Default Swaps' Role in Global Turmoil `Exaggerated'

By Aaron Pan

Oct. 15 (Bloomberg) -- Credit-default swaps have been blamed unfairly for causing the global financial crisis, the head of an industry body that represents dealers and sets trading standards said.

``Both the role and effects of CDS in the current market turmoil have been greatly exaggerated,'' Robert Pickel, chief executive officer of the International Swaps and Derivatives Association, said in testimony before the Senate Committee for Agriculture, Nutrition and Forestry yesterday. ``To say that CDS were the cause, or even a large contributor, to that turmoil is inaccurate.''

Credit-default swap trading expanded 100-fold since 2001 as insurance companies, hedge funds and investors used the derivatives to protect against bond losses and speculate on companies' ability to repay debt. Lawmakers and regulators have called for more oversight of the $54.6 trillion market after the bankruptcy of Lehman Brothers Holdings Inc., which was among the top 10 backers of the contracts.

Blaming credit-default swaps for the credit crunch ``reflects confusion of the various financial products that have been developed in recent years,'' Pickel told lawmakers. The securities have a beneficial role to play in helping financial markets allocate risk, he said.

Increased Regulation


Democratic Senator Tom Harkin, chairman of the Senate Agriculture Committee, yesterday said credit-default swaps should be regulated by the government. New York Insurance Superintendent Eric Dinallo agreed more oversight is required.

Commodity Futures Trading Commissioner Bart Chilton and Securities and Exchange Commission Chairman Christopher Cox have also said oversight is needed for the contracts.

Default swaps currently trade in private, exposing investors to default risk from trading partners. They pay the buyer face value in exchange for the underlying securities, or cash equivalent, if a borrower fails to adhere to its debt agreements.

Criticism of the part the swaps played in the failures of Lehman and American International Group Inc. led U.S. derivative exchanges to say they plan guarantees on the contracts using a clearing house.

The U.S. took over New York-based AIG with an $85 billion loan to cover obligations at a unit that sold protection on securities through the credit-default swap market.

Trading Declines

The volume of trades in the contracts worldwide fell to $54.6 trillion from $62 trillion in the first half, the ISDA said in a statement on Sept. 24. It was the first decline since New York-based ISDA started surveying traders seven years ago.

``There is little dispute that ill-advised mortgage lending, coupled with improperly understood securities backed by those loans, are the root cause of the present financial problems,'' Pickel said.

The Markit CDX North America Investment Grade index, a benchmark gauge of credit risk linked to the bonds of 125 companies in the U.S. and Canada, fell 43.5 basis points from Oct. 10 to 176.5 as of 4:29 p.m. in New York yesterday, according to broker Phoenix Partners Group.

A basis point, or 0.01 percentage point, on a credit- default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.

To contact the reporter on this story: Aaron Pan in Hong Kong at Apan8@bloomberg.net.