There is almost no doubt at least some part of this market will be cleared. Will it ever extend down to individual names is still an open question, but the major indexes will be cleared.

Also, note that this product is unlikly to remain completely OTC. CDS are really corporate bonds in disguise, and corps are regulated by the SEC. I don’t think that the former lassie-faire attitude to new products is in place any longer since the nationalization of Bear, so they will regulate these products. My guess is that a new CFTC regulated market will be approved that allows major players and brokers to trade these in a limited participant marketplace.

Gee, doesn’t anyone else what is wrong with this picture?

The FT actually reported a while back that the repo market was as much a concern as CDS. I find it interesting that the WSJ monograph completely ignores the fact that Bear’s repos were pulled despite the collateral. To Congress Cox made it clear that this dynamic had thrown all the regulators for a loop.

Let’s hope the 4%,6%,8% loss doesn’t wind up with the commercial banks. Just to be safe, I’ll keep clapping until this is past!

Thanks for the kind words,

$60+ trillion in notional amount, the economic exposure is much less. The IMF guesstimates 2%, but in a weak economy, credit risk increases, so the exposure (risk of loss) on existing contracts ought to rise. So what, maybe 4%? 6%? 8% at the worst?

That doesn’t mean all that would come a cropper in a downside scenario, but that is a better indicator of the real exposure.

But to your real point, if we have a real problem, the Fed’s ministrations will be somewhat like asking the audience to applaud so Tinker Bell will live.

Respectfully, with 60+ trillion outstanding, aren’t we likely to discover that many of the bets were placed with 21st century bucket shops? If so, won’t the counter party defaults bring the system to its knees regardless of Federal Reserve interventon?

Thanks for all the time and effort you put into this blog. Your posts and the comments are consistently the most intelligent and thoughtful I’ve read.

Unless they have a central clearer, the failure of any sizeable participant (and BTW that includes the monolines and AIG) will bring the whole financial system down. This is vastly better than having the taxpayer bear the risk, which is where we are now.

Agreed but CDS would have to be standardized to be traded. The opaqueness and customization are the big reasons the product is so lucrative. Moving it to an exchange would make it far less profitable.