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According to standard ISDA definitions,

A Credit Event occurs if the Reference Entity  "seeks or becomes subject to the appointment of an administrator, provisional liquidator, conservator, receiver, trustee, custodian or other similar official for it or for all or substantially all of its assets".

Does this mean that Fannie and Freddie's credit default swaps have been triggered, and that the protection seller must pay out on them? Yes.

Thirteen "major" dealers of credit-default swaps agreed "unanimously" that the rescue constitutes a credit event triggering payment or delivery of the companies' bonds, the International Swaps and Derivatives Association said in a memo obtained by Bloomberg News today.

In itself, that doesn't worry me overmuch. The way that credit default swaps work, the protection seller receives an insurance premium every six months from the protection buyer. If a credit event occurs, then the seller has to pay out the face value of the bonds in cash, while the buyer has to deliver an actual bond.

In this case, the bargain is no great hardship for the seller, since the bond being delivered is essentially going to be an obligation of the US government. Indeed, if Frannie's spreads tighten in today, the protection seller might actually make money on this trade.

But of course it's more complicated than that. Even if the netting on bilateral CDS works out fine, there's also the index CDS to worry about:

A settlement of credit-default swaps would probably be the biggest attempted in the market's decade-long history because Fannie and Freddie are members of the benchmark index of U.S. credit risk, Percy-Dove said. The index comprises the most frequently traded contracts in the U.S.

Lots of index swaps get triggered the first time any credit in the basket suffers a credit event. Which means that there could be some big unwinds coming up very soon.

(HT: Alea)

Source: Frannie CDS Triggered