globalmacro

A Bet Against the Banks

Here is a quote from the article user posted: "the top 25 banks held credit default swaps, both as insurers and insured, worth $14 trillion, the currency office said, up $2 trillion from the previous quarter".

The point that needs to made is that 7.8T in exposure is not the same as 7.8T in losses. Banks have been using CDS instruments to play both sides of the market as the insurer and as the insured. So, simply stating that someone has CDS exposure and that's bad is akin to stating that I must be in trouble because I have 1M in equity exposure and the market is going down. If you took the time to look at my equity exposure more closely, you might notice that it is divided almost evenly between longs and shorts (call it a long-short strategy). So, the fact that I have 1M in equity exposure, in and of itself, says nothing about how I should perform in the market.

So, all red herrings aside, if someone wants to do an analysis on net exposure of JP Morgan's aggregate CDS portfolio, I think it would be very illuminating. What you might find is that alot of the exposure is simply hedging against potential negative outcomes in its regular business activities. In effect, much of JP Morgan's CDS holdings could be bearish in orientation. The scariest thing in all this uncertainty is that I don't think anyone really knows the answers to some of these questions. But stating that JP Morgan has CDS exposure, no matter how large the number sounds, is not going to be enough to convince me that this exposure is somehow harmful or that it will drive its stock price lower.