CDS does not guarantee a good night’s sleep

If Greece restructures its debt, credit default swap owners appear to be covered against losses. But what if the restructuring is “voluntary” or debt magically changes nature: the insurance may prove illusory. → Read More

Post scriptum. Collateral damage with CDOs

Guaranteeing (1) the reinsurance (2) of credit risk (3)

May 14 the Belgian government – again – had to intervene to save KBC Group. The risks in synthetic collateralised debt obligations the financial group is exposed to have led to write-downs of 3,8 billion EUR in the first quarter. We remind the reader that the fair value of a financial instrument at any time should reflect a potential transaction price. A change in fair value does not necessarily imply a cash outflow.

But where all of these junk credits not set to zero? → Read More

Collateral damage with collateralised debt obligations

Trading debt

The most important reason for the existence of banks is their ability to transform assets. A bank enables us to contract long term debt despite the typically shorter life span of our assets. By bundling our checking accounts a bank can, for example, extend mortgages.

This transformation is (among others) possible through securitisation, i.e. making debt such as credit card balances, corporate loans, receivables or mortgages tradable. KBC Bank for instance sells on a regular basis a pool of mortgage credit of its customers to a special purpose vehicle that in turn issues debt certificates with different risk profiles to investors. The interest and principal payments of these IOU’s are funded by the repayment of the often thousands of underlying individual mortgages. → Read More