Talk:Credit default swap

CDS = Ponzi Scheme ?

http://www.nakedcapitalism.com/2008/10/initial-lehman-cds-auction-90-cents-on.html this wiki page is fundamentally flawed, it lacks deeper references to warnings of the risk and dangers of CDS.

Insider Trading

This article might need some text about insider trading (and other aspects of missing regulation) of CDSs in the article. I mean situations, in which somebody with insider information of a forthcoming credit event buys protection from said event. I think this is a big issue in the CDS market. Reiska 15:24, 3 August 2007 (UTC)

Anyone with access to insider information usually is supposedly restricted in their ability to transact on it anyway, but even if they do, so what? It's a good thing, isn't it? They've transmitted information to the external market, which will cause other people to be more wary of that company because of the higher spreads. Tristanreid (talk) 17:22, 13 June 2008 (UTC)

CDS Agreements in a Bankruptcy

What about credit risks associated with CDSs themselves? What if the risk seller goes bankrupt after the buyer has paid a lot of premiums? What is the status of the CDS agreement in bankruptcy proceedings? Are there any precedents? Reiska 15:24, 3 August 2007 (UTC)

This is the most important point about cds and nobody ever really thinks about it. If you own a bond hedge with CDS the diff is not free money as some assume, its the price of credit risk of that cparty. If bank risk start to deteriorate the value of your 'hedge' gets severely undermined. The bank may nevr actually go bust, but as LTCM found out, you dont need to have a default for this to cuase some severe pain. The only real way of hedging a bond is by selling it.

Comment2

I guess the CDS will usually be handled like any other item in case of a default. If it has positive market value (protection buyer pays 50 Bp, while current fair value credit spread is only 30 Bp.) the CDS will probably be sold and will continue on. OTOH if it has a negative value (either because of a default or because current credit-spreads are wider) the protection buyer would simply receive its quota.

However, CDS trades are usually not done without CSA (ISDA Credit Support Annex) to limit counterpart risk by margin calls. 194.166.212.120 18:13, 22 August 2007 (UTC)

What about deteriorating bank risk?

It makes sense that the cost of ensuring a weak credit might be 140 ( Philippines for example ) and a weaker bank such as Lehman (cost 110). But what price should a cds with lehman be for philippines? Ive got two risks, Phil AND Lehman. Given spreads are similar probability of default must be similar. If lehman were to go bust before Philippines Id lose my hedge and it may cost me a lot more to replace the contract with someone else. If Phil goes bust the I get my protection unless Lehman then go but as a result (cant meet payements on default). But its not just Lehman, banks in general. It is not true that banks are too big to fail, look at Continental Illiois or Northen Rock? It doesnt seem to make any sense for bank paper to trade close to risky credits as that would imply that they are both as risky. Whats the point of ensuring yourself with an entity that is just as risky? Im sure Northern Rock didnt trade CDs (did they?), but what price would you pay NR to ensure you against other companies defaulting? Nil?

Generally you require the counterparty to post collateral to make up for the difference in the current and market premia. The problem is that this isn't enough to completely ameliorate the counterparty risk, and it also adds the problem of a short-term cash shortfall to make collateral calls (which is the problem with any unfunded asset) Tristanreid (talk) 17:39, 13 June 2008 (UTC)

Question on 2nd example

In the example given under speculation, I don't quite understand why the premium on the CDS would be $100 000.
Zain Ebrahim 09:50, 7 September 2007 (UTC)

Recognized Credit Events

Are rating downgrades recognized credit events? —Preceding unsigned comment added by Gonzen (talk • contribs) 13:55, 19 October 2007 (UTC)

Good question. I'll check and get back to you. If I were to guess, I'd say that there's nothing stopping two counterparties entering into such an agreement. Zain Ebrahim (talk) 22:15, 30 April 2008 (UTC)

Yes, downgrades are credit events. And while two counterparties can enter into any agreement they want, CDS are generally well defined by ISDA agreement. The advantage is that the contract becomes liquid, they can use another contract to unwind the first. Tristanreid (talk) 17:24, 13 June 2008 (UTC)

No, downgrades are not (ordinarily) credit events. PIMCO[1] and others[2] list the most common events on their investor page: basically, debt default, failure to pay on time or unfavourable debt restructuring. The ISDA[3] says that downgrades are only a credit event in ABS, and only in the case of a downgrade below CC (which is pretty much the sign of an impending default anyway). -- Marcika (talk) 08:19, 7 August 2008 (UTC)

Technical minutiae

I've removed the previous edit about CDS trading at par, which is not necessarily the case for cash bonds, because this is alluded to in the preceding sentence about the basis arising from "technical minutiae". Pls feel free to revert my changes or, better yet, provide a list of the technical minutiae that result in the basis. Finnancier (talk) 15:36, 3 January 2008 (UTC)

The hedging example

Just a thank you to the editor, who explained in nice basic terms, the cash flow construct of a CDS transaction between two parties. Helped me understand the concept and logic behind the contract better than many textbooks could! 86.42.229.49 (talk) 23:22, 8 January 2008 (UTC)

The hedging example

Good writing but how are the values in this example calculated? propably obvious but wuold be good to show the calculateions in verbatim format...192.100.116.143 (talk) 11:46, 30 January 2008 (UTC)

"The market for credit derivatives is now so large, in many instances the amount of credit derivatives outstanding for an individual name are vastly greater than the bonds outstanding. For instance, company X may have $1 billion of outstanding debt and $10 billion of CDS contracts outstanding. If such a company were to default, and recovery is 40 cents on the dollar, then the loss to investors holding the bonds would be $600 million. However the loss to credit default swap sellers would be $6 billion. In addition to spreading risk, credit derivatives, in this case, also amplify it considerably."

The calculation appears to be in error. The loss to the holders of the bonds would be $600 million if they had not purchased a credit default swap, and $0 if they had purchased a credit default swap. The loss to the credit default sellers would be $9.6 billion as there are only $1 billion in outstanding bonds that can be sold for $40 cents on the dollar. Pringle1972 (talk) 19:29, 25 September 2008 (UTC)

You make a good point, but you're assuming that none of the insurers have any coverage themselves, and that none of the insurers are insuring each other, OR that all insurers of insurers will also default at the same time as the bond issuer. The first case is an unlikely one because CDS sellers buy other CDS's to hedge the risk they have assumed on the first one. Why would someone buy the insurance if they don't have any exposure to the underlying bond? That's the only way $10 billion of contracts would have been generated under the conditions of the first case - 9/10ths of the buyers would be paying to insure bonds they aren't even exposed to. Even in this case, they won't lose the full notional value, they will lose he premiums paid. In the second case, where everybody including all the CDS sellers defaults all at once, the losses are still limited to premiums paid plus the unrecoverable bond. In both cases, the total losses wouldn't exceed $6 billion, because in the first case we don't assume that insurers default, and in the second case the defaulting insurers don't lose the value of the commitment they defaulted on. --99.163.50.12 (talk) 17:59, 28 September 2008 (UTC)

Please clarify the first paragraph

If someone stumbles in here who knows that they are talking about, could you please rewrite the introductory paragraph so that it's comprehensible?

"A credit default swap (CDS) is a bilateral contract under which two counterparties agree to isolate and separately trade the credit risk of at least one third-party reference entity. Under a credit default swap agreement, a protection buyer pays a periodic fee to a protection seller in exchange for a contingent payment by the seller upon a credit event (such as a default or failure to pay) happening in the reference entity. When a credit event is triggered, the protection seller either takes delivery of the defaulted bond for the par value (physical settlement) or pays the protection buyer the difference between the par value and recovery value of the bond (cash settlement)."

• What is a "reference entity". Is there any relationship between the ref ent and one of the other parties?
• Presumably the "protection buyer" and "protection seller" in the 2nd sentence are the "two counterparties" of the first sentence?
• What does "happening in the reference entity" mean?
• "takes delivery of the defaulted bond": What bond? Is this a bond previously issued by the "reference entity". Is a bond always involved or is this just an example?
• Indeed, does there need to be any actual debt involved for the two parties, or are the "two counterparties" simply betting on something happening?

Thanks 68.7.39.11 (talk) 00:30, 23 February 2008 (UTC)

Firstly, I agree that the opening paragraph is not very comprehensible to a person who does not already understand CDS contracts (i.e. anyone who would want to read this article).

A CDS works as follows. Bank A enters into an agreement with Bank B to trade the credit risk on some counterparty (General Motors (GM) for example). Let's say A has purchased a Corporate bond issued by GM. If GM defaults then A will incur a loss. The CDS will be structured so that if GM defaults then B will cover A's losses.

This is a very simplified explanation and there are several other issues. For example, A need not have any exposure to GM but may still enter into the above agreement for purely speculative purposes.

To answer your questions then:

• GM in this case but it may be any other corporate entity. In fact, as far as I know, the CDS may be entered into without the reference entity even being aware of it.

• Yes. A would be the protection buyer and would usually pay B regular coupons.

• I'm sure you can figure this one out now.

• This is just an example and it should be clarified in the article.

• Yes, that may be the case.

Zain Ebrahim (talk) 14:55, 25 February 2008 (UTC)

Questionable para under "Criticisms"...

The 4th para ("Derivatives such as credit default swaps also create major distortions in the traditional indicators...") seems to be saying that stocks of failing companies aren't sold down in the market--but that, as we all see everyday, is BS. Any company reporting any major performance or credit or accounting issue is IMMEDIATELY cut down to size in the stock market, and this IS reflected in any index that it is part of. So I'm not seeing the basis for this theory that derivatives cause false index stability. At least as far as any major stock index is concerned (e.g. S&P 500). I would like to see some references for this theory, and/or a more convincing presentation of it. If it's purely the author's idle speculation, I recommend this para be removed. Rep07 (talk) 19:12, 25 February 2008 (UTC)

I've removed it entirely, and the paragraph above it as hopelessly POV original research. There are grains of truth in some of what I removed, but the veracity of the material on the whole isn't good enough to justify remaining. The asymmetric information part is salvageable, but needs a source. In order that the material can be retained, but without copying it all here, here's the diff where I removed it. If someone thinks it would be valuable to copy here, go ahead, but it really shouldn't go back in wholesale without some sources and some POV reduction. And here's the diff where an anon added it in the first place. - Taxman ^Talk 15:01, 7 April 2008 (UTC)

I agree with the remove. It was unsourced, mostly incorrect, POV and poorly written. The article is a lot better without it.

But I'd just like to reply to Rep07. Whoever introduced that section into the article wasn't refering to "reports" of a major issue, he/she was merely saying that the big players (JPMorgan etc) would normally have more information than everyone else and instead of selling their exposure to a company that they think might decline, they could simply buy insurance which would result in an incorrect price and hence index value. Zain Ebrahim (talk) 15:25, 2 May 2008 (UTC)

Opening section

I cleaned up the opening section and added a ref. Any comments? Zain Ebrahim (talk) 23:26, 30 April 2008 (UTC)

We need to update this page, post haste! AIG's failure due to its huge credit default swap debt, as well as the sheer scale of this whole mess, has made it incredibly important in the US and global economy. For one thing, the amount of CDS debt now is not $45 trillion, but $70 trillion! This has the potential of bringing down the entire economy, if the whole thing goes balls up. Saukkomies 11:20, 18 September 2008 (UTC)

A few days ago there was a link to this: http://en.wikipedia.org/wiki/Commodity_Futures_Modernization_Act_of_2000 Why was it removed? I think it is important to note why regulation on CDS's is banned. —Preceding unsigned comment added by 149.136.17.253 (talk) 18:53, 9 October 2008 (UTC)

Incomprehensible

I came here after seeing an item on BBC2's Newsnight, hoping to get some clarification in plain English about what Credit Default Swaps are.

I was totally disappointed.

Anyone who can explain to a layman what is going on, given the enormous sums of money involved, will be doing me a favour. No-one who didn't already know what "CDS" meant would not leave this article much wiser.

cannon— Preceding unsigned comment added by Cannonmc (talk • contribs)

Could you perhaps clarify which part of the first paragraph confused you? A pays B regular payments and B promises to pay A a large sum if C defaults. Please read the first paragraph again and tell us which part of it you find confusing. Thanks, Zain Ebrahim (talk) 08:34, 7 August 2008 (UTC)

You know what? Your second sentence is the most comprehensible explanation of this I've seen yet. Why can't some derivation of this be the lede? As it is it attempts to take in too many synonyms, and the post at the beginning of this thread is the result. Daniel Case (talk) 18:53, 28 September 2008 (UTC)

That's pretty close, but B often also promises to pay A a series of smaller sums if C is in trouble, and D is responsible for deciding if C is in trouble and just how much trouble it is in. Edward Vielmetti (talk) 21:46, 28 September 2008 (UTC)

Ah ... so it isn't quite as simple as a game of chicken between lender and third party over whether the borrower will default. Still, we should get this in the lede. Daniel Case (talk) 04:26, 29 September 2008 (UTC)

Re-gig the first three paragraphs

I know what CDS's are, but the first two paragraphs are way too complicated to introduce people to this rather complex instrument.

History Needed

Can anyone supply a history of this product? Probably some form of CDS can be traced to the Champagne Trade Fairs of the 12th-13th centuries; their 21st century, thermonuclear application needs elucidation.

teneriff (talk) 19:51, 21 September 2008 (UTC)

sorted! The word on the street is the idea was first conceieved during on one of Morgans Corporate Jollys. I couldnt find a web reference for that , and Im not sure theres any need to name the individuals most responsible, but at least this article should name the Bank that introduced the product. FeydHuxtable (talk) 18:02, 2 November 2008 (UTC)

credit default insurance

Isn't this also called "credit default insurance"? or is that the insurance version? (i.e. seller actually set up a reserve) --Voidvector (talk) 08:33, 25 September 2008 (UTC)

weasel words

I read the first paragraph, and my eyes glaze over. Can this be rewritten in english please? esp. a version of english designed to enlighten and not to confused. Edward Vielmetti (talk) 06:48, 27 September 2008 (UTC)

Financial WMD's? Global systemic risk?

This article must be getting lots of views from people who want to know why CDS keeps being talked about as the systemic risk that threatens the entire global financial system, and justifies the unprecedented actions of the U.S. Treasury and Federal Reserve. The existing descriptions of Buffet's criticism and of the amplification of the risk associated with some specific liability aren't enough information nor enough scope to address this. --99.163.50.12 (talk) 18:44, 27 September 2008 (UTC)

Bad example - only tells half the story

Under Criticisms: "company X may have $1 billion of outstanding debt and $10 billion of CDS contracts outstanding. If such a company were to default, and recovery is 40 cents on the dollar, then the loss to investors holding the bonds would be $600 million. However the loss to credit default swap sellers would be $6 billion." This statement of the loss to the CDS sellers ignores the CDS coverage that virtually all these sellers have against loss. I believe the net loss is still only $600 million. The whole reason that $10 billion of CDS contracts are outstanding is that each CDS seller is likely to turn around and purchase another contract for their own coverage. Yes, in case of a default, somebody is going to lose $600 million, but it its't going to be multiplied 10 times after all these insurers cover each other. If I'm wrong, then this section needs citations that I can go look at, which show why the net loss gets magnified. I believe that it's only true in the case when everybody defaults: the original bond seller and all the sellers of the CDS contracts. And even if that happens, I believe the losses would be limited to unrecoverable bond debt PLUS whatever CDS premiums were paid by the buyers. Furthermore, the $10 billion of CDS contracts aren't all outstanding to the company that issued the bonds - they're outstanding to many other parties in addition to some held by that company. I'm'a change that. --99.163.50.12 (talk) 17:22, 28 September 2008 (UTC)

Perhaps someone could add the results of the Lehman auction to illustrate a real world example. Also might be interesting to illustrate the problems caused by subordiated bonds recovering more than senior debt as in the case of Fannie and Freddie. —Preceding unsigned comment added by 82.24.214.128 (talk) 16:38, 10 October 2008 (UTC)

Better introduction needed

The introduction should be written in such a way that it is intelligible to the non-specialist. Right now it reads like a legal contract. A bit of plain English in the body of the article would be welcome as well.Wwallacee (talk) 08:04, 2 October 2008 (UTC)

Thanks for the input. Have a look at the opening sentence now. Please tell us what you think. Zain Ebrahim (talk) 09:11, 2 October 2008 (UTC)

this page for others, this article is a botch-ups. Let someone else have a go, they may do a better job! —Preceding unsigned comment added by 89.194.192.239 (talk) 06:30, 3 October 2008 (UTC)

First paragraph, Wiki Fascism or just an Ass?

I added a simplified first paragraph, after numerous comments about the unintelligible opening of this subject. Someone is deliberately making an essentially simple subject unintelligible to the ordinary person, is this what Wikipedia about - I think not. In essence CDS's are analogous to insurance. Taking out an "insurance policy" on an investment, that will pay out if that investment looses money. The investment can be almost anything, the "insurance policy" (CDS) offered by a fool who thinks he understands risk, in an "ever up" market. As anyone can see, in a downward market there is a $13 trillion pack of card, ready to tumble into dust. Much like World Trade Centre 1,2,and 7. Except we are talking about BIG money, and many more lives (suicide and family breakups)[4].

A very popular UK journalist Jeremy Clarkson (for those 300,000,000 who watch Top Gear or read his London Times column) wrote an interesting London Times newspaper article [5] ridiculing descriptions of CDS's, after he found his money had been invested in one collapsed bank (UBS), being offered to switch it to another (AIG). His article ridiculed the sort of technical garbage found in this article. This is a man who hob knobs with hedge fund managers, as per other article he has written over the years. It is quite valid to go into the technicalities, but anyone wanting to learn about such subject would be WELL ADVISED to avoid Wikipedia. —Preceding unsigned comment added by 89.194.192.239 (talk) 05:45, 3 October 2008 (UTC)

---

In essence, a Credit Default Swap can be thought of as a type of "insurance" taken out when making an investment. The "insurance premium" is paid to a third party to protect the buyer of the investment should the original investment lose value. However, CDS's are not considered insurance for regulatory purposes.

CDS's are made between counterparties. The issuer of the CDS calculates the risk they carry and charges a ongoing fee. The original issuer of the CDS derivative may pass on part or all of the the risk to others, making it difficult to know who holds the obligation, should the original investor see a loss on their investment. Also see Derivative (finance), rating agencies and hedge. A more complete explanation follows.

---

Firstly, please calm down. I don't think your opening section is a good one - starting out by describing a CDS the way you did as a type of insurance is poor for two reasons:

• It doesn't imo give the reader the correct understanding of what CDSs are. Remember, neither counterparty needs to have any exposure to the reference entity, and
• you didn't include a reference. WP:V is possibly one of the most important rules here.

With respect CDSs are basically insurance contracts. Ted Seides of Protege Partners , who anticipated the current crises in his 2007 paper "The Next Dominos: Junk Bonds and counterparty Risk" says that Credit Default Swaps closely resemble insurance contracts. From a low level operational perspective there clearly are substantial differences, but from an commercial perspective CDSs are effectively a form of insurance. Comparing them to insurance in the opening sentence gives the casual reader something to latch onto and helps make the rest of the article easier to understand. FeydHuxtable (talk) 18:12, 2 November 2008 (UTC)

Okay, let's look at your first paragraph now. Please have a look at WP's explanation of how the lede shuold look. The opening sentence should provide to a lay reader an answer to the question "What is a CDS?". Saying what it is "in essence" is therefore inappropriate. Currently, the opening sentence does answer this question. If you can think of a way to make the sentence more readable, you're welcome to do so.

With respect, your second paragraph is very likely to confuse a lay reader. You use several terms without defining them and I cannot imagine someone making their way through that with full comprehension of its intent.

Please note that I'm not saying that the current lede is great, it clearly isn't. But it fits closer with WP guidelines than your recommendation. I'd be quite open to attempts to improve the current opening section. Zain Ebrahim (talk) 08:14, 3 October 2008 (UTC)

I don't understand why you think my addition to the "lead" was likely to confuse a lay reader when clearly yours many attempts certainly has done. The terms I used hardly require defining unless the reader is below 12 years of age, but then most kids are more interested in candy than understanding CDS's. You define Wikipedia guidelines as if they are set in stone, they are not. No wonder your continual revamps are such weasel words. If someone want to understand what a CDS is, legal / technical jargon is not going to help. There are times when describing something, requires a loose analogy, "to get the ball rolling" (See what I mean - England is my country, England invented the English language!). Many many popular commentators refer to CDS's as a type of insurance when explaining their technicalities (I won't bother reference that statement).

I find it very sad that many people may be looking to Wikipedia to find out what a CDS is, and why CDS's are imploding the world economy, and bankrupt many citizens. All they find is this unintelligible rambling. Just look at the comments in this section, and these are people who have a feel for this subject. There is no need to drown Wikipedia in technical legal definitions, leave that to the corporate backed systems that got us into this mess. —Preceding unsigned comment added by 89.194.11.91 (talk) 17:40, 7 October 2008 (UTC)

For me the problem was that the definition, which I couldnt understand, was not followed immediately by an example. Every definition should be illustrated by an example. The article contains good examples, but they come much later, too late, I would say. Actually, a CDS can easily be understood by anybody just from one example, without even the need of a definition. —Preceding unsigned comment added by 86.17.173.199 (talk) 15:18, 27 October 2008 (UTC)

CDS for the Complete Idiot

In the early nineties, a Credit Default Swap product was an insurance policy on investments. Around 2000, a bipartisan congress passed a law to prevent regulation of CDS transactions.

CDS transactions became a form of gambling when CDS products were purchased by people who did not have investments in the items being insured. It was like me buying a fire insurance policy on your house.

Hedges were used by people who bought and sold CDS products so they were not on the hook for the pay off. Example: I buy CDS from company A for $100 fee and sell an equivalent CDS to company B for a $200 fee, making me $100 at "no risk".

Unregulated leverage allowed the CDS sellers to sell products without enough reserves to pay off obligations. Risks were hidden from public view. Hedge funds helped to propogate the hidden risks.

Source: This American Life, episode 365 --jwalling (talk) 20:09, 4 October 2008 (UTC)

60 minutes, Wall Street's Shadow Market, October 6, 2008 has a simple "idiot's" definition from Prof Michael Greenberger at around 4 mins 50 secs.

"A contract between two people, one of whom is giving insurance to the other that he will be paid in the event that a financial institution or financial instrument fails"

It's a biased piece in as much as the whole video has a negative tone towards credit default swaps but I think including a layman's definition, perhaps somewhere in the definition section after the lead, might be a good idea. Ha! (talk) 19:56, 6 October 2008 (UTC)

Rewriting the lead

I made yet another stab at rewriting the lede. It probably needs another few lines, and a few more references, but essentially it's accurate and unambiguous. Edward Vielmetti (talk) 04:51, 6 October 2008 (UTC)

Yes, this is much more readable while it still maintains accuracy. I like it. I was just wondering if we could replace "specific credit event named in the contract" with "specified credit event". The former seems tautologous. Zain Ebrahim (talk) 11:45, 6 October 2008 (UTC)

Updated that one sentence in the lede. We need at least two more sentences there, one that ties this instrument to current events, a second which links to an additional section to be written on risks associated with inability to fulfill terms of the contract. Edward Vielmetti (talk) 15:48, 6 October 2008 (UTC)

Hooray! It is starting to look better! I think the first paragraph should end at ...for example bankruptcy or restructuring. This gives a reasonable and simple explanation, as an opener.

The next paragraph can go on: The associated instrument does not need to be associated with the buyer or the seller of this contract.[1] though needs slightly better explanation, and clean-up (2 x associated), and could start with "Technecially", to qualify the technical aspect of the sentence, and the fact that it is still a little bit gobbledygook.

The third paragraph works well, but again needs slightly more detailed explanation and perhaps the word "a simple form of insurance", and the last line is a little obtuse "US Commodity Futures Modernization Act of 2000 specifically barred regulation of these trades." does this mean the trades were made illegal, or just unregulated?

Originally used as a simple form of insurance against bad debts, these instruments became a tool for financial speculation when the US Commodity Futures Modernization Act of 2000 specifically barred regulation of these trades. —Preceding unsigned comment added by 89.194.198.180 (talk) 17:09, 8 October 2008 (UTC)

single-name ?

Resolved

In Credit default swap#Operational issues in settlement I red-linked and then tagged "single-name" with clarifyme. Does it mean counterparty risk (also not clearly explained in wikipedia), for example in the sense that the single counterparty (say another bank) in a single transaction may fail to settle the transaction? Or in the sense of a single mortgagor defaulting? I found it mentioned here in this google-accessible book:

Pricing and Hedging Interest and Credit Risk Sensitive Instruments
By Frank Skinner
Published by Butterworth-Heinemann, 2004
ISBN 075066259X, 9780750662598
288 pages

on page 275: "A single name credit derivative is one in which the credit risk of just one entity is traded" -84user (talk) 14:40, 6 October 2008 (UTC)

Thanks for the clarification of "Single name (only one reference company)" from [6]. That makes sense in the context of CDSs in the article. It seems that single-name probably has that meaning in other contexts too, I saw "single-name exposure" in several Moody's and Standard & Poor's rating reports and had wondered what they meant. This German article suggests translating it to Kontrahentenrisiko which is "counterparty risk" in English, which also makes sense. -84user (talk) 16:21, 6 October 2008 (UTC)

single name exposure

thanks for noting this; I think this should be a section in the credit risk article, or perhaps it needs its own.

some quotes and citations:

a source:

The Handbook of Structured Finance By Arnaud de Servigny, Norbert Jobst, Norbert Josef Jobst Contributor Arnaud de Servigny, Norbert Jobst Published by McGraw-Hill Professional, 2007 ISBN 0071468641, 9780071468640 785 pages

says on p 18 that single name exposure may be

• repetition of a given corporate name in numerous portfolios
• presence of the same server in multiple deals
• high dependence on the cash flows generated by a single entity

this is contrasted with "pool exposure". note that some part of the fiction of credit derivatives is the notional independence of the underlying instruments, and the more single name exposure you have, the less this fiction stays true.

an article on the topic: http://www.risk.net/public/showPage.html?page=96530

also note that the more mergers and acquisitions you have, the more you get single name exposure.

also also note that in the world of computer networks the similar concept is route diversity, and you get similar sorts of unpredictable systematic shocks when get you things like an earthquake wiping out a bunch of "diverse" routes that all happen to go through cables that go through one part of the ocean floor off Taiwan.

Edward Vielmetti (talk) 17:07, 6 October 2008 (UTC)

"Single name" in the CDS context means purely that there is one single reference entity. This distinguishes such a contract from multiple-name (e.g. basket or portfolio) or, especially, index trades (e.g. on iTraxx or CDX indices). It has nothing to do with counterparty risk.--DerivMan (talk) 23:16, 10 October 2008 (UTC)

Better lede, but let's illustrate it

I see that the current opening sentence of this article explains the concept that much better. For a subject so much in the news of late, this is good.

However, I have an idea. I'm thinking of sitting down with Inspiration tonight and making a simple diagram to use in the lede. Anybody else for this? Daniel Case (talk) 18:16, 7 October 2008 (UTC)

Yes please do. What kind of diagrams had you in mind? Personally I would like to see one that links house loans to CDSs. Maybe one that shows the relative size (maybe pie charts?) of these big numbers I see in pages 5 and 3 of 2008-115a.pdf below: "Net current credit exposure for U.S. commercial banks decreased $59 billion, or 13 percent, in the second quarter to $406 billion." (does not seem too bad) and "The notional amount of derivatives contracts held by U. S. commercial banks in the second quarter increased by $1.8 trillion, or 1%, to $182.1 trillion." (so large?) -84user (talk) 08:42, 10 October 2008 (UTC)

There is no link between home loans and regular CDS. (Well, all these thing are linked somehow, but no direct link.) There is a link between home loans and CDS on ABS, and the ABX index, because those are CDS on asset-backed securities (or an index of them in ABX case), where the asset-backed security is essentially a pool of mortgages. But that's a different market to regular corporate CDS.--DerivMan (talk) 23:21, 10 October 2008 (UTC)

No, no. I want to do a diagram that illustrates how one works, apart from anything related to the current situation. Daniel Case (talk) 02:30, 23 October 2008 (UTC)

I think such a diagram would be quite useful. Are you thinking something like the ones we see in textbooks with a block for A (buyer) and a block for B (seller) and a block for C (ref ent) and arrows from A to B (regular payments) and an arrow from B to A (contingent claim upon C's default)? That would be quite helpful - go for it! Zain Ebrahim (talk) 15:40, 23 October 2008 (UTC)

History of these instruments

It's missing, and if we had a good section about it it would illuminate the issue.

Some data I'd expect to see:

• size of market per year over time
• origin story of the first ones
• key papers in the field describing and valuing these
• key simplifying assumptions in the analysis (and how they go wrong)

I'd like readers to be able to decode statements like this one from Accured Interest:

http://accruedint.blogspot.com/2007/04/how-does-credit-default-swap-cds-work.html

In fact, selling CDS protection in consort with owning a LIBOR floating asset is exactly like being long a 5-year FRN (if you ignore things like financing costs). Think about it, with the 5-year FRN, you'd get paid LIBOR plus some spread so long as the credit doesn't default. If it does default, you suffer the difference between par and the recovery rate. The CDS/LIBOR combination has exactly the same payout structure. For that matter, selling protection is also very much like buying a 5-year fixed corporate and hedging with a 5-year LIBOR swap. You wind up just collecting the spread. For this reason, the CDS should have a similar spread as cash bonds when compared to LIBOR swaps. —Preceding unsigned comment added by Edward Vielmetti (talk • contribs) 13:56, 9 October 2008 (UTC)

I agree completely with the need for an addition of a History section.

I also agree with the recent editing out of the more negative comments about CDSs in the intro, but think that we will likely need to explore this issue in more detail elsewhere in the article.Duedilly (talk) 15:35, 9 October 2008 (UTC)

Good resource: http://www.occ.treas.gov/ftp/release/2008-115a.pdf VermillionBird (talk) 20:09, 9 October 2008 (UTC). To expand, the previous is the "OCC’s Quarterly Report on Bank Trading and Derivatives Activities Second Quarter 2008," which has some useful and interesting information including historical values (100% annual growth rate from 2003 to 2007) and other facts (three largest dealers hold 92% of contracts and 5 largest hold 97%). VermillionBird (talk) 02:41, 10 October 2008 (UTC)

I edited out the reference to Blythe Masters having invented CDS (and CDO's). She was certainly around, but it's inaccurate to say she invented them. The reference did cite an article but that article stated it without sources and was clearly written by someone with no knowledge of the product.

I also deleted the negative comments presented as fact. If someone can write a reasoned, accurate and balanced summary of the recent criticisms of CDS that should be included in the criticisms section.--DerivMan (talk) 21:28, 9 October 2008 (UTC)

I agree fully with Derivman's removal of the note that Masters created CDSs and CDOs. If someone can find a reliable source indicating so then I'd be glad to include it in the article. The writer of that article doesn't seem to have had a thorough understanding of these contracts nor does he seem like the kind of journalist who researches his work properly.

Here's the ref. Now compare that to the article as of Feb this year. If the guy who wrote that article didn't rip wikipedia off verbatim then that has to be a coincidence of note. Btw, our GFDL requires that we get credit for our work - someone should send that guy an email. Zain Ebrahim (talk) 09:53, 10 October 2008 (UTC)

Auction history

I agree we need more on the "History of these instruments", and would like to see at least a table showing the size of market over time. I just added the stub section Credit default swap#Auctions hoping to fill it with a short table of the major auctions, but I found (being a complete newcomer to CDSs) a dearth of information. I looked at the Bank for International Settlements (http://www.bis.org/) but could see nothing on past and planned future auctions. There's meant to be one today. Where is it described? Anyway I hope others can flesh that section out. -84user (talk) 08:20, 10 October 2008 (UTC)

Derivative Exposure

Interesting blog regarding derivatives [7]

Credit default swap exposure:[8]

OCC's Quarterly Report on Bank Derivatives Activities [9]

OCC’s Quarterly Report on Bank Trading and Derivatives Activities Second Quarter 2008 [10]

A Good article a Rense [11]

—Preceding unsigned comment added by 88.106.139.81 (talk) 04:23, 11 October 2008 (UTC) (I replaced Sinebot blurb 84user (talk) 13:06, 12 October 2008 (UTC))

How to explain Credit default swaps?

I am trying to improve my understanding of these CDS so that I might make improvements in either text or diagrams on the above article. Can an expert comment on this following fictitious example?

Company C wants to borrow a million dollars to develop and market a new radio. Bank B agrees to give C a loan, the credit instrument, to be repaid in five years.

Bank B wishes not to risk losing all that money (because it would then be unable to repay its depositors), so it makes a contract, the credit default swap, with Insurer S. Bank B will pay S annual premiums for five years. In return S will, in the event that Company C fails to repay the loan, pay Bank B the money owing from the outstanding loan. In the event that Company C fails, Bank B must also give the credit instrument (the loan) to Insurer S, so that S can possibly recover some part of the loan (from what remains after the liquidation of C). Alternatively if Company C does not fail, then after five years C will repay the loan to Bank B, and Insurer S will no longer have the potential liability of paying out. In this case, Bank B will have paid a stream of premiums and S will have earned that same stream.

I believe this describes an insurance use of a CDS and ignores the speculative use where Bank B buys a CDS without having any loan to insure.

Here are my questions. Some answers I suspect but would not like to assume.

• Is this CDS an instrument "made" by the seller and passed "over the counter" to the buyer in exchange for a complementary contract that agrees to pay the annual premiums?

• Does the seller require sight of the credit instrument that is being insured? And is it marked on the CDS in some unique way? If not, what prevents S from selling multiple CDSs for the same loan? Is it possibly true that the legislation allows this latter case?

• How do seller and buyer keep a record of them? Are they only recorded by the two parties or are they also registered somewhere else?

• Must the seller keep sufficient capital in reserve to pay the buyer? What is this reserve ratio, if any, or is there no regulation at all?

• Would a bank ever sell its CDS if Company C still owed it money from the loan? I guess not, unless another insurer, X, offers a cheaper insurance (maybe C's credit rating improves, or X wishes to take a greater risk). Does this happen?

• A difficult political question: why have the US and UK financial leaders said practically nothing about CDSs? Are they not as big a problem as is made out?

That ends my questions on the insurance use of a CDS, but I am still puzzled as to what happens to all those CDSs that were sold and bought speculatively (without the buyer holding a credit instrument).

For example, I occasionaly see comments (on wikipedia and on BBC blogs), hinting that (a) a CDS sold without adequate reserve should be deemed illegal and that (b) a CDS unattached to its physical credit instrument should also be deemed illegal (in the sense of treating them as unenforceable gambling debts I suppose). I am very curious if this has been discussed in any serious depth.

I welcome any light cast on any of the above! -84user (talk) 14:10, 16 October 2008 (UTC)

---

• These instruments, in the United States were specifically deregulated in the Commodity Futures Modernization Act of 2000, (passed as an un-debated amendment to a budget/appropriations bill in a lame-duck session of Congress, in the last days of the Clinton administration) -- and CDSs are specifically defined as not insurance--hence not subject to U.S. state insurance laws. State laws on insurance (because of a couple of hundred years of experience with insurance company defaults) are very specific about what practices may be permitted in insurance contract. The linked article about the law is very incomplete as of this date. Generally the CDS market industry follows standard contracts promulgated by the International Swaps and Derivatives Association. Those contracts require participants to put up collateral based on the counter-party's credit rating. American International Group, for example because of its previously outstanding credit rating, did not have to put up collateral, or minimal collateral for its contracts, and when its credit rating was reduced, suddenly it needed billions of dollars to put up as collateral for its credit-default-swap counterparties. Because of the non-regulatory stance of the Federal law, the two parties can agree to whatever they want to--there are no requirements, but there are customarily many aspects of these standard contracts that agree to the kinds of "requirements" you ask about. The Federal law on the topic is rather likely to change in the coming year or two, after the new Congress arrives in Washington.
  -- Yellowdesk (talk) 02:08, 17 October 2008 (UTC)

Are collection agencies using credit default swaps?

When a collection agency buys a defaulted credit card account from a bank, can that be considered a CDF? Are they insured against that account not being paid off, when the bank has determined that it's unpayable? If that is the case, could it also be considered insurance fraud and/or be subject to racketeering laws? --Coyoty 23:37, 26 October 2008 (UTC)

• • No. 198.240.128.75 (talk) 11:25, 27 October 2008 (UTC)

Overhaul

• This article needs a complete overhaul. Many sections repeat earlier sections and the whole structure needs rejigging. Furthermore the tone of the article is heavily biased in favour of the description of CDS's as 'insurance'; which is widely discredited by those familiar with the subject. I will be making a number of edits over the next few days; please discuss any disagreements you may have here. Thank you. —Preceding unsigned comment added by Sexual harassment panda (talk • contribs) 21:15, 25 October 2008 (UTC)

  I agree that we should not give the impression that a CDS is an insurance contract - it can be used to hedge credit risk but it's not an insurance contract (because an insurance company will will only insure you against an insurable event). Perhaps we should devote a section to this. My efforts to remove a rewrite of the lede describing CDSs as insurance was met with considerable hostility from an IP editor above. Zain Ebrahim (talk) 08:33, 27 October 2008 (UTC)

  Yes I will remove that quotation. Who the **** cares what some guy from the CTFC said? Furthermore the first paragraph describes a CDS as a 'swap', and the second contains a quote saying that they aren't swaps! 198.240.128.75 (talk) 09:25, 27 October 2008 (UTC)

I think we should switch around the two definitions of a CDS. The current lead is more technical while the second is a more simplified introduction and would be a better starting point for someone new to the subject who probably doesn't know what a swap is. 198.240.128.75 (talk) 11:38, 28 October 2008 (UTC)

I reverted you because (as you can see above), many people wanted a more understandable lede that still conforms to the guidelines set forth in WP:LEDE. However, over the past two weeks, several editors made the new lede more incomprehensible (and inappropriate) than the older one. I see I've been reverted so I won't rerevert but the lede as it stands is at least correct.

We really don't need to shove Swap (finance) in the face of someone trying to understand these things. Credit derivative is better but perhaps we should just say "bilateral contract" or even "contract". Me, I'm just going to wait for the crisis to get boring and then come back here to get this to GAC status. Zain Ebrahim (talk) 14:19, 28 October 2008 (UTC)

I agree the lead needs fleshing out further but the current statement is definitely the better way to start. The current crisis has little to do with cds's (and the article must make that clear) but they are still one of the most important financial products and require a good article. 198.240.128.75 (talk) 15:10, 28 October 2008 (UTC)

Yeah I was saying that when the crisis is over, we might stop getting so many editors adding pointless references to it. Zain Ebrahim (talk) 11:57, 29 October 2008 (UTC)

Criticism Section

Is the Buffett quote really necessary? There's nothing specific in there about CDS; that stuff should be in the full article on derivatives. 198.240.128.75 (talk) 11:27, 29 October 2008 (UTC)

I always thought he was talking about CDS's when he said that. But a (very) quick google search indicates he was talking about derivatives. The Berkshire annual report (from the references section) isn't opening for me - what does that say? If it doesn't mention CDS's specifically, it shouldn't be here. Zain Ebrahim (talk) 12:01, 29 October 2008 (UTC)

Just had a look - "Charlie and I believe Berkshire should be a fortress of financial strength – for the sake of our owners, creditors, policyholders and employees. We try to be alert to any sort of megacatastrophe risk, and that posture may make us unduly apprehensive about the burgeoning quantities of long-term derivatives contracts and the massive amount of uncollateralized receivables that are growing alongside. In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal." So about derivs in general not credit derivs. Worth some discussion on the counterparty risks inherent in the cds mkt though. 198.240.128.75 (talk) 12:46, 29 October 2008 (UTC)

I dunno, I think it would be better to leave that at Derivative (finance)#Criticisms where it's already mentioned. And maybe link to that section from the criticisms section here (something like "See Derivative (finance)#Criticisms for a more general discussion of criticism of derivatives."). Buffet was specifically referring to derivatives after all. Fwiw, Zain Ebrahim (talk) 13:29, 29 October 2008 (UTC)

Let's (rather let you) start again

This entry should be scrapped.

I came here to try to learn more about credit default swaps. This page is no help unless you already know what they are.

It is so filled with insider jargon as to be unusable by an outsider. It would be nice if someone could write in plain English (to be translated into plain other languages) exactly, concisely, cogently what credit default swaps are.

I suspect this is an impossible task as the people who created the mess don't appear to have understood what they were doing so how are they going to explain it to anyone else.

Meanwhile this whole entry adds nothing to wikipedia or its users as it is totally incomprehensible.

A phrase from my schooldays occurs - "bullshit baffles brains". Well, this seems to be the former, it doesn't baffle my latter but it does annoy me because it doesn't add to knowledge. —Preceding unsigned comment added by Cannonmc (talk • contribs) 14:53, 1 November 2008 (UTC)