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  • LOOK OUT: SOVEREIGN CREDIT DEFAULT SWAPS ON THE RISE 0 comments
    Jan 27, 2010 12:28 PM
    It’s possible that the double dip may be unfolding sooner than later. These are the kind of warning signs, which occurred just before the last financial crisis. Here is the Bloomberg report and the underlying IMF report, which generated the story. If anything, the IMF report, is a major warning signal that the credit crisis is on extremely dangerous footing.
     
    Jan. 27 (Bloomberg) -- Traders are buying protection against defaults on sovereign debt at more than five times the rate of company bonds as governments fund ballooning deficits.
     
    The net amount of credit-default swaps outstanding on 54 governments from Japan to Italy jumped 14.2 percent since Oct. 9, compared with 2.6 percent for all other contracts, according to Depository Trust & Clearing Corp. data. European countries led the increase, with the amount of protection on Portugal climbing 23 percent, Spain 16 percent and Greece 5 percent.
     
    Spreads on high-yield securities increased for the sixth day yesterday, the longest period since August.
     
    From the January report of the International Monetary Fund:
     
    Banks not only face the task of raising more capital, but also need to address potential
    funding shortfalls. As noted in the October 2009 GFSR, there is a wall of maturities
    looming ahead through 2011–13. This bunching of financing needs is a legacy of
    shortening maturities during the crisis. A future retrenchment in confidence therefore could severely weaken banks’ ability to roll over this debt.
     
    At a minimum, there is a risk that the public debt issuance in the coming years could crowd out private sector credit growth, gradually raising interest rates for private borrowers and putting a drag on the economic recovery. This could occur as private demand for credit recovers and as banks are still constrained in their ability to extend credit, particularly as financial support measures are being unwound. A more serious risk is from a rapid increase in interest rates on public debt. Such a rapid runup in rates and a steepening of the yield curve could have negative effects on a wide variety of financial institutions and on the recovery as sovereign debt is repriced. Finally, there is the risk of a substantial loss in investor confidence in some sovereign issuers, with negative implications for economic growth and credit performance in the affected countries.
     
    Credit Default Swaps are still rising in value and now also increasing in volume as well. The net amount of credit-default swaps outstanding on 54 governments from Japan to Italy jumped 14.2 percent since Oct. 9, compared with 2.6 percent for all other contracts, according to Depository Trust & Clearing Corp. data. European countries led the jump, with the amount of protection on Portugal climbing 23 percent, Spain 16 percent and Greece 5 percent. So the record levels of debt being purchased at Treasury auctions are being hedged with record levels of bets that those debts will default by big money investors. Hmm, can we think of another time that big money investors bought something with one hand while betting against it with the other?

    Disclosure: none
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