Le five major US banks have signed at least 50 billion credit default swaps to cover claims, in all 80 billion, owed by eurozone nations at risk: Italy, Spain, Portugal, Ireland and of course Greece. Citigroup, in particular, has insured 47% of its loans, around 21 billion dollars. Morgan Stanley's policy is different, limiting CDS to Europe to 1,43 billion. In case of default, it seems to be understood, MS does not believe in the effectiveness of this protection tool, valid for limited crises, not for system ones.
The figure emerges from a New York Times investigation which sheds a first light on the CDS market, so far surrounded by absolute opacity. But things, warns the US newspaper, should change at least in part, because the SEC has enjoined American banks to give more and more detailed information on their positions towards Europe. Many surprises could emerge from the analysis, which could shed new light on the movements of European sovereign debt over the last few months.
What is known as of now is that CDS continue to be an explosive mine on the fate of the market, not yet defused, despite the good intentions announced by the G20, since the 2009 summit. By the end of 2012 , it had been decided by the summit of finance ministers, trade in CDS should be concentrated in organized markets. In particular, the CDS on sovereign states should have been managed by the clearing company controlled by the British Financial Securities Authority. But, eleven months after the scheduled expiry, only 9,4% of the transactions in an immense market with 29.600 billion contracts (data from the Basel BIS) appear to take place in an official clearinghouse.
And yet, the events of 2008/09, culminating in the bailout of AIG, which risked being submerged by avalanches of CDS that it was unable to honor, and of its counterparts (primarily Goldman Sachs) have shown that the CDS, effective in managing contracts on private companies, are unable to guarantee any protection in the event of a systemic crisis such as the one that could be triggered by a wild default of Greece. The 50 billion CDS revealed by the New York Times, therefore, they risk being the tip of an iceberg which, in the absence of new rules, could trigger a systemic crisis.
Emilio Girino, professional and professor in Cuoa's Finance department, dedicated a part of his report during the recent AIAF conference to CDS, with the illuminating title "How to clean up the market of obscure pseudo-derivatives".
According to Girino, it is wrong to consider the CDS as a financial derivative, rather than an insurance coverage contract. In this way it was possible that the derivative could be stipulated without any limitation or foreclosure. "In this way - says Girino - the market was quickly filled with multiple CDS, i.e. the stipulation of several CDS on the same credit, and naked CDS, stipulated even in the absence of a credit to protect". Or "to be a bit crude, the multiple CDS is equivalent to insuring one's house five times or more against fire, the naked CDS means insuring the neighbor's house".
The consequences? The CDS has become a speculative weapon par excellence. “Those who have stipulated a multiple CDS – explains Girino – paradoxically has the interest that the debtor does not fulfill, i.e. that one's house burns down, because the default would result in much more than the fulfillment (in the example, five times the value of the house). Anyone who has stipulated a naked CDS has only an interest in the debtor not fulfilling, i.e. in burning down the neighbor's house, because only in this way will a profit be made". This is the goal of most CDS holders, who have no need to protect themselves against securities they do not own. "Whoever made the value of CDSs on Italy soar even before the rating downgrade did not even possess the shadow of a BTP".
All this is possible because the value of the CDS, transformed into a negotiable instrument, it is influenced by the volume of trade much more than by the creditworthiness of the debtor. After all, exchanges are more opaque than ever, because they take place without any control or transparency. The over-the-counter market is concentrated in the hands of five international banking giants who have an easy time influencing prices in the absence of any traceability of exchanges which, in some cases, take place in sealed envelopes.
Warren Buffett spoke out against this market, who spoke of "financial instruments of mass destruction" (but he also made extensive use of them), and Jean-Claude Trichet. Every attempt at regulation has so far achieved very little.
The consequences are disturbing. “If a system of rules were in force in this relevant part of the system – argues the New York Times – there would be no uncertainty about the counterparties' ability to honor their commitments even in times of crisis. It would be sufficient to impose the passage through the clearing houses, whose task is precisely to verify the consistency of the guarantees of the subjects of the contracts. Only they could impose standard measures and verify the consistency of the guarantees, perhaps increasing them if the circumstances so require".
On the contrary, to use the example of the US newspaper, “if the Italian economy worsens, the cost of protecting a CDS on Italy's default could skyrocket compared to the 401.000 dollars for the 10 million paid in recent days. But in this case the seller of the CDS, often an Italian bank, would have difficulty meeting the commitment. A liquidity crisis would be created which, as a chain, could lead to a systemic crisis”. Difficult to happen, indeed very difficult after the safety net put in place by the ECB. But the only eventuality is a formidable weapon in the hands of a few speculators, who get rich with little risk. In the absence of a real response from the regulators.
