Art Cashin, UBS Financial Services’ director of floor operations, has gotten a lot of attention for his note last Thursday suggesting that the failure of the credit default swap market could send us back to the “Middle Ages.” Traders told Cashin that one reason to be afraid was the opacity of the CDS market.
Yesterday, he retracted many of those comments, noting that the CDS market was actually not quite as opaque as he thought.
In this morning’s Cashin’s Comments, Cashin tackles the CDS issue once again.
It turns out that the CDS markets are more transparent than he thought on Thursday, but more opaque than he thought yesterday. One of Cashin’s readers forwarded him these comments which suggests many of the huge pre-financial crisis risks still remain:
Please inform Mr. Cashin that his opinion of CDS is still fairly accurate. The most vanilla exposure is kept within DTCC. There are several exceptions, or as we call them outliers:
1. Credit linked notes which would reference Greece; these can be very large in size. Over 100mm is not unusual, these can be concentrated with 1 counterparty or spread (sold) to many retail investors through CD’s or other fixed income vehicles. If banks get desperate to unload risk they create these notes.
2. First to default baskets. This is where an insurance company sells insurance on a basket on names usually 5. These trades can be very large an involve loads of leverage. For example, if an insurance company wanted to get some juice 2.5yrs ago when Greece was at 300bps and wrote one of these baskets containing Greece, Spain, Germany Finland and the UK, the spread would be 500bps+ and the size would be 50-100mm easily.
3. Greece risk can sit in the CSO market, similar to the CDO market. These contracts are all private and only the 2 counterparties understand who holds what and there is often a reinsurance market for these (too further complicate matters.)
4. Lastly, legacy contracts can be outside the DTCC system. Say a vanilla cds contract written 7yrs ago with a 10y maturity.
So it is not as simple as some of your readers are implying when one accounts for the structured credit universe. The old shadow banking system that took down AIG still exists. And the scariest part is that the majority of it is sitting over here in Europe where transparency is at a minimum at the best of times.
Cashin also points to this morning’s New York Times article on CDS to reiterate the point that the CDS debates rage on.
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