Tuesday, April 1, 2008

Motgage Meltdown (update)



Mortgage meltdown ran through the Bear Stearns meltdown saga. Now apparently it is possible that there was an additional reason for JPMorgan to "rescue" Bear, other than the upside gain potential. The latest derivate to cause worries is the 'credit default swap.' 

At approximately $45 trillion the total value of existing CDSs is greater than twice that of the entire US stock market. Commercial banks are among the largest players in this field, with (according to the Comptroller of the Currency) the top twenty five banks holding credit default swaps worth approximately $14 trillion at the end of 2007. Among them JP Morgan is the largest at approximately $7.8 trillion. As concerns mount re CDS it is likely that JP Morgan acted to make sure that problems with Bear’s approximately $1.2 billion of CDS did not spill over to JP Morgan…

Which leads us to another set of losers. Per the NYT “… an effect of both deals, should they go through, is the elimination of all outstanding credit default swaps on both Bear Stearns and Countrywide bonds. Entities who wrote the insurance — and would have been required to pay out if the companies defaulted — are the big winners. They can breathe a sigh of relief, pocket the premiums they earned on the insurance and live to play another day…” 

How to price a CDS
Arcane Market Is Next to Face Big Credit Test
Credit Default Swaps: The Next Crisis?
In the Fed’s Cross Hairs: Exotic Game

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