Saturday, February 4, 2012

When Greece Defaults, the Credit Default Swap Dominoes Fall

OfTwoMinds' Charles Hugh Smith today advised that Greece's impending default is set to release a domino-like chain reaction of credit-default swap contracts which will implode the shadow-banking system. 
While Smith is correct in that this would be the almost immediate result of a Greek default, as Jim Sinclair told us Monday, the ISDA will not use the term default for the 70-90% Greek default, as to do so would vaporize the large Western banks that compose the ISDA. As the derivatives market is nearly completely unregulated, look for the ISDA to cover their own a**es, and declare the Greek situation to be anything but a default.  The REAL QUESTION, is what happens to the holders of Italian, Portuguese, Spanish, and French debt when they suddenly realize that their CDS insurance on their junk bonds is worthless.  THAT is the question we should all be pondering this weekend.

A default by any other name is still a default. When Greece defaults, the inter-connected chains of credit default swaps will fall like dominoes.
For your Superbowl half-time reading, here is a brief summary of the situation in Europe:
1. Greece is poised to default, the end-game everyone anticipated in 2011. It is not a matter of if but when.
2. That default will trigger credit-default swap contracts, derivatives known as CDS that protect the owner from events such as default.
3. This will implode the shadow-banking system and the visible banking system, as those who sold the CDS (financial institutions) do not have enough cash or assets to pay the owners of the CDS.
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