CDS/GM: A default by General Motors used to be the scary monster in credit default swap specialists’ nightmares. Now it has happened – and the CDS market is scarcely stirring. Experience, new processes and better information all helped.
Back in May 2005, a downgrade of GM’s debt by rating firm Standard & Poor’s almost caused the credit derivatives market to fail. That wasn’t even a bankruptcy. Later that year, though, car parts maker Delphi did go bust.
An estimated $20bn of CDS – a kind of insurance against default – had been linked to the $2bn or so of outstanding Delphi debt. Because settling CDS contracts at the time involved bonds changing hands, the mismatch temporarily upset both markets. If GM and its finance arm failed – with nearly $300bn of debt between them and huge volumes of CDS contracts on top – it could have been a disaster.
Fast forward just four years. It took advocacy by former New York Federal Reserve boss Gerald Corrigan, the knocking of heads by a successor, Tim Geithner (now US Treasury secretary), a concerted effort by CDS traders and the march of technology. But GM’s failure is hardly making waves in the CDS market.
Of course, GM’s long spiral has given market players years to prepare. But in addition, campaigns like Geithner’s for a shift to electronic trading have paid off. And just this past April the derivatives industry finally set standard terms for cash settlement of CDS trades, so that the underlying bonds don’t need to be involved.
Meanwhile, the vague guesses of four years ago have been replaced by hard data. The Depository Trust and Clearing Corporation, which now collects trading information, was able to say last week that the $35.3bn of outstanding CDS trades on GM - excluding index trades that have GM as one component - netted down to possible payments between market participants of an unremarkable $2.2bn.
There’s still room for improvement. Central clearing of trades, rather than bilateral dealing, is one ongoing effort. Transparency could be enhanced, especially on pricing. Non-standard credit derivatives, such as those that laid American International Group low, haven’t benefited as much from the market’s development. All the same, for the commonest types of contract, the damp squib of the GM bankruptcy suggests the Wild West of credit derivatives is on the way to being tamed.
