Morgenson: Time to Unravel the Knot of Credit-Default Swaps

Below is the link to the NYT column today by Gretchen Morgenson regarding Credit Default Swaps.  I really appreciate her attention to me and my firm, but more for leading with Sylvain Raynes and also including Robert Arvanitis, both of whom have helped me enormously over the past year to sharpen my distinctions on risk.

Time to Unravel the Knot of Credit-Default Swaps
http://www.nytimes.com/2009/01/25/business/25gret.html

Of interest, I agree with Bob’s view that as much as half of the remaining CDS is not an issue since many of these positions do match against opposite exposures, but the remainder is a rancid pile of under-collateralized wagers on default events that are all heading toward 1 in terms of P(D).  Thank to the FASB and the SEC for accelerating the deflation via fair value accounting!  Who would have thought that accountants, who are some of the nicest, smartest people you will ever know, would destroy the world!

One of the key insights I have gained from my conversations with Bob Arvanitis over the last year is the high-beta character of CDS and the way in which this fact only grows overall market risk.  The NYT editors greatly simplified Mogenson’s piece for the level of the generalist reader, but there are some powerful issues raised in the article that will be part of the public debate.

Here are the last two comments we posted on CDS last week FYI.

‘To Stabilize Global Banks, First Tame Credit Default Swaps’, Janury 21, 2009

‘Does Fair Value Accounting + Credit Default Swaps = Global Deflation?’, January 23, 2009

I am especially interested in your comments on

1) the issue of what to do with CDS written against the top four money center banks, which are all under de facto public ownership as will become apparent as loss rates eat remaining private common and preferred; and

2) how to bifurcate the functionality of current CDS into a) an exchanged traded, index like product that tracks the spread/volatility of a corporate single name issuer and b) an exchange traded form of bond insurance with minimum 50% collateral vs net exposure (par less current estimated recovery rate, which will vary with spreads).

Thoughts?

Chris

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