Reacting To Credit Suisse’s Collapse From Credit Default Swaps

If they lent money out to like a big business and that business is unable to pay them back, they will ask other companies to lend them money to cover their losses in case anything happens. So that is what the default swap is. Hey, so you may be starting to hear about a topic or an instrument called a credit default swap. And I thought it would be very interesting for especially what's happening with Silicon Valley bank and Signature bank and the other banks that are going on currently. And so what I wanted to share with you is just some insights and information that's readily available. And I do want you to know that this is not investment advice of any sort. I'm not placing any opinion on this. It is just a mere presentation of information for educational purposes. Let's revisit what is a credit default swap and I'd love to actually refer back to a very popular video that aired a couple of years ago and it's called the Big Short. And I just wanted to show an excerpt of that video.

I want to buy swaps on mortgage bonds, credit default swap that will pay off.

If the underlying bond fails.

You want to bet against the housing market.

Why?

Those bonds only fail in millions.

So in that time it was betting against the housing market on bonds. And for those of you who haven't had a chance to watch or learn or look at the background of what Silicon Valley bank has invested in, they purchased government bonds and with the rapid increase in the interest rates over the past two years, the value of those bonds have gone down in value. So that's just one thing to highlight that the underlying of what the credit default swap was used for is different in terms of what was the bonds on housing market. But this was bonds on government bonds.

Don'T pay their mortgages. That's never happened in history. Excuse me, Dr. Berry. It seems like a foolish investment based.

On prevailing sentiment, the market and banks in popular culture. Yes, it's a foolish investment, but everyone's wrong.

That's a good one.

This is Wall Street, Dr. Berry. If you offer us free money, we are going to take it.

My one concern is that when the bonds fail.

I want to be certain of payment in case of solvency issues with your bank.

I'm sorry, are you.

So I just wanted to just make reference on solvency related to the bank. And this just in my opinion shows using this movie to explain the level of thinking severity that this potential issue could arise in bank defaults and which has happened again for the Lehman Brothers as an example. Well, this was his concern related to the defaults in just the banks in general. As he was entering into these credit default swaps.

You want to bet against the housing market and you're worried we won't pay you?

Yes, that's correct.

Doctor Berry. We could work out a pay as we go structure that would pay out if the bonds fail, but it would also apply to your payments if the value of the mortgage bond goes up. You'd have to pay us monthly premiums.

This is essentially kind of like paying insurance on these bonds. And to pay insurance, there's an upfront requirement for premiums in return, if the event happens, the insurance would issue a claim for that. The substance of this product of a credit default swap behaves like an event that would potentially happen. And if it does, then there would be a claim paid out. And in this case, Dr. Michael Burry would be paying premiums to get and enter into these credit default swaps that legally bind the bank to pay him when that event has happened and which was what paid him.

I have prospectuses on six mortgage backed securities all on short.

We're prepared to sell you 5 million in credit default swaps on these mortgage bonds.

Can we make it 100 million?

So he would be paying premiums on 100 million worth of credit default swaps and the pricing on those premiums are relevant at that time. And because generally these pricing premiums are priced based on the market and because paying is quite low. Now the size of his premiums were quite large given the position size he was taking. But his premiums at that time because of the volatility and the pricing in these credit default swaps would be low. He wouldn't have to pay as high. As opposed to when the fire building is burning and there's insurance available for it, that price because the building is burning would be much higher. But he's much, much earlier. So the premium price hasn't reflected the breakdown of that underlying security that was happening at that time.

Absolutely. We can make it 100 million.

We'll be in touch.

Send some paper.

Now partially why these individual actors were surprised or at least acting, why they were surprised was why someone would pay these premiums for something on an event that had very low probability and likelihood of happening. And you can recall the comment was based on if you are offering money, they're going to take it. And in general to speak when someone is entering into these credit default swaps upfront, they're going to pay those premiums and then the institution is going to receive the premiums from. Let's say Dr. Michael Burry. And as part of the compensation to the bankers in this situation, most likely they're going to get paid for a commission for facilitating that transaction. So the institution, in this case Goldman Sachs, was receiving the premiums which then would pay these particular individuals a commission, presumably, I'm assuming for their sale. On that.

He goes across multiple banks. So I think that kind of illustrates the point.

So he goes across multiple banks and I think that illustrates the point in what I'm trying to talk about in this particular video. Let me just kind of recap first. What is a credit default swap? Well, a credit default swap is a financial contract that allows investors to hedge against the risk of default on a debt instrument such as a bond or a loan. And in that credit default swap agreement, the buyer of the contract pays a periodic fee to the seller of the contract. So in this case, that institution, in exchange for a promise that the seller would compensate the buyer in the event of a default on the underlying debt instrument. What the whole purpose of this video that I wanted to share with you was, I wanted to show you a recent chart of all the credit default swaps from Credit Suisse, a Switzerland based bank who's big on originating a lot of these credit default swaps. And here's what you can see where you can see a very huge spike of these default swaps skyrocketing up, meaning the demand or the claim for these swaps have now started to really increase. So you can see back in 2007-2009, since that housing market crash, in the example that I shared with you, you saw a spike there and then things kind of calmed down and you know, 10 years later, 12 years plus, now you can see the credit defaults off. From 2021 till now, the level of demand on the pricing for these credit default swaps have shot up. And how the markets will work is if there is a high demand with that price is going to push up. So you can see a huge spike from Credit Suisse related to the pricing of the credit default swaps. So that means the demand for these are surging extremely high. And what I kind of want to explain is probably in a more simplistic way is that imagine you have a toy car that you really like and you're worried that someone might happen to break it. So you ask your friend if they can lend you their toy car as backup just in case something happens to yours. In case of the banks, they also worry that when they lend money, which in a sense is the depositors who put money into the banks and the depositor like you may have put money into the bank and, and they've taken that money to lend it back out to other businesses. They've attached collateral, that's number one. But they've also insured that money as they are lending it out. So if they lent that money out to like a big business and that business is unable to pay them back, they will ask other companies to lend them money to cover their losses in case anything happens. That is what the default swap is. And more particular, it's a credit default swap because it's not money, it's actually credit that's being granted when they lend that money out. And now Credit Suisse is a big bank that has lent a lot of money to different companies. And one of those companies they've lent to is Silicon Valley Bank. And we now know Silicon Valley bank is having problems and they are most likely not able to pay back the loan. So Credit Suisse is going to have to use their default swap that they got from another company to cover their losses now because a lot of banks are worried about SVB problems that also need to use their default swaps. So that means there's a high, high demand for default swaps. And that's what I wanted to highlight with that picture that I was sharing with you. And the price of these loans have gone up in the news. You're going to see something along the lines of Credit Suisse. Their default swaps have hit record as SDB's failure has hit other banks. And as we already know now, Signature bank has already happened. And there's as the recording of this time, other banks have also taken another impact. So now we know Silicon Valley bank is one of the banks that have failed, similar to Signature bank and the other ones that are coming along. And if we know that one of the banks that has been offering credit default swaps on Silicon Valley bank, well, let's take a look at Credit Suisse, who was related to that. And I'm just going to pull up their shares and the prices of their shares and just interpret those shares for you to see. So what I'm sharing with you is just a simple financial market chart on Credit Suisse. And if we take a look at back in 2007 with Credit Suisse being at $76 per share, and ever since then, the value of Credit Suisse, every single year, the share value of Credit Suisse has fallen from $76 down to about $2.50 per share. I mean, is Credit Suisse in line to be one of the other collateral damages that will happen from this banking failure. Who knows. But I think it's really interesting as insight for you to see in terms of the price and what has happened to this bank. And I think these are some things that will facilitate some really interesting conversations. That's all I wanted to share with all of you who have watched this video related to credit default swap and I thought it'd be very interesting to relate back to an event back in 2008, 2009 related to the housing financial markets and what happened at that time in case life got too busy and you may have forgotten what has happened to the underlying society when a bank collapses and the potential impacts and the ramifications it can have on society. And one of the things that I wanted to encourage you that now that you know this is potentially something that is very, very relevant that can impact you today, I really would encourage you to to learn about taking control of the banking function at the UNME level and definitely get yourself into watching the free training that we offer. 90 minutes of free training on becoming your own banker@watchibc.com Please feel free to check out the rest of our videos and thank you.