Regulators determined that off-exchange CDSs were the main culprit in the 2008 financial crisis.
The lesson learned was to clear CDSs on exchanges to ensure settlement with proper capitalization.
The cause of this turn of events is the proliferation of CDSs on the company's debt.
That is because a default would trigger the bond-insurance contracts called credit-default swaps (CDSs).
If counterparties pay up, CDSs are a zero-sum game: what the seller loses, the buyer gains.
Similarly, undermining the validity of sovereign CDSs will roil markets and hurt borrowers, as per last week.
Foul-ups with derivatives are hardly uncommon, but CDSs have been causing particular consternation.
Several Internet search results show DB brochures, reports and other information indicating DB actively sells CDSs and other derivative contracts.
The study also says about two-thirds (of all CDSs) are collateralised (and ISDA said 81% was collateralised by cash for sovereigns).
Second, if Greece unilaterally imposes losses, bondholders who have bought credit-default swaps (CDSs), a form of insurance against default, would get paid.
Unsecured creditors who hold CDSs might prefer default to a lengthy restructuring: to them, the insurance policy is worth more than the house.
Mr Paulson (whose fund has done badly of late) was able to buy CDSs cheaply because everyone else was bullish on American housing.
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If implemented, such a "voluntary" exchange wouldn't qualify as a default, which has to be binding, and therefore no CDSs would be paid out.
The problem, says Canfin, is where investors buy up CDSs without having any exposure to Greek sovereign bonds themselves, making money without taking any risks.
There are, for instance, already plans for clearing houses for CDSs.
Credit default swaps (CDSs) are one type of derivative contract, and regulators in the US and EU put them on a faster track to exchange clearing.
CDSs are insurance, so when some debtors went bust in 2008, those who bought CDSs on debt were paid on their insurance, while those who wrote the insurance lost.
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Has DB also sold on- and off-exchange CDSs on Greek debt and is it against the restructuring to protect itself from having to pay out on the CDS contracts?
CDSs were sold as a protection policy to bond holders just for this type of scenario, yet officials may not be fully confident in that CDS protection holding up.
If, as even critics concede, CDSs can be a useful hedging instrument, then excluding "naked" buyers would reduce the breadth and depth of the market, putting "legitimate" hedgers at a disadvantage.
Originally conceived as a means for banks to reduce their credit exposure to large corporate clients, CDSs quickly became instruments of speculation for pension funds, insurers, companies and (especially) hedge funds.
American senators are caught up in a heated debate over a wide-ranging reform bill, a key part of which covers over-the-counter derivatives, especially CDSs, which many see as having exacerbated the crisis.
The failure in mid-September of Lehman Brothers showed that the main systemic risk posed by CDSs came not from widespread losses on underlying debts but from the demise of a big dealer.
"A lot of large institutions are selling European sovereign debt and the corresponding CDSs because they don't feel like they have adequate insurance, " says Mark Grant, of Southwest Securities, a Texas-based investment firm.
Activity in the country's CDSs has been subdued.
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If CDSs are seen as unreliable, U.S. banks' repeated statements about their "limited" exposure to Europe might sound less reassuring, especially if investors focus on warts-and-all "gross" exposures rather than the much smaller "net" figures that subtract the value of CDSs and other hedges.
Assuming the feds had done right and let AIG go under (its error one of failing to hedge its exposure to CDSs), those in need of credit default insurance could have simply taken their business to other financial companies ready and willing to provide what AIG no longer could.
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