Wednesday, January 25, 2012



There is an old saying that”if your wife catches you in bed with another woman the only thing to do is deny it”. So it is with the financial system in today’s world.

The parallel with Credit Defaults Swaps is remarkable and the US Government has already created the regulatory equivalent of the cheating husband to deal with such an eventuality. It is called the International Swaps and Derivatives Association (“ISDA”)

Created in 1985, it was run by a former J P Morgan Managing Director of some 25 years seniority, Mark Brickell who was President from 1988 to 1992. At the end of his tenure he became the chief lobbyist for the industry. His subsequent “successes”, if you can call it that today, included helping to defeat all US Congressional efforts to regulate derivatives in 1994 and again in 1998. It would be fair to say he served his masters well.

Having once displayed his credentials as a regulator who was allergic to regulation, President Bush nominated him to be chief regulator at Freddie Mac and Fannie Mae, the biggest and most bankrupt government sponsored real estate companies on the planet. How is that bail out working out by the way?
In 2005 the ISDA also allowed rule changes to CDO payouts that would benefit those who bet against (shorted) mortgage-backed securities. We all know how well that has worked out for Goldman Sachs J P Morgan and others.
ISDA also has a series of regional committees empowered to make official binding decisions as to what constitutes a “credit event” such as a default. Greece or Portugal etc defaulting on their scheduled debt payments being a simple illustration, although there are many complex variants to this theme.
What is extremely important however are the consequences of a credit event,  namely the triggering of what is effectively an insurance policy called a “credit default swap” (“CDS”), payable in full to the holders of the defaulted debt.
So who then are the issuers of the CDS who would have to pay up; well of course the too big to fail banks. Their plan rather like AIG in the sub prime crisis was to cash the insurance premiums, make huge profits and executive bonuses, on the assumption they would never be called upon to pay. When the sub prime fraud blew up in 2008, AIG was bailed out with tens of billions of dollars by the US taxpayer.
So how much could the losses be from triggering credit default swaps? In this shady unregulated world of shadow banking nobody really knows.
The Bank of International Settlements (“BIS”) produces bi-annual statistics which show outstanding credit default swaps of USD 32 TRILLION. To put this is perspective the entire equity of the top 5 US banks is barely USD 1 Trillion. It does not need a genius to work out that there may be a problem.
Incidentally the BIS total reported derivates, including interest rate swaps, exchange rate swaps and credit default swaps, is an utterly mind blowing figure of USD 700 Trillion, or over ten years global GDP. How strange the world’s financial elite failed to see this as a problem?
However, in reality, the central bankers, finance ministers, all the major banks and even Warren Buffet, who described these derivative products as “Weapons of mass financial destruction” are fully aware that this gigantic powder keg exists, waiting to be triggered by a “Credit Event”.
This is the real risk of Greece, and has nothing at all to do with the measly USD 200 Billion, of un-payable debt, which makes all the mindless mass media headlines. After all USD 200 Billion is barely two months of US budget deficit.    
It has everything to do with avoiding at all costs the detonation of the derivative products.
So when a Credit Event arises, IDSA the sole official and as explained above, “completely honorable and independent “ arbiter, will just like the married man caught in the act, simply deny it.

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