Tag: credit default swaps

Categories
Economics

[2515] Watch out for those CDS

For those who have been following the Greek crisis, they know that March 8 is the deadline for the bond swap that is essential in ensuring an orderly default of Greek bonds. Just 12 days later, Greece is due for repayment that without any haircut to its bondholders, there would be a chaotic default.

The bond swap plan is essential in keeping Greek public finance under control, however arbitrary the preferred debt-to-GDP ratio is. According to the Debt Sustainability Analysis paper dated February 15 leaked during the Greek debt negotiation, a 5% reduction in bond swap participation will increase the debt-to-GDP ratio by 2%. And the baseline assumes 95% take-up rate to reach 129% debt-to-GDP ratio. The magic number is 120% and in order to achieve that ratio, the take-up rate has to be high.

Here is the problem. Some bondholders may have bought credit default swaps in anticipation of a technical default some time back. It is in their best interest to not participate in the Greek bond swaps and trigger the CDS. Participation in the swap will not trigger the CDS.

The deal with the CDS is tricky. I myself am a bit unclear if holding  the precarious Greek bonds until maturity and default will actually trigger the CDS. A broker told me just now that there are so many CDS with varying conditions that it is impossible to know just which CDS will trigger. Ultimately, what is unclear is which is better: the haircut bonds or the payout from the CDS?

I am betting some will in event of plain old default and that will be the reason for some to reject of the bond swap deal. Big enough a rejection and we will find ourselves in a financial whirlwind all over again.

Categories
Economics

[2455] Rising expectation of defaults

More on CDS and the European crisis.

U.S. banks increased sales of insurance against credit losses to holders of Greek, Portuguese, Irish, Spanish and Italian debt in the first half of 2011, boosting the risk of payouts in the event of defaults.

Guarantees provided by U.S. lenders on government, bank and corporate debt in those countries rose by $80.7 billion to $518 billion, according to the Bank for International Settlements. Almost all of those are credit-default swaps, said two people familiar with the numbers, accounting for two-thirds of the total related to the five nations, BIS data show. [Yalman Onaran. Selling More CDS on Europe Debt Raises Risk for U.S. Banks. Bloomberg. November 1 2011]

This should be read in the context of the 50% Greek haircut, although that haircut itself is in question after the Greek government decided to have a referendum on the bailout and its conditions instead of executing it outright. Because of the referendum, CDS holders, especially speculative holders, may yet win their bet.

But even if they win, this might be a repeat of AIG. A Pyrrhic victory, one might say.

Categories
Economics

[2451] Damned if you do, damned if you don’t

The holders of $22 billion in Italian CDS may be growing anxious after receiving news that a 50 percent haircut on Greek debt will fail to trigger a credit event that would force sellers of the swaps to pay out.

[…]

If this failed to trigger a CDS event, many investors may find themselves without protection, potentially triggering substantial and unexpected losses.

More broadly across Europe, DTCC data show that net notional CDS outstanding for France, Italy, Germany, Spain and the U.K. total nearly $100 billion. [Michael McDonough. Efficacy of CDS in doubt. Bloomberg Brief: Economics. October 28 2011]