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Banks deep into unregulated 'gambling'Credit Default Swaps

Heard an interesting broadcast on Marketplace (a PRI radio program;
April 1, 2008) on the issue of Credit Default Swaps. Interesting aspect
is that nearly 45T USD of these are "in play" in the market.

According to the discussion, The Bear Sterns buyout may have been a self
saving mechanism for JPmorgan, as the risk of Bear Stern's failure
becomes a risk of collapse for the holders of these guarantee
certificates.  Perhaps JP Morgan saw a risk exposure due to their own
trades with Bear Sterns.

Very interesting financial instrument, intended to spread risk around
("probably the most important instrument in finance," according to
former Fed chair Alan Greenspan), however, when many begin to suffer,
there's little assurance that any of the other holders of these swaps
may be actually able to back up a default.

 From the program transcript:

The value of the entire U.S. Treasuries market: $4.5 trillion.

The value of the entire mortgage market: $7 trillion.

The size of the U.S. stock market: $22 trillion.

OK, you ready?

The size of the credit default swap market last year: $45 trillion.

http://marketplace.publicradio.org/display/web/2008/04/01/credit_default_swaps_q/


 Wikipedia has a very good page on CDS, which provides an excellent overview of the both the workings and the insane complexity of these things. The page points out that the amount of CDS written on a bond issue may eventually dwarf the actual value of the bonds. So if a $1bn bond issue defaults, with creditors ultimately perhaps receiving $.40 on the dollar in a settlement, there may be $10bn worth of CDS outstanding, which means someone is on the hook for $6bn. http://en.wikipedia.org/wiki/Credit_default_swap