Fannie And Freddie Generating CDS Defaults, And Exposing Transparency Issues

The recent move by the Treasury to place Fannie and Freddie into conservatorship amounts to the equivalent of bankruptcy in the credit derivatives market, generating defaults, and causing dealers in unwind various credit default swaps (see Financial Times article). The move once again highlights some of the problems with the CDS market, as no one really knows the real level of exposure. The notional protection outstanding is expected to be significant, but again, the exact amount is difficult to estimate. Settlement and trading procedures, as well as general transparency, needs to be improved. While the Fannie and Freddie related CDS issues may have less concerns, given that the value of the agency debt is still high and is currently backed by the U.S. government, the next Bear Stearns-like default may not provide as clear an exit plan. The powers to be need to act fast given that the growth of the CDS market is outpacing the current trading infrastructure, while the need for hedging credit risk has never been greater.