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June 02, 2005

Gillian Tett on Credit Derivatives and IB Losses

From the Financial Times:

FT.com / Companies / Financial services - Credit derivative swings hit hedge funds: Recent swings in the price of credit derivatives have inflicted losses of about $1bn (£550m) on hedge funds and large banks, according to estimates by Goldman Sachs. The figure - which some traders consider far too conservative - represents the first public estimate of the damage created by the recent turmoil in instruments such as collateralised debt obligations. "A back-of-the-envelope calculation suggests that the change in net present value among market-to-market players [in the CDO market in the past three weeks] is about $1bn," Claus Toft, a senior strategist at Goldman Sachs, told a conference in London....

Mr Toft stressed that the losses sustained by hedge funds and banks could be easily absorbed by the overall financial system. However, the estimates come amid intense curiosity about the problems faced by some institutions in the CDO market. So far no bank or hedge fund has admitted to serious losses from CDOs. And some bankers hope that these losses will shrink in the coming weeks, if credit market prices recover. Indeed, some bankers now believe that a rebound is under way, because new investors are coming into the market....

The main reason hedge funds and banks suffered was that they held the so-called "equity" tranches of CDOs, the riskiest slice of debt. These tranches fell in price in mid-May, partly due to the problems at General Motors and Ford, the US carmakers...

Posted by DeLong at June 2, 2005 10:18 AM