Covering, or not, all those CDS chitties
Given the total absence of chaos in global financial markets, the next three weeks or so provides an excellent window to be getting some real datapoints on just what proportion of the notional $54 trillion in outstanding credit default swaps are worth as much as
the Post-It notes that more than a few of them are written on.
The International Swaps and Derivatives Association (headed by the eponymous, if slightly misspelled, Robert Pickel, chief executive) will, starting today, begin the process of settling up the fallout from the implosions of Phoney and Fraudy, Lehman Bros and Washington Mutual. Meaning that by the end of this month, if not before, word should start leaking about just whose — in some cases, long since incinerated — premium income is going to come up somewhat short of their contractual obligations.
Today’s action involves as much as an estimated $500 billion of contracts covering Fannie Mae and Freddie Mac debt which could, assuming a recovery of 85 cents, trigger obligations of $75 billion. The key words being “estimated” and “assuming” because, as is standard operating procedure in the foggy morass of CDS swamp, everybody’s guessing: “the number of derivatives that reference Fannie and Freddie is not known,” according to The Financial Times, failing to mention the somewhat relevant facts that nobody is much more enlightened as to who’s on the hook, and whether or not the hookees have kept chips in hand for the croupier’s call.
Despite being the largest test of ISDA’s CDS settlement protocol so far, the potential fallout will be substantially attenuated by the fact that the GSEs’ debt is now explicitly guaranteed, and likely exceeds, by a considerable margin, the value of the contracts written against it. So consider this a practice run for the the Lehman Bros and WaMu punch-ups, currently scheduled for Oct. 18 10 and Oct. 23 respectively.
Noted with interest: 60 Minutes ran a piece last night that managed to conflate the CDO and CDS issues; it included a brief interview with Pickel notable for three things:
- His deer-in-the-headlights expression;
- The silence between questions and his answer; and
- A doubtless National Rifle Association-inspired statement that “There’s nothing wrong with credit derivatives,” or words to that effect.
by Aline van Duyn
The Financial Times Oct. 6 2008
Background reading
International Swaps and Derivatives Association Inc