CDS will be trendy again

The image above is just for fun, it doesn't really have anything to do with the content of the article other that the turmoil we are currently witnessing in the banking sector is causing CDS for several financial institutions to spike.

I find it hilarious and tragic at the same time that those two sentences can coexist on a financial news website in times like these.

Today we'll briefly talk about Credit Default Swaps, the darling of the great financial crisis (from now on GFC). An example of what happened back then: Lehman Brothers owed $600 billion in debt of which $400 billion was covered by CDS. The bank’s insurer, American Insurance Group, lacked sufficient funds to clear the debt, and the Federal Reserve had to intervene to bail it out.

For those of you that are not familiar with what happened in 2008, please go watch The Big Short, and pay attention to the info it provides. It is a really good movie, and pretty much explains what MBS & CDS are, how they imploded and why.

A Credit Default Swap (CDS) is a derivative that provides the buyer with protection against default. The buyer of a CDS makes periodic payments to the seller (similar to an insurance policy). In exchange, the seller agrees to pay the security's value and interest payments if a default occurs.

CDS on Deutsche Bank, the largest bank in Germany, are quickly surging. This means the cost of insuring bond holders against a default is rising. It's an indication of increasing risk and loss of confidence. The riskier the credit, the higher the cost to insure. Really not different that traditional insurance policies.

And here are the CDS on Schwab. What seems clear to me is that it doesn't look like they will be able to offset a run on deposits.

Please pay attention to your finances, these are very treacherous times.

Let me leave you with this - QE not QE. The FED balance sheet expansion goes vertical. One constant of the last few years is that the slope of expansions get steeper and steeper, pretty much vertical.

Stay safe out there.