THE DOT - if this turns orange or red be alert

Wednesday, November 12, 2008

The CDS - financial nuke's destruction power calculations

I wonder how they want to manage that even if it were just $33 tril. (which is an understatement by 50% at least), as the BIS has different numbers in order to put them into an exchange mode they first need to settle the P/L of all trades. It can only work as a futures exchange that every difference needs to be settled on a daily basis, otherwise the clearinghouse cannot take the risk to guarantee the difference. Since we had unprecedented moves extreme huge losses/gains must have accumulated. we are talking of multi-trillions - even double digit trillions if things get worse, which is likely - I do wonder there the money should come from?

Excerpt Bloomberg:

Fed Said to Seek Oversight of Credit-Default Swap Clearinghouse

By Matthew Leising

Nov. 12 (Bloomberg) -- The Federal Reserve is seeking to become the lead regulator for clearing trades in the $33 trillion credit-default swap market, according to people with knowledge of the proposal.

The Fed, the U.S. Securities and Exchange Commission, the Treasury Department and the Commodity Futures Trading Commission are discussing a memorandum of understanding that lays out oversight of clearinghouses that would become the central counterparty to credit-default swap trades, said the people who asked not to be named because the discussions are private.

Just take the example of Russian bonds, as the CDS jumped substantially yesterday. As they jumped over 100 BP on 1 day, let's assume that we have $300 bil of outstanding nominal value. In that case, the ones who sold those CDS to others need basically to adjust that rising default risk and, in case of an exchange, the one year payment risk premium differential of $3 bil. is the least they need to transfer. But actually it should happen on the lifespan of the CDS, which might be around 5 years on average (just a guess) so 5 times the $3 bil. The problem is that these kinds of sums have been accumulated in the last 12-18 months. Extreme moves at the low emerging market debt was about 300BP over treasuries - now it's at 1000BP. Let's assume ( have to look up the real numbers) and that is relevant for $5 tril. emerging market debt (just a fictive sample calculation) that would give us a $210 bil. premium adjustment for one year. For 5 years we are above $1 trillion. I do not think that money is around for transfers and we have to face defaults, which makes 100% refunds due - in a depression scenario this would lead to $10-20 tril. in defaults easily

Excerpt:

Russia Debt Risk Jumps After `Clumsy' Ruble Widening, Rate Rise

By Denis Maternovsky and Bradley Cook

Nov. 12 (Bloomberg) -- The cost of protecting against a default by Russia soared after the central bank increased the ruble's trading band and lifted its benchmark interest rate to stem record capital outflows.

Credit-default swaps on Russian government bonds jumped to 7.17 percent of the amount insured from 6.14 percent yesterday, according to CMA Datavision prices. The yield on its 30-year dollar bonds increased to 10.77 percent from 9.1 percent, according to Bloomberg prices.

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