Wednesday, March 21, 2012

Q&A With The Doc: Who Took the Loss from Greek CDS Contracts?

Ron writes:
Can you help me understand the Greek CDS situation? Who took the loss, which banks had to pay out the insurance? How much money are we looking at? Shouldn't this be a news event? What is going on here? Or did the Fed cover all the banks loses?

Ron, CDS are traded OTC or over the counter, meaning not on an exchange. They are mainly private contracts between 2 parties, thus no one knows the total risk involved. The media reported something like $3 billion in risk- but that is NET exposure.....which assumes 100% of counter parties make good on their debts/ hedges. The aftermath of the Lehman Brothers' bankruptcy should tell you all you need to know about assuming all counter-parties will able to honor their obligations for derivatives payouts.

Yes, obviously this situation SHOULD be a MAJOR news event, but the MSM in the US is more interested in MOPE (managing the perception of economics) rather than reporting the facts.

Yes, the fed is likely to have provided liquidity swaps to put out fires- indirectly by providing swaps with the ECB, who is then able to bail out affected banks.

As far as how much money we are looking at- Jim Sinclair who has written more about and has a more complete understanding of the derivatives market than just about anyone- estimates around $17 Trillion in derivatives could be tied to Greek debt. It is important to recognize however that only the ~15% of bondholders who rejected the Greek bond swap (new bonds for old ones) were ruled by the ISDA to have had a credit triggering event, meaning CDS contracts must be paid out. A JPM employee last week stated that just on JPM's book they have around $1 Trillion in derivatives exposure to Greek debt. There is a reason for the complete media silence on the issue.

Hope this helps.


Ron Responded:
So is this a non event this time or is there still a chance of some sort of credit event coming tied to the CDS payouts? Days or weeks?

Doc: Appears to be a non-event this time, likely due to the fact that the majority of bond holders accepted the 85% write downs and were deemed to not be a credit event...although I would say we need to wait a week or 2 to know for sure since we don't know the contract specifications for timelines allowed for payment, etc.  The CDS auction to determine CDS payouts was completed on Monday.