Monday, October 06, 2008

$60 trillion? someone help!

New know it all folks like Steve Kroft of 60 Minutes like to report that the credit default swap market is between $50 and $60 trillion, maybe much higher. We know that he has no idea what he's talking about, but what is he quoting? He said that it was from the only published reports available, an aggregate from the firms dealing in the swaps. A few thoughts:
---That's the notional value, which does not eliminate offsetting collateral
---Since this would be at at least 30 times the entire U.S. sub prime mortgage debt outstanding, is this suggesting that multiple naked bets against subprime debt were allowed to be made without collateral? That should be impossible, and is highly unlikely.
---Is a large portion of this credit default swap market written against corporate debt unrelated to the mortgage market, mostly as a hedge in stable value type money funds or short term bond funds?
---Or, do these giant numbers being quoted encompass the entire credit derivatives market?, which is far broader than the credit default swap market. The majority, likely the great majority, of credit derivatives are simply creating pools of bonds or loans, and mostly bank loans, and dividing them into strips of ratings and return so investors can reliably tune up their investment diversification. For example, take a large pool of banks loans that are not so marketable as individual credit risk, and cut this pool into AA or above, triple B and A's, double BB's and below investment grade. These tiers will obviously have different return characteristics and fund investors could calibrate their investment risk by choosing to invest in various tiers based on risk and return required by their investment criteria. This is, in the realm of derivatives, pretty plain vanilla stuff and it helps spread risk and build credit market liquidity. If these are being included in the figures being thrown around as the credit default swap market then it is a wild exaggeration.
---Is it even possible that the credit default swap market could be even a quarter of the numbers being thrown around by the talking suits on television? If it is, someone please clue me in.

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