Counterparty risk in the market for credit default swaps, as measured by the CDR Counterparty Risk Index (CRI), hit an all-time high on Tuesday as traders reacted to Lehman Brothers’ bankruptcy and the unknown future of AIG.
“The market is in turmoil as massive unwinds of open CDS positions sweep across all desks and uncertainty surrounding the viability of the broker-dealer business model spreads contagiously across Europe and the US,” Tim Backshall, CDR’s chief strategist, said.
The CRI hit 389.33bp this morning, compared with its previous record wide of 250bps during the Bear Stearns-induced market panic.
“While Monday was extremely weak, sentiment feels even worse today (Tuesday) with CDS on AIG (not in the CRI) pointing to an imminent default as Goldman Sachs is sold aggressively on news, Morgan Stanley CDS breaks over 800bps, and the Merrill Lynch - Bank of America deal seems under tremendous doubt as rumors emerge of considerable write-downs to come for Merrill Lynch,” Backshall said in a note to clients.
The note continued:
European financials are wider but have far outperformed US financials so far (although their average risk has risen by almost 60% this week). US brokers are clearly the worst but US banks have almost doubled their risk in the last few days from an average of 195bps to 388bps currently with Wachovia and Citigroup the worst of the bunch as Washington Mutual (not in the CRI) remains on the brink.
Credit is underperforming equities (despite the sagging feeling across both markets) as stock prices are down on average 27% across the members of the CRI. US brokers (including Lehman) are down over 46% with US banks down over 23% this week alone. Once again European financials are outperforming (down only 16%) against an average 35% drop in US financials. With counterparty risk so high, and the expectation of contagious defaults rising, the need for tougher regulation, more transparency, and a central exchange-based clearing house has never been so clear and we feel the CRI remains a useful indicator of stress in the global financial markets.”
None of which bodes well for Felix Salmon’s nerves. Over at his Marker Movers blog - in a post titled, “AIG is toast” - Felix declared:
My one hope is that someone will essentially find a way for AIG’s bondholders to suffer all the losses, while AIG’s counterparties suffer very little if at all. (That also seems to be the idea behind Barclays buying Lehman’s brokerage operations.) So long as counterparty risk is minimized, we should be able to get through this. But will that happen? I have no idea.
Neither do we, frankly.
