Charlie Bottle

My Top 10 Market Predictions for 2009

Ed, thanks for sharing your views on such a broad rage of areas. One comment: I share your bearishness on China's Economy. In all likelihood it is already contracting. In any case no way you can be vindicated on your berishness as the offcieal figures will certainly not fall below 5%.

A Critical Market Juncture (Again)

The introduction of a clearinghouse in the "middle" of all CDS contracts means that each contract would have as counterparty the clearing house (just like in a derivatives exchange) rather than another participant.

For example, a contract where LEH sold JPM CDS on a name, becomes effectivelly two transactions: LEH sells to the clearing house; the clearing house sells to JPM. This way JPM is not exposed to LEH counterparty risk (or vice-versa).

By creating this hub structure, this sytem effectivelly diversifies counterparty riks and allows the system to better absorb the default of any individual counterparty. The problem with the existing over the counter structure is that it coexists with concentrations of exposure to a limitied number of counterparties by any given participant which creates the potential risk for a domino effect of counterparty defaults. This is why JPM had little choice but to buy bear strearns, and why the Fed is very focused on this.