As reported on "Real Money".: The catalyst for this afternoon's dive appears to be a letter by the President of the NY Fed asking for a meeting on 9/15. The issue is industry concern about "unconfirmed trades". The market seems to be thinking this may be another Long term Capital type event in the making, and the market is getting some panic selling on the news.
Fed Summons 14 Banks to Discuss Credit-Derivatives Controls Aug. 24 (Bloomberg) -- The Federal Reserve Bank of New York invited 14 of the ``major participants'' in the credit- derivatives market to a meeting next month amid concern the $8.4 trillion industry is rife with unconfirmed trades. The meeting at the Fed's New York office on Sept. 15 will focus on market practices, according to an Aug. 12 letter sent to bank chief executives by New York Fed President Timothy Geithner. Fed spokesman Peter Bakstansky confirmed the letter's contents and declined to name the firms invited. The credit-derivatives market more than doubled in the past year, giving companies, investors and governments the ability to bet on or protect against changes in credit quality. A backlog of confirmed trades may undermine investor confidence, a group led by E. Gerald Corrigan, managing director at Goldman Sachs Group Inc. and a former New York Fed president, said last month. The Counterparty Risk Management Policy Group, the banking industry group led by Corrigan that first met in 1999 after the collapse of hedge fund Long-Term Capital Management, said in a report on July 27 that ``urgent'' effort is needed to tackle the ``serious'' accumulation of trade confirmations. Banks should be prepared to consider reducing trading until the deals are confirmed, the report said. JPMorgan Chase & Co., Deutsche Bank AG, Goldman Sachs Group Inc., Morgan Stanley and Merrill Lynch & Co. dominate the credit- derivatives market as the five most-cited trading partners, according to Fitch Ratings. `Senior' Executives The Fed's letter said ``a senior business representative and a senior risk management person,'' should attend the meeting. Credit derivatives are the fastest growing part of the $24 trillion derivatives market, based on the so-called notional value of the debts underlying the contracts. A derivative is a financial obligation whose value is derived from interest rates, the outcome of specific events, or the price of underlying assets such as debt, equities and commodities. Investors use credit-default swaps to bet on a company's creditworthiness or protect against non-payment. The contracts are the most common credit derivative. Like insurance, buyers pay an annual fee similar to a premium to protect a certain amount of debt against default for a specified number of years. In the event of a default, they get the face value of the bonds or loans. The settlement process for credit-default swaps is resource intensive, and typically requires faxed signatures. Banks and companies risk getting swamped by investors seeking settlement on their contracts in the event of a corporate default, Corrigan's group said. Derivatives traders must ensure they have systems and controls in place to keep up with the growth in their business, the U.K.'s Financial Services Authority said in a letter to companies this year. To contact the reporters on this story: Hamish Risk in London at hrisk@bloomberg.net; Justin Baer in New York at jbaer1@bloomberg.net Last Updated: August 24, 2005 14:34 EDT http://www.bloomberg.com/apps/news?pid=10000087&sid=aCcyORCwEhVw&refer=top_world_news
This is basically a "fail to deliver" of bank instruments. A bond pro told me it could cause an immediate devaluation in the currency and a world wide panic out of our bonds. It's about the leverage. They have got to reduce the leverage.
I know, I heard rumours about this going back to when a few hedgies had problems awhile back. Its just too tempting for a few players not to play with extreme leverage. You have it, and you say why not, especially if your only been in it for 5 years, and you think deriv instructments have little risk because you hedge it.
actually, I think it has more to do with this: A buys a CDS from B Then A sells it to C If there's a default on the reference asset, C will need to collect from B. But it will need to go through A (who is flat) first. If there are delays, then a corporate default could clog up the system as banks wait to get paid. Hard to say how severe this could be.
Actually, "confirmations" are usually a back office issue. Trader A at Firm X sells to Trader B at Firm Y. If not confirmed electronically, the back office of each firm communicates with one another to verify that each firm recognizes the trades and accounts for them. Where the system runs into problems is when rogue traders, being down millions of dollars for the firm and afraid to book the loss, will tell their back office that in fact, yes, a closing trade was made, "don't worry about confirming it". So the trade is "closed" in the firm's books at some small losses when in reality the position is still open and the firm is losing tens of millions of dollars. Basically what is probably happening is some institution or institutions are on the wrong end of a series of dervative trades and their balance sheets are not reflecting this reality. In fact, they may be erroneous reflecting that a trade was closed for a gain when in fact the trade is still open and losing hundreds of millions of dollars.
well some of the more exotic products developed are in house stuff, that they create and sell off. Some are derivatives of derivitives and are done all in house sold to another party and then they wrap it up as another product and sell it again. All of this isnt strongly regulated because its diffulcult to understand.
If there was a real problem, the Fed wouldnt wait for everyone to come back from vacation before having a meeting.