Woo-hoo, I just read this on Robert Peston’s blog at the BBC…
"Today is the beginning of "auction season", when the International Swaps and Derivatives Association starts a series of auctions to settle who pays what to whom on a plethora of credit derivative contracts relating to businesses that have gone into default.
It’s settlement time on those humungous insurance policies for corporate debt, called credit default swaps, which I’ve mentioned to you as being another potentially lethal flaw in the financial economy.
In the coming three weeks, payouts of hundreds of billions of dollars may be made – or at least demanded – to cover losses arising from the defaults on the debt of Fannie Mae, Freddie Mac, Lehman and Washington Mutual.
Sandy Chen, the analyst at Panmure who’s been a smart predictor of credit-crunch accidents, estimates that payments on Lehman’s battered bonds could be as much as $350bn.
Now the problem here is that for every beneficiary of these payments, there’s an underwriter – those who provided the CDS insurance – which has to find the cash. And, as I’ve pointed out, this was a largely unregulated market, so the great fear in markets is that some underwriters have insufficient capital and will simply collapse when the claims are made.
That in turn would hurt financial institutions expecting to be paid out on their CDS contracts and damage others with separate exposure to the collapsed businesses. The shock to the system could be very severe.
To compound the current anxiety about all this, the CDS market is so opaque that it’s impossible to know right now who is holding the radioactive baby.
This gigantic CDS mess has contributed to the seizing up of money markets in recent weeks, the tendency of all banks and financial institutions to hoard cash – because no-one knows who or what may be vulnerable during the CDS auction season.
That, as if you needed telling, is just one more reason why the US $700bn bank bail-out is no panacea, even if we should be relieved that it has passed its first Congressional hurdle.
The financial weather ahead remains stormy and unpredictable."
Crikey! So when these CDS contracts start being unwound we could see some massive banking failures in the coming weeks that even the US $700bn bail-out plan might not be able to stem.
Time to don your hard hats – "Don’t panic Mr. Mainwearing!"
I’m very nervous about holding substantial equity investments right now, which is why I’ve converted most of my pension into cash and gilts. We’ll see what happens, maybe it’s a storm in a tea-cup, maybe not, but I’d rather be safe than sorry.