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A credit default swap (CDS) is insurance bought by a lender to protect against a loan default. Say the CDS buyer is holding some sketchy corporate debt issued by a distressed company such as, oh, let's just pick one out of a hat, Bank of America! If said company goes down, the CDS holder can "swap" the defaulted bonds for their face value in cash. The price of the CDS is called the "spread." The higher the spread, the greater the perceived likelihood that a default will take place.
Earlier this morning Bank of America's five-year CDS spread, which has been steadily rising over the past several weeks, suddenly blew wider by another 25% (see chart above). Ominous for unprotected lenders. And shareholders.
If MainePERS portfolio managers have not dumped the stock by now, you may be seeing them soon at a pharmacy near you. Will there be meds enough for BAC's collapse?
From Yves Smith at www.nakedcapitalism.com:
"We are now seeing the downside to extend and pretend. Years of regulatory forbearance mean that investors know the marks on the balance sheet of a beast like Bank of America (and frankly all the other big banks) have a ton of air in them. And now that the economy is looking seriously wobbly and the odds of son of Credit Anstalt are well above zero, it means big banks are at real risk of getting seriously whacked in a major stress event. Worse, with Dodd Frank (supposedly) barring bailouts and Tea Partiers on an anti-bank, anti-Fed, anti-spending warpath, it might not be so easy for the authorities to rescue a big bank if a run started (not that I’m advocating a rescue, mind you, I’m looking at this from the vantage of a bank shareholder)....
Now normally, investors accept the unknowability of bank equity because they have some faith in the system. Does anyone have any confidence in the system now? Financial regulators have shown themselves to be incompetent and/or badly captured by banks. Earth to base: letting off bank management easy is bad for investors in the long run. Being an investor in an overly risky bank looks swell until it suddenly isn’t."
Complete commentary viewable here.