More Proof that Credit Default Swaps Caused the "Credit Crisis" → Washingtons Blog
More Proof that Credit Default Swaps Caused the "Credit Crisis" - Washingtons Blog

Tuesday, May 26, 2009

More Proof that Credit Default Swaps Caused the "Credit Crisis"

I have argued for a long time that the credit default swap counterparty risk held by banks is the primary reason that they stopped lending to each other, you know, the so-calloed "credit crisis" or "liquidity crisis", which is reflected in the interbank lending rates (Libor) shooting through the roof.

Indeed, as the Financial Times wrote on October 7th:

Banks are hoarding cash in expectation of pay-outs on up to $400bn (£230bn) of defaulted credit derivatives linked to Lehman Brothers and other institutions, according to analysts and -dealers.

As Fox News wrote:

Massive positions are just starting to be unwound in the credit default swaps market as tens of billions of dollars worth of these contracts are now getting settled in the aftermath of several high-profile flops.

Banks are hoarding cash in expectation of expected payouts on anywhere from $200bn to $1 tn–no one knows the amount, adding to volatility–for defaulted credit derivatives linked to the collapse of Lehman Brothers, the government’s seizure of mortgage giants Fannie Mae and Freddie Mac, the government’s rescue of American International Group, and the failure of Washington Mutual.

This has just been verified yet again, this time by the chief economist at a large Japanese bank:

“It’s premature to judge that the credit meltdown is fully over,” said Kazuto Uchida, chief economist in Tokyo at Bank of Tokyo Mitsubishi UFJ Ltd., a unit of Japan’s largest bank. “Banks remain wary of extending credit to each other due to strenuous concerns about counterparty risk.”....


  1. Well, CDS are not the problem...they are a _symptom_ of the problem. The real problem as I see it has basically two parts: 1. fractional reserver lending and 2. the political establishment has essentially merged with the banking system. These two factors combined prevent banks from booking losses (many of them should in fact be out of business). In other words, its the fact the contracts can't be torn up (as they should), not the contracts themselves that are the problem.

  2. Merlin, I don't necessarily disagree. CDS are the gun, but someone used the gun to commit murder.

  3. I read the CDS's are in the quadrillion range. What a setup. How did that happen "on accident"??


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