On January 10, 2012, we noted that a proposal to use credit default swaps to price deposit insurance (Financial Times, December 28, 2011) was completely impractical for two reasons: lack of volume and the fact that the riskiest banks were in fact CDS market makers. In this blog, we update our January 10, 2012 blog by reporting on credit default swap trading volume for all U.S. banks for the 103 weeks ending June 29, 2012.
The data through June 29, 2012 re-confirms that there is no “large and active market” in bank credit default swaps. Using data reported by Depository Trust & Clearing Corporation during the 103 weeks ending June 29, 2012, there were credit default swaps traded on only 13 reference names among U.S. banking firms:
ALLY FINANCIAL INC.
AMERICAN EXPRESS COMPANY
BANK OF AMERICA CORPORATION
CAPITAL ONE BANK (USA), NATIONAL ASSOCIATION
CAPITAL ONE FINANCIAL CORPORATION
CITIGROUP JAPAN HOLDINGS CORP.
ISTAR FINANCIAL INC.
JPMORGAN CHASE & CO.
THE GOLDMAN SACHS GROUP, INC.
WELLS FARGO & COMPANY
There were no additions to this list between our previous report based on data through December 30, 2011 and June 29, 2012. These 13 reference names represent 11 consolidated corporations, four of which would not be considered banking firms by most observers prior to the recent credit crisis (American Express, Goldman Sachs, MetLife, and Morgan Stanley). During the 103 weeks of data on all live trades in the DTCC credit default swap trade warehouse, there were no trades on any of the other 6,211 banks insured by the FDIC in the United States as of June 30, 2012.
Credit default swap trading volume on the 13 firms listed above is based on data from the Depository Trust & Clearing Corporation and calculations by the Kamakura Corporation. We assume that each firm has a percentage of dealer-dealer trades equal to the 76% of all trades in the DTCC trade warehouse that were between dealers on September 7, 2012. The trading volume for the 13 reference names is summarized here:
There was an average of only 3.12 non-dealer credit default swap trades per day during the 103 weeks ended June 29, 2012 for the 13 banking entities listed above. None of the banks listed above averaged more than 7 non-dealer trades per day over the 103 week period studied. Six of the 11 firms listed are in a conflict of interest position as major dealers in the credit default swap market: Bank of America, Citigroup, JPMorgan Chase, Morgan Stanley, Goldman Sachs, and Wells Fargo. Dealer-dealer trades made up 76.00% of live trades in the DTCC over the 103 week period studied. The dealers would be setting deposit insurance rates for themselves if credit default swap pricing were used to determine FDIC insurance premiums.
There were 13 x 103 or 1,339 observations of credit default swap contract volume on U.S. banks. 92 of these observations, 6.87% of the total, were for zero contracts traded during the week. The largest single week of trading recorded was for 434 contracts, the equivalent of 20.68 non-dealer trades per day during that week. That volume was for Bank of America Corporation during the week ended October 22, 2010. The graph below shows weekly gross trading volume for Bank of America Corporation for the 103 weeks ended June 29, 2012:
Our conclusions from January 10, 2012 remain unchanged. Credit default swaps are an impractical basis for pricing bank deposit insurance for a number of reasons:
- The number of reference names traded over the two years ended June 29, 2012 is only 13, but 6,222 banks in the United States were insured by the FDIC as of June 30, 2012.
- Almost half of the reference names traded are major dealers in the credit default swap market, so they are in a conflict of interest position
- There is a risk of collusion that is similar to the risks of collusion in the Libor market
- Credit default swap pricing is affected by the probability of a bail-out of senior debt holders, so CDS pricing understates the true risk of failure for a bank that is “too big to fail.”
Detailed Information on CDS Trading Volume by Individual Reference Name
Donald R. van Deventer
Honolulu, October 3, 2012