Wednesday, November 2, 2011

Big U.S. Banks Betting on Big European Banks Betting on Big Europe

Got that?
[too big to fail>too big to fail>too big to bail? -ed]

From Bloomberg:
Selling More CDS on Europe Debt Raises Risk for U.S. Banks
U.S. banks increased sales of insurance against credit losses to holders of Greek, Portuguese, Irish, Spanish and Italian debt in the first half of 2011, boosting the risk of payouts in the event of defaults.

Guarantees provided by U.S. lenders on government, bank and corporate debt in those countries rose by $80.7 billion to $518 billion, according to the Bank for International Settlements. Almost all of those are credit-default swaps, said two people familiar with the numbers, accounting for two-thirds of the total related to the five nations, BIS data show.

The payout risks are higher than what JPMorgan Chase & Co. (JPM), Morgan Stanley and Goldman Sachs Group Inc. (GS), the leading CDS underwriters in the U.S., report. The banks say their net positions are smaller because they purchase swaps to offset ones they’re selling to other companies. With banks on both sides of the Atlantic using derivatives to hedge, potential losses aren’t being reduced, said Frederick Cannon, director of research at New York-based investment bank Keefe, Bruyette & Woods Inc.

“Risk isn’t going to evaporate through these trades,” Cannon said. “The big problem with all these gross exposures is counterparty risk. When the CDS is triggered due to default, will those counterparties be standing? If everybody is buying from each other, who’s ultimately going to pay for the losses?"...MORE
HT: 5 Ducats who writes:

Big Banks Betting on the Euro

This Bloomberg article is troubling. It appears too big to fail US banks are betting that Eurozone government and banks are also too big to fail. In the long run, it is probably a good bet. Ultimately, the ECB will probably print enough money to bail everyone out. But in the short run, there could be some very uncertain times.

Right until Germany and the ECB capitulate, some US bank investments, shorts, and CDS counterparties may look like the will fail. It is quite possible that some smaller nations and banks will fail (Greece and Portugal would be analogous to Bear Sterns and Lehman). The fear that someone bigger (substitute Spain, Italy, & France for Citi, AIG, & Merrill Lynch) is what forces the ECB act decisively. But in the interim, the large and perfectly hedged positions in US banks don't look all that hedged after all, which would cause panic to jump across the Atlantic.

I'm not against taking bets on the ECB bailout. It is probably a good trade (except for on Greece and Portugal). But it is a trade that has to be made with your own money....MORE