Any Other Business | 18 October 2008

The ticking parcel I failed to spot and the oil-price prediction I got spot on

Last week’s global stock market panic, the overture to this week’s astonishing round of state interventions, was in part provoked by fear of humongous losses in something called ‘credit default swaps’. These arcane inventions by Wall Street rocket-scientists are a form of derivative contract — or ‘weapon of financial mass destruction’, as Warren Buffett put it — akin to debt insurance. A ticking parcel of at least $400 billion worth of them relates to bonds issued by Lehman Brothers before it went bust. Since Lehman paper is now priced at only 8 cents on the dollar, enormous claims are about to emerge against the parties to the swaps. The trouble is, as New York’s insurance superintendent Eric Dinallo observed, ‘No one knows who owes this money, how much each counterparty owes, or whether any of these counterparties will now be in trouble themselves.’

As I read that, I recalled a misty day in April 2005 when I lunched in the private restaurant at the top of the Gherkin, the London headquarters of the Swiss Re insurance group, with three masters of the money universe, traders of 30 years’ experience apiece. This credit derivatives market is getting out of hand, they agreed cheerfully as we savoured the recommendation of Swiss Re’s sommelier: no one knows how much paper has been issued, or who’s holding it, or what it’s really worth; fortunes are being made trading it, but one day it will blow up in our faces. That was three and a half years ago. I thought little more about it until last week. It was a huge story and I missed it. But then so did Swiss Re: the Gherkin was sold last year for £630 million, but that sum covered less than half of Swiss Re’s losses so far on credit default swaps.