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Monday, January 28, 2008


first mainstream mentions of credit default swaps

i was in naples -- where housing conditions are unbelievably bad, as the folks i talked to were only beginning to understand -- this last weekend and happened to catch over a dinner cocktail a bleak 60 minutes report about the housing bust. i never expect new information from something like television news, but it's often a barometer for how far into the kubler-ross cycle we are as a society. we're past denial now, at least -- but there was still no mention at all of either negatively-amortizing pay-option arms or credit default swaps. this even as bank of america is forecasting "disaster" (their word) if ACA is allowed to go into default and cash settlement becomes the only way out.

but tonight i caught wind of this piece in the washington post.

The astonishingly rapid evolution of swaps took place largely outside the view of regulators. Many Wall Street investors now say that these side bets may have magnified losses in the mortgage industry because they pulled in unrelated investors and financial institutions.

An example of this danger came to light when a little-known firm called ACA Financial Guaranty caused some of Wall Street's biggest banks to write down billions of dollars in holdings, restating their value on corporate balance sheets. ACA revealed last month that it had promised to cover $60 billion worth of mortgage and corporate debt, but had enough cash to cover only a fraction of that. Merrill Lynch, Citigroup and financial institutions in Canada and France, which had all sold swaps to ACA, set aside billions in case the firm collapsed.

ACA isn't the only firm that took on more swaps than it could handle. Two of its larger competitors, MBIA and Ambac Financial Group, had also promised to cover massive losses in subprime mortgages but now say they don't have enough cash to do so.

That shortfall is threatening MBIA and Ambac's $1 trillion business of providing insurance to companies and municipalities that issue bonds. The prospect of losses rippling across the bond markets has pushed banks and regulators in New York and Washington to craft a multibillion-dollar rescue package for the firms. It could involve a cash infusion of up to $15 billion.

With the possibility of a recession and the global financial system unsettled, federal officials say the swaps market has become a primary concern. Since swaps are traded privately, outside any exchange or clearinghouse, it is difficult for regulators to know how losses can spread and who is making the riskiest bets.

"Given the size of the market now and the lack of public information on who holds what . . . this market will be really tested for the first time if we do see a big round of defaults," said David Munves, head of capital markets research group at Moody's. "It's a risk factor no doubt."

so there's some progress. more on the nascent monoline bailout via bloomberg.

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