Lifting the veil: New data on credit default swaps

For people who can't get enough of huge numbers: The derivative-securities industry has begun providing a weekly tally of outstanding credit default swaps, in a move to try to defuse concerns about the risks the instruments pose to the financial system.

There now are $33.6 trillion in swap contracts outstanding on government debt, corporate bonds and asset-backed securities worldwide, the Depository Trust & Clearing Corp. said in the first weekly report on its website. That’s actually less than the $50-trillion-to-$60-trillion numbers that often have been bandied about.

Credit default swaps are, in effect, insurance contracts that allow investors to protect against the risk of default on a government or corporate issuer’s debt. Swaps also can be used to speculate on a default.

Because the contracts are private agreements between investors and don’t trade on an exchange, data on the size and scope of the swaps market haven’t been readily available, even as the business has mushroomed in recent years.

The fear has been that a major corporate failure could bankrupt untold numbers of swap sellers.

That issue came to a head after brokerage Lehman Bros. Holdings Inc. failed in mid-September, and some analysts worried that investors who sold insurance on Lehman debt could owe tens of billions of dollars in payments to insurance buyers.

However, the net amount of money changing hands between Lehman swap sellers and buyers totaled $5.2 billion at the final settlement of the trades, according to DTCC. It was the first time the group had released such information from its data warehouse.

Likewise, the overall total of $33.6 trillion in gross outstanding swap contracts overstates what is at risk because it includes offsetting trades among swap investors.

The gross total of swaps outstanding on Brazil's government debt, for example, is $147 billion. But the "net notional" swap amount on the country's debt is $12.2 billion, after canceling out overlapping trades, DTCC said.

Even those net amounts can be misleading. They represent the maximum amount that sellers could owe buyers, without taking into account the recovery rate on defaulted debt (which could be substantial, thereby reducing what sellers would owe).

From Bloomberg News:

After canceling out overlapping trades, Italy's government debt tops the list [of net notional swaps] with $22.7 billion in contracts, according to DTCC data. A net amount of $16.6 billion of contracts are outstanding on Spain; $12.4 billion on Deutsche Bank, Germany's largest bank; and $12.1 billion on General Electric Co.'s finance arm, GE Capital Corp.

DTCC, which is owned by major brokerages and other financial firms, provides clearing, settlement and information services for securities trades.

The securities industry has faced calls for federal regulation of the swaps business. By releasing more data on the business, the industry is trying to damp fears that swaps are a time bomb waiting to explode.

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

Comments

[Mr.Bilko]

Like the (regulated) insurance contracts that credit default swaps try to emulate, they have expiratory terms. CDS contracts peaked somewhere near $60 trillion, in 2007. So, yes, 33.6 trillion in credit default swaps is a bit more sane than $60 trillion, but as Warren Buffett said in 2002/2003, CDS's and similar types of derivatives are financialy weapons of mass destruction.

As long as another major financial actor does not tank (i.e. Lehman Bros, WaMu, Bears Stearns) then the stock markets should be less prone to wild swings. When CDS's go below the $1 trillion mark, i.e. year 2000 numbers, then we call all breathe easier. In the meantime, the wild gyrations in the stock market can be pinned to CDS obligations and the need for firms to cover the credit default swap positions (i.e. sell stock to raise capital) as those positions change.

[trudy self]

$33.6 trillion is less than $50-$60 billion? Even with overlapping trades. In whose currency? I assume that is a typo.

[Tom Petruno]

Trudy -- That was indeed a typo. Trillions, not billions. I've fixed it. Thanks.

Tom Petruno

[Bill]

Everything would get simple real fast if these secret bogus contracts were audited to their true value, ZERO. As it is, a plague of consultants and accountants will appear, to create an industry of trying to assess their true value. Those gamblers at the casinos of Wall Street have lost their bets and must pay up now. One more bailout scheme could break the bank and saddle all of us taxpayers with the BS boyz' gambling debt.

[Kim]

Does anyone really know what proportion of all outstanding credit default swaps the DTCC can actually account for? Keep in mind that this is an unregulated industry, and these are figures being reported by the industry itself. I think we have to assume that these figures represent only the amounts the DTCC has decided to disclose. The actual amounts outstanding could potentially be far larger.

[dfine]

The CDS market should be abolished. There should be a moratorium on writing them at the very least until the monetary system's exposure to the is assessed and greater transparency is arrived at.