This has been a unregulated market and perhaps may be the cause of the greatest amount of pain on Wall Street. It also is the area which has been least talked about by regulators. The rules are not clear. There is no centralized clearing. There is no accounitng for the overall size of the market and the extent of its use is vast.
The credit crisis is actually a combination of three crises from the same root cause. There is the mortgage crisis which is ongoing but has been lost in current the problems of the stock market. There is the the lending crisis or the seizing up of the credit markets for all normal bank lending. This may be the most important area for the good the economy. The third crisis is associated with swaps in the CDS market. This is the big unknown.
This problem of CDS was the driver of the AIG bail-out. It has been an issue with their financial products group and not the core insurance area. The size of the CDS exposure for AIG was greater than the amount of capital outstanding. If the buyers of these swaps want to unwind them and the other side cannot provide the cash, then we have a major liquidity problem. There is the counter-party risk, but the underlying risk that was being hedged is now an exposure to the holder of the swap protection.
The CDS market is the one to watch in the coming weeks and with corporate spreads rising it is only going to get worse.
The credit crisis is actually a combination of three crises from the same root cause. There is the mortgage crisis which is ongoing but has been lost in current the problems of the stock market. There is the the lending crisis or the seizing up of the credit markets for all normal bank lending. This may be the most important area for the good the economy. The third crisis is associated with swaps in the CDS market. This is the big unknown.
This problem of CDS was the driver of the AIG bail-out. It has been an issue with their financial products group and not the core insurance area. The size of the CDS exposure for AIG was greater than the amount of capital outstanding. If the buyers of these swaps want to unwind them and the other side cannot provide the cash, then we have a major liquidity problem. There is the counter-party risk, but the underlying risk that was being hedged is now an exposure to the holder of the swap protection.
The CDS market is the one to watch in the coming weeks and with corporate spreads rising it is only going to get worse.
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