Friday, September 23, 2005


Credit Players Paperwork 'In Disarray'

CNN Money reports on the huge increase in derivatives. "Credit derivatives, complex investments based on the value of corporate bonds, have soared in popularity on Wall Street, sparking regulators to step up their scrutiny of this rapidly growing marketplace."

"One of the most common credit derivatives, a credit default swap, calls for the seller to pay if the underlying bonds get downgraded or if the issuer defaults. The swaps are akin to insurance for investors, and supporters say they help spread and manage risk."

"The credit derivatives market overall was worth about $8.4 trillion last year, and has roughly doubled in each of the last three years."

"'Risk transfer through derivatives is effective only if the parties to whom risk is transferred can perform their contractual obligations,' Federal Reserve Chairman Alan Greenspan said in a speech last spring."

"Last week, the Federal Reserve Board of New York met with several Wall Street firms to discuss its worries that the contracts are not being processed in a timely way, the Fed announced."

"The regulators worry that a series of big corporate defaults, while unlikely, could nevertheless pose substantial risks to financial markets, with ripple effects on interest rates and the broader economy. When General Motors and Ford debt first got cut to junk status last spring, many hedge funds and proprietary trading desks at banks reportedly lost hundreds of millions of dollars."

"Many hedge funds and other investors move so quickly that a big default or downgrade could trigger simultaneous sell signals, causing everyone to head for the exits at once. Another problem is with how trades are settled, Tanya Azarchs said, adding it was troubling to see that back-office operations of many players in credit derivatives markets were in disarray. 'That makes you question whether anything else is wrong as well,' she said."

"Lastly, if trades don't get processed accurately after a default or series of defaults, there could be flood of lawsuits that can become 'really messy and difficult for the court system' if the paperwork is in disarray, she said."

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