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