Streetwise Professor

March 5, 2008

A Fearless Prediction

Filed under: Derivatives,Economics — The Professor @ 10:07 am

There are widespread conjectures that the credit crisis will soon roil the corporate bond market, leading to an appreciable increase in defaults. Apropos a piece from almost exactly two years (and 200 posts) ago, I fearlessly predict that this will lead to multiple squeezes and manipulations in the credit default swap (CDS) markets for defaulting securities. This will happen regardless of whether ISDA and market participants agree to alternative settlement mechanisms, such as cash settlement and auctions.

A wave of defaults will lead to a tsunami of litigation. Myriad issues will be litigated. Squeezes will be one. The legitimacy of changing settlement mechanism (from delivery to cash settlement, for instance) will be another. I also imagine that given the still creaky backoffice and confirmation systems in the CDS market, there will be numerous disputes over the validity of contracts. Many insurance sellers will attempt to walk away from their obligations to pay in the event of defaults, pointing to defects in–or complete absence of–trade confirmations.

What fun will be had by all.

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