Wednesday, April 16, 2008

Its LTCM just bigger - part 2

This is coming out of the International Swaps and Derivatives Association annual conference in Vienna today, and it complements our article from yesterday: Its LTCM just bigger.

"Anything that begins with the letter C, whether it's CDS, CDO or CLO, is being tarnished to some extent,'' said Jonathan Moulds, Bank of America's head of Europe, Middle East, Africa and Asia business. "The industry has been criticized and will continue to be criticized.''

A few interesting facts:

  • The market for over-the-couner derivatives - $454.5 trillion

  • Credit default swaps outstanding almost doubled last year from $34.5 trillion.

  • Problems in OTC derivatives known to the authorities and the industry since 2006, when banks were asked to cut a backlog of 150,000 unconfirmed credit-default swap trades. Greenspan said at the time he found the build up and the industry's practices "unconscionable.''

  • At ISDA's conference a year ago, European Central Bank President Jean-Claude Trichet warned of "dangerous herding behavior'' in a market that had become "excessively complacent.''
Here is a thought:
The pressing question is why are the problems just now surfacing when they were known already since years? It is also interesting to note that the current crisis started with Bear Stearns and reached its climax (for now at least) with Bear Stearns. A possible answer lies way back during the days of the Long Term Capital Management debacle (LTCM). Much like today the New York Fed organized a bail out of a hedge fund that got in trouble because of leverage in derivative contracts. The only bank not participating in the bail out was Bear Stearns.

OTC derivatives market was out of control and this fact was known among industry insiders and authorities. The current crisis was viewed as the last and only chance of breaking the vicious cycle of the shadow banking system of derivatives. Bear Sterns got thrown into the snake pit.

This is a wild idea based on a hunch but interesting nevertheless. The alternative that the subprime mortgage market, as an insignificant part of the general credit market, is able to cause this dislocations is hard to believe either. Of course it is the official version. In any case the severity of the current crisis is real and although the risks are not eliminated yet they are better researched which makes me at least more confident that the industry will weather the storm.

source: Derivatives Face Regulation Amid `Calamitous' Risks

source: Its LTCM just bigger

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