50 trillion in credit default swaps

[Zoocat]

I'm beginning to understand how these CDSs are affecting the economy. Apparently, the total amount is about 50 trillion. Since they were unregulated and the transactions nontransparent, no one knows how many are left out there, waiting to be dumped on some other financial institution.

I'd appreciate some smart people explaining how this might play out. What other financial institutions might be at risk here?

 

[saluki9]

First, understand this. CDS contracts almost never get closed, instead they get offset. So if my firm writes a CDS on $10M of Merrill Lynch debt and later decide I don't want the exposure, I will usually just buy an offsetting contract for $10M

So, the notional amount of my exposure would be $20m, but the amount at risk would be $0.

Don't get me wrong, the CDS situation is screwy, but there are a lot of people trying to cause alarm by using the "t" word when that doesn't give you a good idea of the amount actually at risk.

These things need to be on an exchange, the CME group at Citadel are working on that now.

 

[FIRE'd@51]

So, the notional amount of my exposure would be $20m, but the amount at risk would be $0.

In theory you are correct. However, your offsetting trade may have been put on with a different broker, so you may have counter-party risk on both transactions, thus potentially disrupting your hedge. This is the reason, as you say, these things should trade on a centralized exchange, where the offsetting trades truly cancel out.

 

[chinaco]

IMO - There things should only be able to be written against the actual asset... no creation of a gamble against bonds that do not exist.

For example: If GE has $100B in bonds... that is the extent of CDS that can be written in total by all underwriters. If speculators want in... they have to buy one of the max $100B GE CDS that is on the market. The amount should be capped. Anything else is merely creating inordinate risk in the market (and for companies).

But that may not be practical... so companies that underwrite those things should have to hold reserves of about 33% of what they write with no more than 10% written for any other entity, and limited in business sectors, countries, etc....

Writing a CDS that has no underlying asset and selling it to a speculators is just printing money an loading up on liabilities... hoping the bill never comes due.

 

[Hamlet]

Does anyone know where this $50 trillion number came from? I see it a lot but have never heard the original source.

Seems like a very hard thing to estimate the amount for, given that there isn't any disclosure for these things.

Did someone just make this number up, and since its been printed a few times it is now "fact"?

I'm beginning to understand how these CDSs are affecting the economy. Apparently, the total amount is about 50 trillion. Since they were unregulated and the transactions nontransparent, no one knows how many are left out there, waiting to be dumped on some other financial institution.

I'd appreciate some smart people explaining how this might play out. What other financial institutions might be at risk here?

 

[saluki9]

In theory you are correct. However, your offsetting trade may have been put on with a different broker, so you may have counter-party risk on both transactions, thus potentially disrupting your hedge. This is the reason, as you say, these things should trade on a centralized exchange, where the offsetting trades truly cancel out.

Yeah I know, I was trying to make my example as simple as possible. With any swap you always have to factor in counter party risk.