The Great Untangling – Capital Markets –

I should stop reading this stuff …

The Great Untangling – Capital Markets –

Some fear that worse may be yet to come. The failure of another big actor in the market would send dealers and other counterparties scurrying to replace trades, almost certainly at a higher cost. Replacing those struck with Lehman, as spreads widened after its bankruptcy filing, is thought to have cost some dealers upwards of $200m each.

That risk remains, judging by CDRâ??s counterparty-risk index, which measures the health of CDS dealers (see chart 1). The next shock could be the failure of a hedge fund with a big swap book, given the spike in redemptions and margin calls many funds face, thinks Pierre Pourquery of the Boston Consulting Group. Hedge funds wrote almost a third of all credit protection last year (see chart 2).

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Sellers of protection will be watching nervously for a wave of corporate defaults as big economies slip into recession. Standard & Poorâ??s expects the default rate on junk-grade debt to leap to 23% by 2010. Sovereign debt is looking wobbly too, especially but not exclusively in emerging markets. The cost of insuring against a default by the United States has quadrupled since January.

The full article is worth reading and not as dire as this section suggests. It is good to see that the market as well as regulators are looking to resolve the transparency issues with regard to credit default swaps. It seems that until transparency is installed, the financial system will remain on the brink.