Credit Default Swaps- the next big crisis?

I wrote a paper on the Credit Default Swap Market. The concerns over CDS market has been raised recently by Satyajit Das. I have also seen a few comments on Eurointelligence which say:

The danger of credit default swaps

Are credit default swaps – financial instruments that insure against non-payment of interest – the next subprime? The Naked  Capitalism blog has dug up a Bloombery story, quoting a BNP Paribas analyst, as well as Eurointelligence contributor Satyajit Das, saying that there is ticking time bomb. Andrea Ciccione from BNP Paribas has done the maths, and concluded conservatively default of over $150bn. Altoghether about $1.3 trillion is at risk. Das makes the point that CDS are going to complicated the financial crisis, saying that this may well freeze up the financial system. Ciccione in particular fears counterparty risks from hedge funds, who have written many CDS. The crisis could be triggered by a rise in bankruptcies from their previously low levels, as global growth slows down. (The point is you don’t a long and deep recession to produce a scary scenario. A mere return to normal is all it takes.)

The conclusion of my paper is much the same – CDS is moving towards increasingly dangerous territory. Fed and other Central Banks by their interventions avoided what could have been a crisis in CDS. As it is simple CDS are difficult to price butthe players are increasingly moving onto more complex, low investment graded and longer tenure CDS products.

I have received some comments not agreeing to the problem but that is how it is. Unless there is a crisis we never agree to a problem at hand. Post-crisis analysis is always better than pre-crisis. When Nouriel Roubini said in 2006 that sub-prime crisis could be a big disaster, no one agreed to him. Not that I am Roubini but I believe policymakers need to look at the developments in CDS.

Update:

Bloomberg has an article summarising the developments in CDS market. It ios on very similar lines of my paper

8 Responses to “Credit Default Swaps- the next big crisis?”

  1. Manish Kayal Says:

    Nice article Amol. Keep it up.

  2. Credit derivatives in Microfinance « Mostly Economics Says:

    […] am not really sure of this development. With wide scares expected in CDS market, we have some developments in microfinance. It is not as if I am opposed to CDS in general, but we […]

  3. Settlement problems surface in CDO markets « Mostly Economics Says:

    […] as I said in my CDS report, settlement is a problem with these complex instruments. In times of low volatility all these firms […]

  4. Rareness Says:

    Somehow i missed the point. Probably lost in translation 🙂 Anyway … nice blog to visit.

    cheers, Rareness.

  5. RBI says Credit derivatives will have to wait « Mostly Economics Says:

    […] market (see few possts here). I also did some research on the most popular Credit derivative- Credit default swaps. The CDS market has expanded substantially with most trades in – multi-name , non-rated and longer […]

  6. Revisiting concerns in credit derivatives markets « Mostly Economics Says:

    […] concerns in credit derivatives markets When I first wrote the report raising concerns over Credit Default Swaps, people asked I don’t understand why will there be a crisis. Then there were a series of […]

  7. Fannie Mae/Freddie Mac could trigger CDS crisis « Mostly Economics Says:

    […] created at an exponential pace without thinking adequately about their settlement. I had pointed in my research that all it needed was a negative event ( a trigger) to show how problematic this market […]

  8. Drew Says:

    So now here is the extra proof that CDS are very dangerous. Bear Sterns and AIG backed up by the FED since they were heavily trading CDS. If those firms weren’t helped by the FED all the other investment banks would have all been crippled sending this economy into a depression.

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