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The CDS Market Currently

Tuesday, August 19, 2008

The following passage is taken from Frank Barbera's essay on today's Financial Sense market wrap, GSE Woes and More Fed Easing Ahead

  • Put another way, the CDS market currently has a notional value that is greater than the combined value of the US Equity Market ($21.50 Trillion), Government Bond Market ($.4 Trillion) and Mortgage market ($7.1 Trillion) combined. Within the CDS Market, commercial banks are among the major players, with the top 25 banks holding more than $13 Trillion in Credit Default Swaps. Among the top four banks, JP Morgan Chase ($7.80 Trillion), Citibank ($3 Trillion), Bank of America ($3 Trillion) and Wachovia ($1.6 Trillion). To better understand Credit Default Swaps (CDS), assume that Party 1 bought credit default insurance from Party 2 to protect himself from a default on a bond, or as a bet on a company's health. In the case of actual default, Party 2 would pay the bonds full value to Party 1. However, and here is where things go seriously awry, the CDS market is not regulated, and Party 2 often has the right to assign the insurance contract to yet another party, Party 3. Party 3 can then assign the contract to Party 4, and Party 4 may assign it further to Party 5. In this instance, in the case of an actual default, Party 1 may have to find and track down the ultimate party responsible, who may or may not be in a position to actually pay the bond's value. Are you getting the idea that this is a not a kosher market?

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