The Next Derivatives Bloodbath: Insurance and Auto Makers → Washingtons Blog
The Next Derivatives Bloodbath: Insurance and Auto Makers - Washingtons Blog

Saturday, October 11, 2008

The Next Derivatives Bloodbath: Insurance and Auto Makers

This essay is about future derivatives problems. But before we look to the future, let's recap what happened yesterday, to gain some perspective.

Post-Game Analysis on Lehman

As the Washington Post writes today about yesterday's auction of some $400 billion dollars in credit default swaps for Lehman:

'If we see defaults from the standpoint that protection sellers don't pay up, then we're going to have a huge problem in the market,' Telpner said. 'But we don't have any explicit evidence indicating that sellers ultimately are not going to be able to pay the amounts owed to buyers.'

And the Sunday Times writes today:

"The valuation leaves the insurers of the debt a bill of about $365 billion. It is not clear whether the insurers, which are required to settle the bill in the next two weeks, will be able to pay – a development that could further undermine increasingly stressed capital markets."
Will the "insurers" of Lehman's CDS be able to pay up? The big bank insurers to the Lehman swaps have been hoarding cash, and so can presumably pay.

The bigger question is whether the hedge funds - such as Citadel - will be able to pay up or will go belly up. The next couple of weeks will tell.

But even if no companies are wiped out by their Lehman CDS obligations, it is clear that yesterday was, indeed, a traumatic day for the world economy. As today's Sunday Times article put it:

"Lehman’s corporate debt default promises to increase the stress across global credit markets. Sean Egan, of the Egan-Jones ratings agency, said: 'This is a killer. Lehman said a month ago that it was in terrific shape and now you can’t even get ten cents on the dollar for its debt.

'It underscores the deep structural flaws in our financial system, knocks confidence in the financial markets and raises the cost of capital. It also demonstrates that we are experiencing not only a crisis of confidence, but a crisis.'"

Next Up: Automakers

The next phase of the derivatives wipeout will hit insurance companies and auto makers.

Initially, Standard and Poor's is saying that GM and Ford may very well go bankrupt.

As of 2004, "GM was among the five companies most frequently included in credit-derivatives contracts in 2004, along with Ford Motor Co., France Telecom SA, DaimlerChrysler AG and Deutsche Telekom AG, Fitch said."

Indeed, according to Fitch's, as of 2004 and 2005, there were perhaps
billions of dollars in GM credit default swaps traded per day. Fitch's noted that "GM CDS are the second most included named in synthetic collateralized debt obligations (CDOs), behind Ford, as disclosed in several Fitch analyses of the CDS market."

On October 3rd, Bloomberg wrote:

General Motors Corp. saw its credit default swaps rise to a record after the automaker said Sept. 19 it was going to draw down the remainder of a $4.5 billion revolving credit line to preserve cash because of the instability in the financial markets. Detroit-based GM, the largest U.S. carmaker, has lost almost $70 billion since 2004.
As of June of this year, "The cost to insure GM's debt with credit default swaps rose to 33.5 percent upfront . . . plus annual payments of 500 basis points" and "Ford saw its credit default swap spread increased to 30.5 percent upfront, plus 500 basis points annually".

According to financial advisor Mike "Mish" Shedlock, there are appromixately one trillion dollars of credit default swaps for GM.

If GM goes bust, there would be huge credit default swap liability. While I have seen no estimates of the current amount of Ford CDS, it is probably also quite high, given that it was one of the most common CDS issued in 2004.


The insurance companies are also getting hit hard by CDS.

The October 3rd Bloomberg article states:
"The cost to protect against default by Hartford, Prudential Financial Inc. and MetLife Inc. soared to records and shares fell yesterday on speculation that turmoil in financial markets may be spreading to insurance companies."
As an article at Naked Capitalism explains:
First it was banks and securities firms, and now the focus of worry has widened to include insurance companies. Reader John referred us to a Reuters article that MetLife credit default swaps are now trading on an upfront basis, which means buyers of protection against the default of MetLife bonds must make an upfront payment as well as agreeing to periodic fees. Only companies seen as being in serious risk of failure trade on an upfront basis. Another story shows similar pricing of XL Capital CDS.

Concerns about MetLife became serious when the company announced it was writing down its investment portfolio and withdrew its 2008 earnings forecast.

From Reuters:
Metlife Inc's credit default swaps on began trading on an upfront basis on Thursday, indicating perceptions that its credit quality is considered distressed.

The cost to insure Metlife's debt rose to around 10.5 percent the sum insured as an upfront sum, or $1.05 million to insure $10 million in debt for five years, in addition to annual premiums of 5 percent, according to Markit Intraday.

The swaps had closed on Wednesday at a spread of around 717 basis points, or $717,00 per year for five years to insure $10 million in debt, according to Markit.
The second Reuters story:
Credit default swaps on XL Capital Ltd [an insurance copmany] began trading on an upfront basis on Thursday, and its stock price plunged more than 37 percent.

The cost to insure XL's debt rose to around 12.5 percent the sum insured as an upfront sum, or $1.25 million to insure $10 million in debt for five years, in addition to annual premiums of 5 percent, according to Phoenix Partners Group....

The swaps had opened at a spread of around 750 basis points, or $750,00 per year for five years to insure $10 million in debt, according to Phoenix.
Instead of being the end of the derivatives bloodbath, Lehman was probably just the beginning.


  1. Hello there, Can any one suggest some good websites that can assist in finding a good rate for auto insurance? I have found a great website that has helped me find an incredible rate,
    they give you the best rates from lots of local providers

  2. Hello, my name is Matt Turner. I happened to come across your site and I actually have one that's very similar about car insurance and I thought it would be beneficial for us to do a blogroll link exchange (or a single link exchange). Please let me know if you're interested and I'll put your link up right away. My email is and my url is

  3. I greatly enjoyed looking through your blog and found an informative one for finance related topics.
    Debt Consolidation,Credit Help

  4. This comment has been removed by the author.

  5. Nice blog on Insurance related products, I liked reading it, keep posting the way you have always been, thanks.

    affordable term life insurance quote

  6. Few have wow gold even heard wow gold of the god buy wow gold called Bandos. buy wow gold For many cheap wow gold centuries he cheap wow gold has been thought wow power leveling to be an wow power leveling ancestor of the power leveling ogres, perhaps power leveling even the beast wow gold that claimed buy wow gold the lands of cheap wow gold the Feldip Hills world of warcraft gold and Jiggig.

  7. Buy Warcraft(wow power leveling)please point machine to enter the website(wow power leveling)of Warcraft

  8. t is what we call 'the syndrome of the passive patient'. Basically we can't have anything with nothing and we know that if the client does not implicate himself wow gold or herself a little bit financially then he or she won't make the effort later on and make
    biodegradable cutlery the changes which are truly necessary. This is why it is essential for me that the people I help implicate themselves and why I do not work for free. It is very important for me to know that I am not working pointlessly on an individual's analysis, producing a reading that wow gold 5000 will not be fully read or assimilated while all I really want to do is to pass on the valuable information which SRO gold. is going to so radically change your life Isis. Experience has shown me that the only means for me to be absolutely certain that the person who requests my work Get free WOW gold is going wow gold sale to make the effort and implicate himself or herself to bring about real change is to ask for a small financial participation. Isis, you will understand that if you don't want pulp egg tray to spend a few dollars to ask me to produce this full reading for you whilst I have already spent over
    food container 10 hours on your file without asking you for anything at all in return (once again please understand
    SRO gold

  9. Do you like playing in the game which you need to use wow gold, when you do not have World of Warcraft Gold, you must borrow warcraft gold from friends, or you buy wow gold. If you get cheap wow gold, you can continue this game.

  10. Blog is interesting and motivated me a lot!! thanks

  11. Hola me párese un excelente blog con una muy buena y atractiva temática, saludos y hasta siempre.

    Firma: lo mas codiciado del planeta

  12. This is a very insightful article. Maybe we do need to take more control of our auto insurance and such. Thank you for making me think!

  13. Thank you for nice post and nice blog!


→ Thank you for contributing to the conversation by commenting. We try to read all of the comments (but don't always have the time).

→ If you write a long comment, please use paragraph breaks. Otherwise, no one will read it. Many people still won't read it, so shorter is usually better (but it's your choice).

→ The following types of comments will be deleted if we happen to see them:

-- Comments that criticize any class of people as a whole, especially when based on an attribute they don't have control over

-- Comments that explicitly call for violence

→ Because we do not read all of the comments, I am not responsible for any unlawful or distasteful comments.