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Back in early 2007 I wrote about the risks in the market for credit default swaps, a type of financial instrument that basically serves as insurance against bond default. The crux of the article was that some of the insurers in question might not be able to pay when the time came, and that would be trouble.
Almost exactly a year later, in January of this year, I wrote that the Fed’s bailout of investment bank Bear Stearns may have been intended to prevent exactly that type of situation (though I noted that I’d expected the trouble to come from hedge funds, not from full-fledged investment banks).
Today, the bankruptcy of investment bank Lehman Brothers may have set some CDS market problems into motion. As this Bloomberg article dryly notes:
Bond-default risk soared worldwide as the collapse of Lehman Brothers Holdings Inc. sparked concern that the $62 trillion credit-derivatives market will unravel.
It turns out that Lehman was one of the ten largest “counterparties” (credit insurers) in the default swap market, so their failure is obviously a big deal.
On the other hand, things probably won’t be allowed to get too bad before the next bailout is put into place.
— RICH TOSCANO