Saturday, March 10, 2012

Cluster Bombs

This notion of "default insurance" behaving like any other insurance risk has been flawed from the beginning. The generators in most insurance are truly (or very close) to random, and probability densities actually have meaning and make sense when making investment and coverage decisions.

With CDS, risks are clearly correlated and non-random. This makes CDS a VERY dangerous game to play to the unitiated and/or for those who are short term in their thinking.

This creates a perfect insolvency bomb for many banks.

March 10 (Bloomberg) -- Austria is facing a capital
injection of as much as 1 billion euros ($1.3 billion) into KA
Finanz AG less than two weeks after bailing out Oesterreichische
Volksbanken AG.

The International Swaps & Derivatives Association yesterday
ruled that Greece’s use of collective action clauses forcing
investors to take losses under the nation’s debt restructuring
will trigger default insurance payouts.

In a statement before ISDA’s decision, KA Finanz said it
may have risk provisions of about 1 billion euros if credit-
default swaps on Greece it has written are activated.

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