Saturday, October 01, 2005


Credit Derivatives Up $4 Trillion In 2005

The people at Elliott Wave International have some incredible news on derivatives. "A 'storm' could well come from 'events' that are actually related to the markets, even if they don't show up in the headlines. Such as, the explosion in credit derivatives, which grew 50% in the first half of 2005, to $12.43 trillion. (For comparison's sake, the U.S. gross domestic product is some $11 trillion.)"

"There's no simple way to explain what credit derivatives are; in oversimplified terms, they shift the risk of default away from debt holders to third parties. The immense volume of this activity means that no one really knows who's on the hook for what; reports say that the credit derivatives market now has an eight-month backlog of unconfirmed trades."

This from the subscription service. "In recent months, derivatives transactions have strained Wall Street's ability to process the trading. According to the latest reports, for instance, it will take eight months to clear a backlog of unconfirmed trades in the credit derivatives market. The head of the New York Federal Reserve says the problem 'poses risks not only to the financial institutions which use(derivatives) but to the financial system as a whole.'"

"A general rule of thumb is that the farther a loan gets from the originating lender, the more complex the counterparty claims become and the higher the risk of default. With the weight of deflation and widespread default bearing down on the economy, those risks are rising fast. The explosion in credit derivatives is an effort to 'manage' the escalating risk."

"It cannot end happily, however, because no one now trading credit derivatives(except possibly some of the traditional lenders that are selling susceptible credits into the market) envisions the unprecedented default rates to come. When they can't even figure out who owns what, figuring out who owes what will be nearly impossible."

I wonder how this will play out, it seems to me it is once again a game of musical chairs. How do insurance companies play into this in regards to underwriting etc...

This is one of the items that will make credit very hard to get in the not to distant future. Liabilities and risk exposure are gonna kill the carry trade.
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