Thursday, May 14, 2009

Systemic Risk from $28.2 Trillion in Credit Default Swaps

News sources revealed:

1. As of May 8, $28.2 trillion in credit default swaps were outstanding according to a central registry that captures most trading (Bloomberg)

2. 32 companies had more credit-default swaps outstanding than bonds the contracts protected. (Bloomberg)

Credit default swaps are beyond a risk management tool. Financial firms speculate on another company's failure.

3. Gannett, the publisher of USA Today, may have fallen short of its goals to reduce debt maturing in 2011 and 2012 in part because “a large percentage” of bondholders had bought credit- default swaps tied to the debt, CreditSights analysts said in a May 6 report. (Bloomberg)

4. General Motors may be forced into bankruptcy by debt holders with credit coverage. They stand to be made whole from GM's entering bankruptcy. (Financial Times)

5. The Carlyle Group's David Marchick testified before the Senate Banking Subcommittee on Economic Policy. He stated, "If not handled properly, a GM bankruptcy could be the “Lehman Brothers” of the manufacturing sector given the sensitivity of the automotive supply chain. It could affect suppliers outside the auto sector, including commercial vehicle, heavy equipment and even military suppliers." (Carlyle Group press release)
Credit default swaps can impact a firm's ability to refinance or cram down debt holders. How important is that?

6 Marchick also told Senators, "Moreover, given the staggering amount of new loans that were issued in the 2005 – 2007 that will come due in 2010 – 2014, it will be essential that credit markets can facilitate refinancing of this debt." (Carlyle Group press release)

7. Marchick assessed the current state of credit, saying "Credit markets remain severely compromised. Bank lending remains anemic, particularly to small- and medium-size companies. The non-bank credit system is moribund. Unemployment will likely increase as consumers continue to be very cautious in their spending patterns. Finally, even if we are at the bottom, it will take years to climb out of the hole." (Carlyle Group press release)

It's clear that many credit derivatives are under capitalized and not able to fulfill their obligations. This was shown by Syncora Guarantee's failure. Despite plans announced by the Obama administration regarding credit default swaps, systemic risk remains. Greed remains as America's shadow bankers place credit bets on failure.