Credit Default Swap Volumes Fall Before Pending Rule Changes

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.

From Bloomberg:

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.

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  1. quantacide

    But this is an error attributing causation to correlation (of the drop in volumes). The driver of the CDS business was the Primary Business in Correlation (not small-c correlation, as in Statistics, but big-C Correlation, as in Tranches, Bespokes, CDOs, etc.). That business has dried up, partly becuase of increased regulation, but moreso b/c there is little demand to print levered synthetic products and do silly trades (nobody wants to print a thin-tranche bespoke anymore, let alone a CDO^2). The custom products that were built using CDS (the primary business) has dried up, and therefore, there is no demand for CDS.

    1. TurtleBay

      I have to agree. Things like basis packages (buying a CDS and treasury to arbitrage CDS prices against bond prices) are no longer in vogue. There is a lot less sub-prime deal volume, so using CDS to hedge underwriting exposures when bringing new issues to the market is also not as important.

    2. sgt_doom

      You are sort of correct, but I somewhat disagree with you.

      They have simply moved on to other types of (e.g., CSO, etc.) credit derivatives configurations.

      Possibly it may be the suggestion of criminal prosecution, but doubtful any regulations, because those clearinghouses are owned and managed by the same ones who own the vast bulk of the credit derivatives (as in ICE US Trust, etc.).

      I really don’t believe that loophole-laden so-called financial regulation (Dodd-Frank bill) has any actual effect on the matter.

      Banksters are wary of their fellow banksters, is all….

  2. d cortex

    I thought that the really dangerous swaps weren’t to be regulated by Dodd-Frank. The doom sayers kept telling us that not all swaps were to be regulated…Is this still the case?

  3. Matt

    There needs to be a law against public agencies and non profits from buying or selling Credit default swaps, interest rate swaps and other derivatives. To most of us these violate the fiduciary responsibility on their face.

  4. vlade

    Unfortunately, CVA seems more popular than ever, which may drive demands for CDSes again. Given the derivative exposures, amounts to be hedged for CVA dwarf any mortgage markets.
    I just hope that CCDSes die quietly somewhere..

  5. chris lahaie

    I have a Question for anyone who would like to answer.
    Am I understanding this correctly that the sellers of CDS can still sell swaps to parties that are basically shorting the MBS? and is this again going to put them into an overleveraged position that with a slight drop in price means the capital underlying the mbs would be wiped out?

    I thought, from readding in Econned, that this was one of the major reasons for the collapse.

    1. sgt_doom

      To understand the reasons for the collapse you have to first understand that there are virtually thousands of categories of credit derivatives, with CDS being just one among many.

      The CDS, especially naked swaps, allow for a concerted effort to do “bear runs” on corporations, i.e., taking a number of swaps against a particular company, then shorting their stock to lower the intrinsic value of their bonds, etc.

      While those counter parties to CDS alter the equation, and dramatically increase the actual risk whenever they attempt to back out of a deal but issuing further debt instruments (CDSes) and creating further counter parties, it is simply one layer of a multi-layered ultra-leveraged pie.

      There has effectively been no change, so what you stated is correct with regard to swaps.

      The so-called “financial reform” bill (Dodd-Frank bill) is yet another loophole of loopholes, allowing no critical oversight** of credit derivatives and underlying securitizations, and allowing for the continuing of proprietary trading among the banksters (using those TARP funds, and other Fed facilities, to speculate on exchanges and invest overseas, instead of doing what banks should do…lend), as well as allowing private equity firms to do buyouts of energy corporations (taking them private to avoid oversight) to create more future Enrons.

      **(Clearinghouses were established, e.g., ICE US Trust, ostensibly to make transparent the exchange trading of swaps, but who finances and owns those clearinghouses?

      None other than the very same banksters, or bank-oil cartel, who own the vast majority of the credit derivatives.)

    2. anonymous

      im not following your question…. mbs capital is related to who now?

      but my guess: the difference between 2010 vs 2005-6, is that nobody now believes housing prices ‘always rise’. thus few will sell protection on MBS.

  6. anonymous

    id also like to point out that wikileaks has said it is going to leak a major US bank docs early 2011.

    i can only wish that some of this may contain CDS information. would be fascinating.

  7. gil mendozza zuntzes

    hum… hum… regarding WikiLeaks… ‘Head Hunter’ Condy Rice and ‘Bimbo Wrinkle Two Face’ Hillary Clinton with their bloody hands, torture orders, and their war crimes with the honor of the crooked us government trying to bring charges to Julian Assange for exposing the melodramtic panorama of violence, and ofending the us government and it’s criminal foreign activities.
    Good Job to the New York Times on Posting… and a Fantastic Work done to WikiLeaks! Americans be vigel; and stop been Gullible, Stupid and Crazy!!!

  8. razzz

    CDS occur on a worldwide basis. I think some members of Euroland were trying to ban them against bonds issued by their Countries.

    If clearing houses required higher up front funding with margin calls along the way this might help make them unattractive but so called banks (actually investment houses) gamble with taxpayer monies and get paid off with taxpayer money when bets lack funds to payoff.

    Otherwise, you need worldwide reform on these type of contracts (mostly private OTC) to stem the betting or players just move on to other market arenas to place bets.

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