paulson, of Paulson & Co., bet against mortgage-backed collateralized debt obligations, he didn't hold back. His funds shorted the ABX and longed various credit default swaps--and it paid off. His $15 billion profit in 2007 is the stuff of legends. According to Business Week Online, it ranks up there with the greatest short bets of all time. George Soros is mentioned for his now legendary bet against the British pound just before it dropped out of a fixed exchange rate system. His $1 billion gain in 1992 gave him the title of "The Man Who Broke the Bank of England." Then there's Jim Chanos, the famous short, who bet correctly that Enron would collapse. Bill Ackman is noted for his big winning bet that MBIA' stock would tank.

For more:
- here's the package

New index on counterparty risk: A new way to hedge

Jim Kim — Thu, 19 Jun 2008 07:22:55 -0400

As Wall Street banks have made clear recently, hedging against more credit turmoil is not easy. A lot of hedges have gone bad, leading to some huge losses, even at Goldman Sachs. Financial News Online reports on a new tool: A new index from Credit Derivatives Research that tracks counterparty risk as reflected by average spreads of 5 year credit default swaps for top 15 banks and brokers that operate in the market. If a bank can't pay its own debt holders, it can't make good as a counterparty. So this approximates aggregated risk as opposed to bank-specific risk. There are no exchange-based products or derivatives tied to the index as of yet. But I'm sure that is coming.

For more:
- here's the Financial News Online article

Pain of hedging revisited

Jim Kim — Fri, 13 Jun 2008 12:56:12 -0400

We've noted recently that hedging in the corporate world at large is a tricky business. Some companies, like Southwestern Airlines, have pulled it off. Others, like Bunge, have failed miserably. On Wall Street, broken hedges likely will add to the losses at top banks. Which brings us to bond insurers. The Financial Times reports that top banks--the likes of UBS, Citigroup and Merrill Lynch--stand to lose billions from the recent downgrades by Moody's and Standard & Poor's of bond insurers. The banks had hedged CDOs with the insurers via credit default swaps, the valuations of which are affected by the bond insurers' credit rating. You can't blame the banks for wanting to hedge, but it's not easy in this environment.

For more:
- here's the article

What is the nightmare scenario for the CDS market?

Jim Kim — Mon, 02 Jun 2008 21:33:30 -0400

The sheer size of the market for credit default swaps makes people nervous. But what is the nightmare scenario? What would bring the market to its knees? You might think it would be wave of defaults. But Moody's argues that the biggest danger to the market stems from the potential for failure of a major investment bank. Financial News Online notes participants tend to run flat books, basically offsetting most of their position risks. But if a big counterparty bank were to fail it would rock the system. Havoc might ensure as people wondered if the contracts were at all binding. The lack of a clearing mechanism certainly wouldn't help if people tried to exit positions en masse.

For more:
- here's the Financial News Online article

Related Article:
CDS market creaking?

Oaktree raises massive distressed debt fund

Tue, 20 May 2008 06:59:54 -0400

We've noted that valuations have improved for some on-the-brink debts as of late, notably leveraged loans and some credit default swaps. The trading psychology seems to be improving in part because of the massive bets that private equity firms and hedge funds seem to be making on distressed debts. Case in point: Buyout firm Oaktree Capital Management now has raised a whopping $10.6 billion fund--the OCM Opportunities Fund VIIb--the largest-ever distressed debt fund, according to Financial News Online. Despite the bump in prices, lots of LBO debt may come under pressure if portfolio companies stumble. I do not think that they are late to the game at all. They're not making short-term bets; they expect real carnage.

For more:
- here's the article