Paying off on Credit Default Swaps is So Important

[Joanne98]

Here's something Senator Corker and Senator Shelby and the rest of the union-busting crowd ought to consider: the bankruptcy of GM will trigger the credit default swaps naming GM as the reference entity. A bailout won’t, according to the Bank of America.

The current gross notional amount of credit default swaps with GM as the reference entity is $44bn*. This is down from $65bn just three weeks ago. The net notional amount is $3.4bn, up bit since then. According to the DTTC, the notional amount is the maximum amount of money that will change hands on the occurrence of an event of default, after netting and application of collateral. The Bank of America says the cash requirement is around $4bn, again after netting and application of collateral. According to the Bank of America

"CDS contracts require daily posting of mark-to-market collateral posting," Taksler said. "Given that auto company bonds already trade in the $20s, the additional collateral posting prompted by a potential bankruptcy should be fairly small."

This implies that a large additional amount of collateral has been posted. That money is gone from the banking and investment sector, and isn’t available to be loaned out or otherwise put to good use. It is merely sitting in vaults, waiting around to see what happens to GM. Meanwhile, the price of GM CDSs has gone way up:

continued>>>
http://oxdown.firedoglake.com/diary/2261

Well. Isn't this interesting.

[dkf]

1. Thanks for posting.

Very good info.

[Joanne98]

5. You're very welcome dkf..

[tbyg52]

2. I'll say. Wheels within wheels. nt

[dkf]

3. So the auto bailout is actually a bailout of the financials again.

''Take Citigroup, with its $3tn plus in credit default swaps. Taxpayers are pouring money and guarantees into their treasury. Are they pouring money onto hedge funds and other buyers of protection, trying to prop up their swaps, or solving their exposure to GM and the other failing entities?

And, what about AIG? The Treasury is now participating directly in the shadow world, buying up securities insured by AIG through its CDSs, in the hope it will stop the bleeding of collateral.

[Joanne98]

4. Yep! Which means Shelby will cave. It's just political theatre for his stupid voters!

[jimshoes]

6. Just a FWIW

check out the comments for some chilling reading. Oh and it will make you quite angry when you figure out what's been going on with our bailout money.

[TomClash]

7. I'm not sure I buy this

The notional amount is not significant enough to make that much of a difference compared with amount already poured into the sieve of a financial industry we have.

[GliderGuider]

8. This is the reason Bear Stearns was sold rather than being allowed to fail.

Failure would require a valuation of the company's assets, while a sale or bail-out doesn't. TPTB are deathly afraid of a mark-to-market cascade in derivatives of all kinds, and any single large corporate failure could trigger the general revaluation of a broad range of derivative instruments. So while $44 billion may not seem like a lot of money :-) it could be the straw that breaks that camel's back.

Unfortunately, it's probably just a matter of time until they can't avoid some event like that, and then the toxic sludge avalanche will begin in earnest.

[HamdenRice]

9. A likely default by GM would trigger massive short sales on GM securities

The real danger of cds is not that someone has to payout claims on them (so what? issuer/insurer goes belly up?); it has to do with how the insurers/insurers raise the money to pay out claims.

Cds are like insurance, but it are not funded with reserves like normal insurance. Instead, the issuers of cds use complex hedging strategies that basically involve short selling on the issuer of the reference security.

That's why issuers/insurers actually don't go belly up; the who system is based on hedging, which means that as the company fails, the insurer makes on short sales exactly the amount of money needed to cover the cds contract.

So if we were to tell GM we're not bailing you out, issuers of cds would short sell all GM securities, covering their positions, but making the collapse of the firm inevitable.

Very few people actually understand the danger of cds -- Andrew Cuomo, maybe one NY Times reporter and a few bloggers. Most of the other stuff you read about them is crap.