Comments on: Now It’s Official: That Cheery DTCC Data on Credit Default Swaps is Mighty Incomplete

By: Anonymous

Anonymous — Thu, 20 Nov 2008 03:53:00 +0000

The "zeroing out" concept merely indicates that in aggregate no money is made or lost in CDS. Money is transferred from one party to another.
Think of having a $100,000 insurance policy on your house. If the house burns to the ground, you collect $100k on your policy and the insurance company pays $100k. In total (between you and the insurance company), the gain is zero.
Regarding the question "I just keep wondering when a lot of these swaps will start coming due." They don't really come due. They are insurance contracts that pay out if there is a default and ultimately expire worthless if there is not.
Regarding what is in DTCC's Trade Information Warehouse, it does only include the more liquid, commonly traded CDS. As reported it does not include the illiquid, more customized CDS like AIG entered into. There are more investor's interested in buying/selling protection on General Motors or the State of Italy than a particular mortgage back securities.
Most trading in the CDS market is in the form on index trading (e.g. Markit's CDX in North America and iTraxx in Europe). Markit launched a mortgage backed CDS index in 2006; however, by that time most investors were highly suspect of the mortgage mortgage. Therefore, few wanted to sell protection and the volumes for that particular index were never significant.
There will be more transparency for the more customized CDS contracts like those which AIG sold. However, those expecting to find a massive amount of volume here will likely be disappointed.
It is interesting to me that as the CDS market provides more and more transparency the pundits keep claiming that the problem must be in some area not yet revealed.
To be fair, it seems to me that the CDS market is in part paying for the sins of the past. In an effort to appear to be an important real market, the CDS market hyped the notional value (what this article called gross) knowing that it was nowhere near the actual value. Now the media has picked up that figure, relayed it as the actual value and people are frightened.
The actual value of the CDS market is a very, very small fraction of the notional value.

By: Evelyn

Evelyn — Sat, 08 Nov 2008 05:00:00 +0000

Quotes from the Bloomburg story:

“A market survey this year by the New York-based International Swaps and Derivatives Association, which includes credit swaps on CDOs and other contracts that may not be captured by DTCC's Trade Information Warehouse, estimates more than $47 trillion in gross contracts are outstanding...

``’There appear to be gaps…'”

“Because the DTCC registry captures only commonly traded contracts that can be confirmed over electronic systems, not every swap trade is in the company's report, spokeswoman Judy Inosanto said. Among those not included are credit-default swaps on CDOs, she said.”

 So there are at least $47 trillion in gross contracts outstanding, of the most virulently derivative kind of instrument (CDS on a CDO)? So the theory is that these will kind of net out to zero somehow unless – but what could possibly go wrong?

Could someone provide a link to an explanation of how this zeroing-out is supposed to work, or why anyone thinks it should all come out even – a wash – and not something a lot more untidy?

By: Anonymous

Anonymous — Fri, 07 Nov 2008 20:37:00 +0000

November 7, 2008

Suggested first Obama legislative bill:

1. All “off balance sheet items” forbidden by law.
2. All cards (derivatives etc.), and the card holders hands, on the table as of date of enactment.
3. All non-certificate holder CDS’s, etc. null and void.
4. Trading in any kind of non-certificate derivatives punishable by law.

Earl L. Crockett
Santa Cruz, CA.

By: SilverDollar

SilverDollar — Fri, 07 Nov 2008 19:12:00 +0000

keep up the good work, Yves. great post!

By: Lockstep

Lockstep — Fri, 07 Nov 2008 18:37:00 +0000

Excellent post. I was asking around about the same issue.

By: fresno dan

fresno dan — Fri, 07 Nov 2008 17:29:00 +0000

I just keep wondering when a lot of these swaps will start coming due. I imagine a lot of the securitized mortgages must have been hedged with such swaps. What happens when interest can’t be paid on any number of bonds? As well as the fact that any number of mortgages still have yet to reset.

By: FairEconomist

FairEconomist — Fri, 07 Nov 2008 15:46:00 +0000

I'm shocked that there's gambling going on in this casino!

To be fair, the fact that the world hasn't blown up indicates the behind-the-scene Lehman settlement was probably fairly orderly. Lehman was a big company with a lot of speculation on it so if the market managed then the most apocalyptic scenarios where the interlocking CDS result in the market not having a stable outcome are probably not going to happen in the next year or two.

I think the problem now may be the big insurer's exposure, just as you say. I can't help but wonder how much of the extra AIG bailout was Lehman related. And the monolines are now getting some (ridiculously inadequate) downgrades. Hmmm.

By: Glen

Glen — Fri, 07 Nov 2008 13:12:00 +0000

Truth hurts; keep it up Yves.