Derivative contract failure is 2% to 3%? Says who? Where?
What does "contract failure" even mean?
that’s what, $20 trillion+?
If nobody long ever offset anything with a short. If no one short ever offset anything with a long.
I’m fully prepared, however, to believe that the sum total costs of failed counter-parties will reach or exceed $1 trillion.
Sum total costs are zero. Every loss on a derivative is offset by a gain on the other side.
Look no further than the so-called “monolines” - they have nowhere near the capitalization to handle the CDS instruments they’re in now
Yes, it'll suck if you were counting on a monoline to pay you and they end up defaulting.
Depends on the value of the marked-to-whatever off the books asset blessed by the bond market. That number is not really. None of really know how much it really is without individually going through ten quadrillion pieces of paper. By the time that happens, America will be bankrupt.
Did the big money, educated guys leave there money in mortgage securities or back them out last May/June 2007 and into emerging markets and energy futures or didn’t they?
Why wouldn’t they keep there money long in mortgage securities if there was a net loss/net gain equation of 0? News flash, they pulled out because there is a winner and loser in fractional percentages because real-estate values were obviously overinflated and correction was inevitable. Hey Toddster, place your bets long on oil for us between August of 2008 and August 2009 for us will ya? There’s a net gain/net loss on equation on that one too.
No, the averaged loss of value in the contract that goes bust is 2 to 3%, taken over the longer term and entire sector of derivatives. Some instruments, however, blow up in spectacular ways that expose the inability of a counterparty to pay even a significant minority of the value of the instrument, which is part of what has caused so much turmoil in the debt markets in the last year.
That’s what I was referring to when people come out and make predictions about the sum total of all derivatives blowing up and the full “notational value” coming due. That simply won’t happen. The losses from the blow-ups, taken across the whole derivative market, will likely amount to 2% of the notational value of the instruments in the sub-market (eg, CDS or other bond swaps in this case; there’s no involvement of options on stocks or commodity futures, which are part of that grand quadrillion total ‘notational value’ scare number).
Even if we were to take 2% of that total notional value of all instruments, we arrive at $20 trillion, which is (I believe) far, far too high.
Such scenarios would require that all derivatives contracts become due and payable all at once, and that the holder of the contract can, will or wants to demand full payoff all at once.
In the debt market, this isn’t the case. For example, each CDS class is different; some contracts have wiggle clauses, deferred payment clauses, etc. The holder of a contract can demand “accelerated payment” from someone who issued a CDS (eg, the monolines), but if this forces the monolines over the edge, then what was the benefit to the guy who wanted to be paid again?
I can completely believe, however, that when this Charlie-Foxtrot in the US credit markets is done, tho, that there will have been losses and write-downs adding up to $1T or more. The more I look into the debt derivative markets, the more I see that these instruments were created, sold, re-sold, etc, with little regard as to whether or not all the parties involved in the contract would be able to meet their obligations if the underlying instruments made an unforeseen move, the “black swan” issue of markets moving in co-ordinated downtrends. This is the result of stupid mathematics inside these instruments, and the Monte Carlo analysis used to “prove” how unlikely the failure scenarios are.
The best example of this is the “monolines” (who should be called duo-lines, really), who wrote credit default swap instruments on CDO’s. The monolines have nowhere enough capital to pay off the number of CDS buyers who will very likely have a legit claim to collect on the CDS contracts written on residential mortgage CDO’s and other instruments.
This has been evident to a lot of bond market analysts for quite a while, and people like Bill Ackerman have been talking about this in public for quite a while - like five years.
This is why S&P and Moody’s finally started taking down the ratings on MBIA, etc, this week: because the ratings agencies’ credibility is now on the line. To continue to insist that there was nothing wrong at MBIA (et al) would require a child-like innocence that allows children to believe in the Easter Bunny. There’s simply no way to wave a wand over MBIA’s balance sheet and say “This company can meet all their obligations easily” and give them a AAA rating.
Even a modest downgrade of MBIA (et al) ripples through the market like a boulder tossed into a pool. Various large banks who are holding a lot of paper (including muni paper) insured by MBIA (et al) will have to take write-downs because MBIA is no longer carrying a AAA credit line, which means that the insurace “wrapper” around the bonds they’ve insured is sometimes lower in financial rating than the bond the wrapper was insuring.
A downgrade like this:
http://investor.mbia.com/phoenix.zhtml?c=88095&p=irol-newsArticle&ID=1168119&highlight=
Is like throwing a hand grenade into a wading pool.
Without a AAA rating, MBIA’s business model is compromised; the reason why any government sovereign (eg, city, state, county, etc) would buy muni bond insurance is because MBIA (or other monoline) has a AAA rating, which would allow the issuing political entity to offer the bonds at a lower interest rate.
But with a downgrade of five levels, to A2 on watch negative... pfah. There’s plenty of counties and states with a credit rating higher than what MBIA now has as a result of the ratings cut, and there is no reason for a Aa1, Aa2, Aa3 or A1-rated county to give MBIA (et al) a chunk of money to “wrap” their muni bond.
So there goes MBIA’s bread-n-butter business and income, which will lead to further problems in a short while, because what was the problem again? Oh, yes, MBIA is short of capital - which is what results from profits, which is what comes from their bread-n-butter business, wrapping muni bonds.
It is easy to see why Moody’s put on the “creditwatch negative” — they knew that slashing the rating would result in a hit to MBIA’s business model and cause more problems down the road.
ACA Capital Holdings Inc., the bond insurer that lost its investment-grade credit rating in December, won a fifth forbearance from its trading partners on $60 billion of credit-default swap contracts.
Counterparties waived collateral requirements, termination rights and policy claims against ACA Financial Guaranty Corp. until July 15, the New York-based bond insurer said in a statement distributed on Business Wire. The fourth forbearance agreement had been extended to June 20.
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On Jan. 17, Merrill Lynch & Co. wrote down $1.9 billion in securities it had tried to hedge through ACA. Canadian Imperial Bank of Commerce had to sell more than C$2.75 billion ($2.7 billion) in stock to investors to rebuild its balance sheet after taking writedowns tied to ACA guarantees.