Monday, September 22, 2008

Credit Default Swap's Role in Financial Meltdown

Right now the market hates risk. For credit to move, investors require peace of mind. Unregulated credit derivatives, in the form of credit default swaps, provide that security. What happened to the pricing of those instruments? Last summer Bloomberg reported:

On Wall Street, Bear Stearns Cos., Lehman Brothers Holdings Inc., Merrill Lynch & Co. and Goldman Sachs Group Inc., are as good as junk.

Bonds of U.S. investment banks lost about $1.5 billion of their face value this month as the risk of owning the securities increased the most since at least October 2004, according to Merrill indexes. Prices of credit-default swaps based on the debt imply that their credit ratings are below investment grade, data compiled by Moody's Investors Service show.

Another story showed the cost of covering $10 million in loans/mortgage securities via credit default swaps last year:

Goldman Sachs
July 26, 2007 $81,000
July 27, 2007 $105,000

Bear Sterns
July 27, 2007 $110,000

Fast forward to September 2008. The Wall Street Journal reported the same piece of mind soared, up to 9 times the prior year.

Morgan Stanley
September 10, 2008 $300,000
September 15, 2008 $450,000
September 18, 2008 $900,000
September 19, 2008 $560,000
September 22, 2008 $498,000
September 24, 2008 $790,000 (update)

Today's numbers come from a Reuters' story on credit default swap pricing for those newly designated commercial banks.

Goldman Sach's cost for "coverage" is now $328,000 a year on $10 million of credit. Even with the commercial bank conversion, swaps cost three times last year's amount. The high cost of "coverage" via unregulated credit default swaps is killing America's credit system.