A quick note on CDS

Credit Derivative Swaps – either you really get it, or you’re in the dark – right?  No!  Here’s a primer on the current CDS problems roiling the markets this week:

“Counterparty risk in the CDS market lies with the sellers of protection, or the insurers of risk. Banks are the primary sellers of CDS, totaling 40% of all written CDS and representing notional exposure of $18.2 trillion. Hedge funds appear to be in over their heads as well. According to printed statistics and consistent with anecdotal evidence, hedge funds are sellers of 32% of all CDS, insuring exposure of $14.5 trillion. Recent estimates indicate that the entire hedge fund market is approximately $2.5 trillion in net assets under management. Thus, hedge funds are bearing risk in excess of their ability to pay the piper if anything goes wrong. Those left holding the bag will be the sellers of CDS (the insurers), owners of CDOs, financial guarantors of CDOs, and may include another link in the food chain.

If we focus on banks alone and convert the roughly $20 trillion notional exposure into a $20,000bn / 50 = $400bn net exposure (factor 50 as in Robert Pickel article) and divide by 10 major banks this still results in a net exposure of around $40bn per bank. “



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