It’s Time to Stop the Nonsense

It’s hard to overstate the amount of nonsensical chatter on credit default swaps (CDS) in the past few days.  At the top of our list is a column by physicist Mark Buchanan in Bloomberg BusinessWeek.  It says that CDS make today’s sovereign debt crisis “different – and possibly more dangerous” because they create a “largely invisible network of ties among institutions around the world, which could ultimately cause global financial chaos.”   That’s because CDS are “mostly arranged ‘over-the-counter,’ not traded on any exchange or recorded by any central information repository.”

Really?

Does the author not know about DTCC’s CDS Trade Information Warehouse?  (For that matter, doesn’t anyone at Bloomberg BusinessWeek know about it either?)  It’s only been up and running since 2008, capturing more than 98% of all CDS transactions.  Its launch may not have rivaled the neutrino time trials recently carried out by CERN in Europe.  But surely its existence should be known to someone purporting to be an expert on the CDS market.

The CDS warehouse offers a significant level of regulatory transparency and helps to ensure that AIG can’t happen again.  Some of the information it captures is public and is available here.

Note in Table 6 of the DTCC data that the net notional on Greek debt currently measures US$3.7 billion.  This figure is calculated by summing the net exposures of the protection sellers, so it is impossible for any one firm selling protection to have more than $3.7bn in exposure.  Of course, given that there are many net sellers, any one seller’s exposure is likely to be far less.

Also, firms’ net exposures are partially offset by the recovery value of the underlying obligations. For example, if the post-default recovery value of Greek debt was (hypothetically) 50%, the maximum aggregate amount payable would be 50% of $3.7 billion, or $1.85 billion. Furthermore, statistics indicate that, on average, 70 per cent of derivatives exposure is collateralised and the level of CDS collateralization is likely to be even higher as over 90% of CDS transactions (by numbers of trades) are collateralised. Thus, in this example, of the $1.85bn that would be payable, about $1.5bn is secured.

So please, let’s stop the nonsense. There are serious issues to be discussed regarding global regulatory reform and the financial markets.  Greater transparency and the threat of CDS contagion in the event of a Greek default aren’t among them.

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