Credit swaps are no problem, their inventors and managers insist


Credit Swaps Said to Total Near $34 Trillion

By Shannon D. Harrington
Bloomberg News
Tuesday, November 4, 2008

NEW YORK -- Credit-default swaps totaling $33.6 trillion are outstanding on governments, companies, and asset- backed securities worldwide, the Depository Trust & Clearing Corp. said in a report that gives the broadest data yet on the unregulated market.

Turkey, Brazil, Russia, GMAC LLC, and Merrill Lynch & Co. had the biggest dollar amount of contracts outstanding on their debt as of Oct. 31, the DTCC said in the report, released on its Web site today. Turkey alone had $188.6 billion of default swaps written against its debt. The New York-based DTCC estimates it sees about 90 percent of all trades.

In total, about $15.4 trillion of transactions were linked to individual corporate, sovereign and asset-backed bonds. About $14.8 trillion was tied to indexes.

The DTCC, which operates a central registry of credit swaps trades, released the data for the first time as traders in the market say concerns about potential losses from the contracts are overblown. The industry has stepped up efforts to counter critics among U.S. lawmakers and regulators who blamed the lack of data in the market for exacerbating the financial turmoil.

"Publishing this data will provide greater transparency in a critical market," Tim Ryan, head of the Securities Industry and Financial Markets Association said in a statement today. "This is an important initiative upon which the industry will continue to build."

... Lehman Collapse

The collapse of Lehman Brothers Holdings Inc. contributed to a decline in financial markets last month because no one knew how many contracts were outstanding on the securities firm, or who holds them. Estimates ranged as high as $400 billion, though the actual amount turned out to be $72 billion, the DTCC said.

After subtracting redundant trades, only $5.2 billion actually changed hands, DTCC said last month, the first time it had released such information from its data warehouse.

Credit-default swaps pay the buyer face value in exchange for the underlying securities should the borrower fail to adhere to its debt agreements. They are private contracts between two parties, don't trade on an exchange, and aren't processed through a central clearinghouse, making it virtually impossible for the public to asses the amount wagered on the debt.

... Trading Growth

Trading exploded 10-fold during the past decade as the market went from being largely a tool for banks to hedge loans to a place where hedge funds, insurance companies and asset managers could speculate on the creditworthiness of companies, governments, and other borrowers, including homeowners.

The Federal Reserve is pushing dealers to create a clearinghouse to act as a counterparty on each trade, eliminating the risk of one side defaulting.

DTCC is controlled by a board of members, including JPMorgan Chase & Co., Goldman Sachs Group Inc., and other dealers that created and control trading in the credit-default swap market.

The industry should "get the word out about the small size of these risks compared to the notional amounts on which the contracts are based," said Mark Brickell, chief executive officer of Blackbird Holdings Inc., which provides an electronic trading system for derivatives, and former chairman of the International Swaps and Derivatives Association.

Criticism of the market intensified in September after the collapse of Lehman and the U.S. government's bailout of American International Group Inc., which faced bankruptcy after credit-rating downgrades forced it to post more than $10 billion in collateral on credit swap trades that had plunged in value.

... Cox Criticism

U.S. Securities and Exchange Commission Chairman Christopher Cox called for authority to regulate the credit swaps market, saying the lack of disclosure and the web of connections between dealers in the market threatened the stability of the financial system. The Federal Reserve Bank of New York, which has spent the last three years pushing dealers to curb risks in the credit swaps market, last week said it welcomed the DTCC's disclosure.

"The risk to the market from these instruments would be far less if investors had the benefit of basic disclosures," Cox wrote in an opinion column today in the Washington Post, in which he repeated his call for authority to regulate the market. "The lack of transparency around credit-default swaps played a role in the collapse of AIG and contributed to the crisis of confidence that has enveloped other financial institutions."

Until now, publicly available data on the market was largely limited to bi-annual surveys by ISDA and the Bank for International Settlements, that showed the gross notional value of trades outstanding for the entire market, a number akin to trading volume.

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