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ART CASHIN: Forget Greece, Traders Are Worried About Something That Could Send Us Back To The Middle Ages

In this morning’s Cashin’s Comments, UBS’s Art  Cashin addresses what worries traders these days.

A Greek default has been on everyone’s minds lately.  But the traders  Cashin has talked to think that it’s just the tip of the iceberg.

The bigger fear is what happens in the credit default swap (CDS)  markets.  No one knows how big it is, who the counterparties are, and,  worst of all, whether the CDS contracts will actually trigger in what many would  consider a default.

Here’s an excerpt from Cashin’s note:

Is There More At Risk Than Greece In A  Greek Default – Recently, there has been a buzz building on trading  desks and trading floors that there may be a lot more at stake in a potential  Greek default than the media has been talking about.

As of now, most of the public discussion has  centered on potential contagion among the banks as most of the Greek sovereign  debit is held by the European banking community.

Traders, however, fear that the real risk is in  the area of credit default swaps (CDS).  They are insurance policies,  individually written, that basically say – if Greece defaults, we’ll pay you  what they should have.

Credit default swaps have grown exponentially  over the last decade.  Since they are individually written, there  is no clear visible record of how many CDS contracts are outstanding.  Also  unknown is who is involved.  The two parties obviously know who the  counter-party is but there is no public record that would allow a regulator or a  third party to find out who was involved. … No  one knows how much CDS exposure there is on Greek debt but is assumed to be a  lot.  Banks and others looked at the very high and attractive yields  on Greek bonds and began salivating.  But, what about that risk  – better buy some insurance. … Recall that, months ago, negotiators on the  Greek debt bumped into part of the CDS problem.  If the holders agreed to  take 50 cents on the dollar, would that trigger their CDS on that bond (paying  them the conceded 50 cents and making them whole).

At that  time, many contended that if the bondholder “accepted” the offer of 50 cents on  the dollar, that made the event voluntary and it would not “trigger” the CDS  payout.  That caused lots of folks to ask for a ruling from the ISDA (the  ruling group on CDS contracts).  If you “accepted” an offer with a gun to  your head, was it really voluntary? … But, traders fear a worse  outcome might occur if the CDS contracts do not kick in.  What  good is insurance that doesn’t pay off.  That could lead to the assumption  that all CDS insurance was useless.  That would stratify debt around the  globe.  Great credits could get all the money they wanted, but less than  great credit would be shut out because it could not be insured.  That could  make the future one in which “the haves” will have whatever they want and all  others nothing.  Welcome back to the Middle Ages.

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