On the one hand, I’m being proven somewhat wrong in my dismissive views of the impact of Dodd-Frank. Credit default swaps, a product I’ve viewed as essential to rein in (it’s a fee machine for Wall Street that has produced clear harm and has almost no socially productive uses) have fallen markedly in volume prior to expected rule changes this summer. On the other hand, Wall Street is hammering out details (code for watering the legislation down by wrangling for favorable interpretation) and volumes are expected to partially rebound once this period of uncertainty has passed.
Trading in credit-default swaps, Wall Street’s fastest-growing business before the credit crisis, has tumbled 40 to 60 percent from three years ago as banks prepare for new regulation of derivatives.
The declines estimated by executives at four of the biggest dealers of swaps means lower profits at firms that used to get as much as two-thirds of credit-market trading revenue from the derivatives. Moody’s Investors Service says pending rules may translate into job cuts of as much as 50 percent in groups that trade the contracts.
Investors are avoiding strategies that contributed to $1.82 trillion in writedowns and losses amid the worst financial crisis since the Great Depression. The net amount of credit swaps outstanding globally has fallen 20 percent from October 2008…
The five biggest dealers — JPMorgan, Goldman Sachs Group Inc., Morgan Stanley, Citigroup Inc. and Bank of America Corp. – – bought a net $430 billion of credit protection as of Sept. 30, down 38 percent from $689.9 billion in March 2009, filings with the Federal Reserve Bank of New York show.
Barclays Plc analyst Roger Freeman in New York estimates that before and during the credit crisis, Goldman Sachs generated two-thirds of its credit-trading revenue from derivatives. The contracts now likely contribute about a third, with the rest coming from bonds, he said. …..
While Freeman expects a rebound once regulators meet their July deadline to write market rules, the changes will likely squeeze profit margins and prompt bank executives to cut more trading jobs….
The changes may drive down pre-tax profit margins for credit swaps to 22 to 23 percent from about 35 percent, said Sanford C. Bernstein & Co. analyst Brad Hintz, ranked by Institutional Investor as the top analyst covering brokerage firms.
One issue that will make a diffference on how much ultimate impact the dealers will feel is how much of CDS they will be able to get classified as “non-standard” and hence not required to clear centrally. That would allow for more opacity and more profit potential to dealers. So while this development so far looks favorable, this is not over till it’s over.