From Volume 7, Issue 39 of EIR Online, Published Sept. 23, 2008

Global Economic News

Credit Default Swaps: 'Damocles Sword Over Financial Sphere'

PARIS, Sept. 15 (EIRNS)—The French economic daily Les Echos reports today that most financial experts are even more worried about the future of credit default swaps (CDS) than about the future of banks, calling it "another Damocles sword hanging over the financial sphere." This, after the International Swaps and Derivatives Association (ISDA) declared the nationalization of Fannie Mae and Freddie Mac a "credit event." This decision is expected to have grave consequences on those CDS covering the risks of the debt of the two agencies. Showing how insane the system is, the fact that Freddie and Fannie now have Federal backing, means that, in theory, the risks incurred by their debt has largely decreased! This means that those selling the risk protections (i.e., the CDS) have to adjust their prices by liquidating their positions, implying mega-losses.

CDS don't appear in ordinary accounting procedures, since they are derivatives traded over the counter (OTC). As a result, nobody really knows how big this bubble is. The Financial Times admits that the minimal volume of CDS stands somewhere between $200-500 billion. That's big enough to make a CDS collapse to be considered as another "systemic risk." Even worse, the CDS collapses would seriously endanger the credibility of the rest of what officials estimate as at least $600,000 billion worth of derivatives.

Stricken by panic about the bankruptcy of Lehman Brothers—which owns a vast chunk of CDS derivatives—New York bankers organized a two-hour special trading session on Sunday, Sept. 14, in an attempt to walk out of this minefield. Les Echos quoted the director of the pension fund Pimco as saying that, "That is an extremely rare event."

Bloomberg yesterday ran the full statement of the ISDA: "ISDA confirms a netting trading session will take place between 2 pm and 4 pm New York time for OTC derivatives. Product classes involved are credit, equity, rates, FX and commodity derivatives. The purpose of this session is to reduce risk associated with a potential Lehman Brothers Holding Inc. bankruptcy filing. Trades are contingent on a bankruptcy filing at or before 11:59 pm New York time, Sunday, Sept. 14, 2008. If there is no filing, the trades cease to exist. These trades are subject to a protocol which is being distributed by ISDA. Traders should execute the protocol and return to ISDA."

Britain Faces Unprecedented Budget Deficit

Sept. 19 (EIRNS)—The public sector deficit of Great Britain could reach £100 billion according to The Independent. This would be the largest "black hole" in the deficit since World War II. In June alone, net borrowing by the public sector was £10.4 billion, putting the deficit so far this year at £60 billion, up from a forecast £43 billion. This does not include the bailout of Northern Rock, which cost the government £100 billion pounds, nor does it factor in any future bailouts by the Bank of England of the much larger trouble banks such as HSBC or Barclays, now that Britain's own real estate bubble is bursting.

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