Armageddon Trade: Credit Default Risk Premiums on 10 Year Treasuries Hit Record

US Treasury 10-yr CDS hits record high
By Emelia Sithole-Matarise
Dec 1, 2008 6:19am EST

LONDON (Reuters) - The spread or risk premium on 10-year U.S. Treasury credit default swaps hit a record high on Monday, extending a recent trend as market participants continued to fret about the scale of the government's financial rescue programmes.

Ten-year U.S. Treasury CDS widened to 68.4 basis points from Friday's close of 60 basis points, according to credit data company CMA DataVision.

Five-year Treasury CDS widened to 52.5 basis points from 46 basis points at Friday's close, it said.

DTCC Report Omits A Significant Amount of Credit Default Swap Exposure

In a nutshell, the DTCC Report failed to include the Credit Default Swaps that cover the CDO's. This is because the DTCC only captures 'commonly traded contracts and not privately negotiated derivatives such as those on collateralized debt obligations (CDOs).

This is a key gap in the report since the market for these customer derivatives is quite large, and it is the failures of the CDOs that are in the process of failing, and bringing down banks and other financial institutions with them.

It is not surprising that the DTCC omits the custom, or privately written, derivatives. Because each one has variations, placing these on an electronic exchange seems a daunting task indeed.

But it represents an important caveat to anyone looking at the DTCC report and then attempting to draw conclusions about the overall swaps market net exposures.

Bloomberg
Credit-Default Swap Disclosure Hides Truth on Risk at Banks
By Shannon D. Harrington and Abigail Moses

Nov. 6 -- The most comprehensive report on unregulated credit-default swaps didn't disclose bets in the section of the more than $47 trillion market that helped destroy American International Group Inc., once the world's biggest insurer.

A study by the Depository Trust and Clearing Corp. fails to include privately negotiated credit swaps that insurers such as AIG, MBIA Inc. and Ambac Financial Group Inc. sold to guarantee securities known as collateralized debt obligations, according to analysts including Andrea Cicione at BNP Paribas in London.

New York-based DTCC's report, released on its Web site Nov. 4, showed a total $33.6 trillion of transactions on governments, companies and asset-backed securities worldwide, based on gross numbers. While designed to ease concerns about the amount of risk banks and investors amassed on borrowers from companies to homeowners, the study may have missed as much as 40 percent of the trades outstanding in the market, Ciccone said. (Oops, lol - Jesse)

The data are ``likely to underestimate the amount of net CDS exposure,'' he said in an interview.

Trading of credit derivatives soared 100-fold the past decade as banks, hedge funds, insurance companies and other investors used the contracts to protect against losses or speculate on debt they didn't own.

Banks worldwide have taken $693 billion in writedowns and losses on loans, CDOs and other investments since the start of 2007, according to data compiled by Bloomberg...

Commonly Traded Contracts

Because the DTCC registry captures only commonly traded contracts that can be confirmed over electronic systems, not every swap trade is in the company's report, spokeswoman Judy Inosanto said. Among those not included are credit-default swaps on CDOs, she said...

Professor Marvel Never Guesses. He Knows!

Is it likely that a fresh look at the economic data had Ben Bernanke and Don Kohn doing a sharp about face on the balance of risks to the economy? Given the speed with which their change in policy was communicated, catching a fellow Fed head flatfooted in spouting the party line the day before, it seems more probable that something on the order of one or more major players started to spew smoke from the cracks in their mark to moonbeams calculations, and Hank made that call to the Professor.

We obviously don't know, but suspect this revelation was connected with a subprime contagion affecting the derivatives markets. If derivatives are Weapons of Mass Destruction, then the Credit Default Swaps market is the H Bomb. Credit Default Swaps, if they start unwinding, can develop a chain reaction that will take out a fair chunk of the real economy, in addition to two or three big name corporations.

Subprime had the Fed a little concerned; CDS has them staring into the abyss and shitting their pants. Aren't you glad we have men so familiar with the mistakes the Fed made in 1929 to 1932 with regard to Fed Policy? We wish they had at least audited the courses covering the Fed's mistakes form 1921 to 1929. Sure, they are the experts; we're just concerned that they may be preparing to fight the last war.