Credit-Default Swap Disclosure Hides Truth on Risk at Banks
By Daniel at 6 November, 2008, 8:27 am
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
By Shannon D. Harrington and Abigail Moses
Nov. 6 (Bloomberg) — The most comprehensive report on unregulated credit-default swaps didn’t disclose bets in the section of the more than $47 trillion market that helped destroy American International Group Inc., once the world’s biggest insurer.
A study by the Depository Trust and Clearing Corp. fails to include privately negotiated credit swaps that insurers such as AIG, MBIA Inc. and Ambac Financial Group Inc. sold to guarantee securities known as collateralized debt obligations, according to analysts including Andrea Cicione at BNP Paribas in London.
New York-based DTCC’s report, released on its Web site Nov. 4, showed a total $33.6 trillion of transactions on governments, companies and asset-backed securities worldwide, based on gross numbers. While designed to ease concerns about the amount of risk banks and investors amassed on borrowers from companies to homeowners, the study may have missed as much as 40 percent of the trades outstanding in the market, Ciccone said.
The data are “likely to underestimate the amount of net CDS exposure,” he said in an interview.
Trading of credit derivatives soared 100-fold the past decade as banks, hedge funds, insurance companies and other investors used the contracts to protect against losses or speculate on debt they didn’t own.
Banks worldwide have taken $693 billion in writedowns and losses on loans, CDOs and other investments since the start of 2007, according to data compiled by Bloomberg.
$440 Billion
AIG first disclosed to investors in August 2007 that it held more than $440 billion of credit-swap trades linked to CDOs. The New York-based company was brought to the edge of bankruptcy in September after the value of the transactions plunged. The insurer was forced to come up with more than $10 billion in collateral to back the contracts after its debt rankings were cut. It accepted an $85 billion government loan in exchange for ceding control to the U.S.
MBIA and Ambac, previously the world’s two biggest bond insurers, lost their top AAA ratings earlier this year because of potential losses on credit swaps sold to guarantee CDOs backed by home loans. Moody’s Investors Service cut New York-based Ambac’s bond insurance rating four levels yesterday to Baa1, three steps above junk, because of potential losses on the derivatives.
A market survey this year by the New York-based International Swaps and Derivatives Association, which includes credit swaps on CDOs and other contracts that may not be captured by DTCC’s Trade Information Warehouse, estimates more than $47 trillion in gross contracts are outstanding.
Insurers including AIG, MBIA and Ambac typically sold protection on the highest ranking slices of such deals, meaning they’d be required to make good on payments only after a substantial part of the underlying debt defaults.
After the failures of Lehman Brothers Holdings Inc., Washington Mutual Inc. and three Icelandic banks that were widely held in CDOs linked to corporate debt, the defaults caused no losses on tranches MBIA guaranteed, Mitchell Sonkin, the company’s head of insured portfolio management, said in a conference call yesterday.
The failure of Lehman, WaMu and the Icelandic lenders caused losses of more than 90 percent to investors holding riskier slices of such CDOs that have less protection against defaults.
“The worry is that these bespoke tranches are being eaten away, and who knows if and when these losses will get realized,” Tim Backshall, chief strategist at Credit Derivatives Research LLC in Walnut Creek, California, wrote in a note to clients yesterday.
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
Derivatives Week
N.Y. AG Probes Brokers On CDS
New York Attorney General Andrew Cuomo has subpoenaed eight interdealer brokers to produce data and other communication regarding their activities in credit default swap trading. People familiar with the situation say Cuomo, as well as the Securities and Exchange Commission in a separate inquiry, are looking to identify dealers who during August and September may have spread false information to manipulate CDS prices. Two of the exchanges uncovered were emails between Marcos Brodsky, a partner at Phoenix Partners, and Roman Shukhman, a credit derivatives trader at JPMorgan. According to documents, the first email from Brodsky suggested Goldman Sachs was looking to sell a CDS index position, while the second one, from Shukhman asked about seeking notification for when a Deutsche Bank had entered the market.