From Volume 4, Issue Number 21 of EIR Online, Published May 24, 2005

World Economic News

Swiss Daily: Derivatives Are 'Ticking Time Bombs'

In an article headlined, "Ticking time bomb in structured credit products," Switzerland's Neue Zuercher Zeitung on May 19 pointed to the precarious situation in the so-called "structured credit" market. This includes the use of capital structure arbitrage (CSA) contracts, that is, combined bets on the stock price and debt titles of the same corporation. NZZ states that the purchase of GM stocks by speculator Kirk Kerkorian has caused a "brush fire" on the bond market, which particularly hit funds specializing in CDAs. The funds faced "painful" losses when the risk premiums on GM bonds "exploded" and the prices of related derivatives plunged, while GM stocks, due to the Kerkorian move, jumped up by 20%. Overall, the downgrading of GM, though not coming as a full surprise, "triggered a chain reaction on the bond market", centered around collateralized debt obligations (CDOs). These CDOs fueled the "sudden explosion" of the GM risk premium. Trying to escape from their CDO adventure, investors "at some point engaged in panic selling, which then derailed the credit derivatives market."

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