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Resource Investor''s Jon Nones sees a ''Hubbert''s Peak'' in silver production

Section: Daily Dispatches

Nobody really knows who would owe whom
how much if the company ever collapsed

* * *

By Henry Sender
The Wall Street Journal
Thursday, February 16, 2006

The financial travails of General Motors Corp. have become a hot
topic in the credit-derivatives market, where protection against
corporate defaults is bought and sold. That is because a GM default,
which isn't immediately likely, could create severe strain, or
worse, in this unregulated market.

The car maker has about $30 billion in debt. Traders estimate more
than $200 billion in credit derivatives are linked to GM. But
because such derivatives don't trade on an exchange, nobody knows
for certain how much credit-default swap protection has actually
been written on GM. And nobody can say with confidence that they
even know who is on the other side of the trades that they have
entered into.

Such uncertainty is one reason that, since last year, regulators
have asked participants in the fast-growing market to get their
operational act together. That encompasses everything from dealing
with a backlog of unconfirmed trades to figuring out who their
counterparties are when one side transfers contracts to another
party. The Fed has asked market participants to report by today on
their progress in dealing with these and other issues. Fed officials
expect to be told that targets set so far have been met.

Four years ago, the derivatives market was a fraction of the size of
the underlying corporate-bond market. Today, it is estimated at
$12.5 trillion, more than twice the underlying market's size, and it
continues to expand rapidly.

That imbalance between the derivatives market and the underlying
bond market can lead to glitches and aberrations when a company
defaults or files for Chapter 11 bankruptcy-court protection. That
is because, to settle these trades, one side is supposed to deliver
actual bonds to the other side in order to collect compensation. But
given the shortage of bonds, bond prices can actually move up on a
company's collapse as players scramble to locate those relatively
scarce bonds.

"One of the areas that needs watching is that the volume or value of
deliverable bonds is smaller than the value of the potential
claims," said E. Gerald Corrigan, an executive with Goldman Sachs
Group Inc. Mr. Corrigan heads the Counterparty Risk Management
Policy Group II, an industry group focused on the derivatives
market. "To find a more permanent institutionalized way to deal with
the situation is a very high priority," he said.

To be sure, the market has weathered major bankruptcy-court filings,
including those of energy firm Calpine Corp., car-parts companies
Collins & Aikman Corp. and Delphi Corp., and several airlines. Each
time, participants worked out procedures to settle trades, by
holding auctions and then announcing a price for cash settlement of
outstanding trades.

But there has been a hold-your-breath air each time. Delphi was a
particular challenge because of the huge amount of credit protection
that had been written on it; the ratio of bonds to derivatives was
about one to 15.

Investors eager to settle trades drove Delphi bonds much higher than
expected, according to Andrew Feldstein, founder of hedge fund Blue
Mountain Capital Management LP. The bonds rose to almost 70 cents on
the dollar before the auction, at which most participants agreed to
settle at 63 cents.

While the process of confirming and closing out trades sounds boring
and technical, such matters are linked to the sort of systemic risks
that keep regulators awake at night.

The face value of these derivatives is huge, far greater in fact
than the net number. But that number is still daunting.

One challenge is to reduce the number of trades, thereby limiting
the amount of potential risk. Dealers say they are making progress.
The industry has spent a lot of time in meetings to iron out
operational issues and is taking advantage of electronic platforms
to reduce the absolute number of trades outstanding.

Many uncertainties could vanish with a move to electronic
confirmation, settlement and trading. There has been progress in
moving to the first two, especially when it comes to trading index
products.

Meanwhile, Mr. Corrigan is organizing a symposium on March 1 to
follow up on issues raised in a report published by the Counterparty
Risk Management Policy Group II last July. The meeting will address
larger issues as well in a continuing effort to "save the players
from themselves," as a regulator puts it.

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