The giant beast of Credit Default Swaps is getting nervous

NEW YORK | Officials from the International Swaps and Derivatives Association have stated that Greece has not had a ‘credit event’ and credit default swap payments will not be triggered, at least not yet. The body’s decision has reignited the debate over the usefulness of CDS.

CDS are a US$32 trillion market, which is more than twice the US gross domestic product and more than twice the national debt. They are financial instruments meant to protect against a default by a particular bond or security, invented by Wall Street in the late 1990s as a form of insurance. It is an unregulated market (there is no requirement that the “insurer” actually have the funds to pay up) and some call it a derivative scheme.

The European Union considers CDS positions can increase risk of financial stability. CDS trading have been blamed for aggravating Greece’s troubles. The EU is in the process of approving a new regulation to ban on naked CDS trading, that is, purchasing default insurance contracts without owning the related bonds. It should be in force in November 2012.

“Purchasing Italian CDS, for example, will now be possible only if the buyer already owns Italian government bonds or a stake in a sector highly dependent on the performance of these bonds, such as an Italian bank,” explains New Europe newspaper.

THE BIG FIVE ARE WORRIED

According to the Comptroller of the Currency, nearly 95 percent of the banking industry’s total exposure to derivatives contracts is held by the nation’s five largest banks: JPMorgan Chase, Citigroup, Bank of America, HSBC, and Goldman Sachs. 

Now the Big Five fear that a “credit event” declared on European sovereign debt could jeopardize their $32 trillion market. William Greider writes about the ‘bank lobbyists’ at The Nation:

“Financial market cynics have assumed all along that Dodd-Frank did not end ‘too big to fail’ but instead created a charmed circle of protected banks labelled ‘systemically important’ that will not be allowed to fail, no matter how badly they behave,” he says.