Big institutional investors and hedge funds are big players in the CDS market, and the market for this particular type of derivative has grown to massive size.
In fact, the amount of CDS derivatives outstanding has doubled every year since 2004 – to a whopping $45.5 trillion today, according to the International Swaps and Derivatives Association. That’s up from just $632 billion in 2001 – a 70-fold increase in just six years.
The trouble is this: the global financial system has already suffered significant stress. Although credit market conditions are now substantially back to “normal” (as I described in my previous post), the damage has been done.
Banks and brokers have already owned-up to subprime losses and asset write-offs of nearly $150 billion since the third-quarter of 2007 (for a firm by firm “hit list” see table above).
There is already evidence that last year’s subprime debacle is spilling over into this year’s junk bond market, credit card and auto loans; and now into commercial real estate too. Yet, the global default rate on high-yield bonds finished 2007 at a 26-year low of just 0.9 percent.
According to forecasts by Moody’s, the default rate will jump more than fivefold to 4.8% by the end of 2008. This growing default rate is sure to trigger massive losses in credit default swaps going forward.
Bond fund manager Bill Gross notes that, according to estimates from Goldman Sachs, "mortgage related losses of $200-$400 billion alone might lead to a pullback of $2 trillion of aggregate lending. Add to that my $250 billion loss estimate from CDS, as well as prospective losses in commercial real estate and credit cards in 2008 and you have a recipe for a contraction in credit leading to a recession."
Another dropping shoe that could go “thud” in the night!
In fact, the amount of CDS derivatives outstanding has doubled every year since 2004 – to a whopping $45.5 trillion today, according to the International Swaps and Derivatives Association. That’s up from just $632 billion in 2001 – a 70-fold increase in just six years.
The trouble is this: the global financial system has already suffered significant stress. Although credit market conditions are now substantially back to “normal” (as I described in my previous post), the damage has been done.
Banks and brokers have already owned-up to subprime losses and asset write-offs of nearly $150 billion since the third-quarter of 2007 (for a firm by firm “hit list” see table above).
There is already evidence that last year’s subprime debacle is spilling over into this year’s junk bond market, credit card and auto loans; and now into commercial real estate too. Yet, the global default rate on high-yield bonds finished 2007 at a 26-year low of just 0.9 percent.
According to forecasts by Moody’s, the default rate will jump more than fivefold to 4.8% by the end of 2008. This growing default rate is sure to trigger massive losses in credit default swaps going forward.
Bond fund manager Bill Gross notes that, according to estimates from Goldman Sachs, "mortgage related losses of $200-$400 billion alone might lead to a pullback of $2 trillion of aggregate lending. Add to that my $250 billion loss estimate from CDS, as well as prospective losses in commercial real estate and credit cards in 2008 and you have a recipe for a contraction in credit leading to a recession."
Another dropping shoe that could go “thud” in the night!
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