One of the many enjoyable acronyms that became household names in 2008 was CDS – credit default swap.  As most investors know by now, these instruments were created to protect bondholders from default.  Of course, what we found out in 2008 was that they really just shifted the risk from one investor to the other.  Sort of like tossing a hand grenade in a circle hoping you aren’t the one holding it when it goes boom.   And as Wall Street imploded on itself in 2008 this game of toss the grenade became increasingly expensive to play as evidenced by the surging cost to avoid the grenade (surging cost of CDS).

What’s frightening about the developments in Europe in recent weeks is that the CDS market is once again sending the same signals.  Someone is going to get left holding the grenade again.  And this time, the market is actually telling us that it’s even worse than it was in 2008.  The only difference is that the problems appear to be across the pond.

The following chart from Danske Bank shows the 5 year CDS rates for 6 of the largest banks in Europe – SocGen, Unicredit, Barclays, Credit Agricole, Banco Santander and BNP.   If this market is giving us a cue its message is more than clear – someone’s paying an awful lot to avoid the inevitable explosion and they’re even more eager to avoid this explosion than they were in 2008.  Is the market underestimating the risk of further credit contagion?  That would appear to be the message from the CDS market.

Source: Danske Bank


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • Dylan Johnson

    Cullen i have a question…if europe fails to come together via economically as you say is nessecary, can we expect to see the Euro fall in value. Will europes debt issues and failure to unite and kick the can down the road policy, invariablly going to lead to a falling Euro?

  • Walk The Talk

    Thanks Cullen, looks like we’ve gone back to the future.
    I wonder who is holding the other side of the CDS trade that is about to blow up in their face.
    I also wonder if Europe will forget about (purposely ignore) mainstreet like the Fed did and continues to do.

  • SS

    The market underestimating how bad this is. The problem is that these banks all need to be recapitalized. And that means we need to go through the same process of 2008. That will involve Euro TARP, capital raises and time. But I don’t think we have the political will to get all of this done in the next 6 months. Plus, can Europe even implement a Euro TARP? What would that entail?

  • Plainview

    If even three of those banks go bankrupt and trigger CDS then owning the CDS will be next to useless because you either won’t be getting paid a damn thing *or* you’ll be paid in some MASSIVELY devalued semi-worthless currency.

  • Cullen Roche

    I’ve been trying to figure this out all weekend. I don’t know what the ECB can and can’t buy. I doubt there is the political will for a Euro TARP at this point. And without a Euro TARP we might just have to see what it’s like to throw the banking system out of the plane without a parachute.

    If any European readers know the process of a Euro TARP (legality, etc) I’d love to know….

  • Wantingtoretire

    In 2008, banks in Europe and America had to be shored-up to be “viable” entities, did they not? Hence, when the crisis appears again do you not expect US banks to be dealt a repeated blow for which there my be no rescue this time around. I am less concerned about the value of the Euro than I am about having a functional banking system that is still able to provide the funds I have on deposit with them. This is on both sides of the pond.

  • Martin

    “it’s like to throw the banking system out of the plane without a parachute.”

    Don’t worry at some point you reach “terminal velocity”…



  • Cullen Roche

    And after you reach terminal velocity you hit the ground. :-(

  • Martin

    Pretty much Cullen, unless your name is Travis Pastrana…


  • Nils

    I think it was suggested when the first banking crisis hit that there needs to be a mechanism to deal with bank failures on a European level. Merkel was against it and so it wasn’t done. This is now of course part of the problem as a lot of those nations who recapitalized their banks now have these huge debts.

  • Rem123

    To provide TARP on a national level is legally extremely difficult, due to strict European competition policies and guidelines for state intervention. See for instance:

    So it has to be arranged on a European level. The new “improved” EFSF has ‘TARP capabilities'; EFSF loans may be used to recapitalize banks. But EFSF loans are only made to programme countries, so for instance Italian banks can not be recapitalized through the EFSF as long as it’s not a programme country (which it never will be, since the EFSF is way too small to support Italy).

    So it basically has to be unanimously decided by the EcoFin council/heads of member states as an emergency measure:

    At least, that’s my perspective on it. But I’m not a lawyer.

  • Rem123

    To add: There still is a discussion between the Netherlands and the European Commission whether the state intervention in Fortis/ABN Amro is to be considered as an unfair advantage. ABN was forced by the EC to sell HBU for instance.

    I do not think that member states can embark on TARP unilaterally as a precautionary measury. Banks have to be on the verge of collapsing to make that possible ;)

  • Mark

    Cullen – you don’t suppose any of the US TBTF banks hold any of these CDS grenades do you?

    I mean, if you are a TBTF bank, what do you have to lose?

  • Wulfram

    Well, the FDIC still insures up to $200K. I doubt they have enough hand to cover a CITI or BOA, so I would keep my cash with the stronger banks.

    I think the more deadly effects would be with contagion to “safe” havens with ties to Europe that are exhibiting bubbly behavior. Australia and Canada come to mind.

    In my estimation, these countries have been fueling a credit and real estate bubble off of the weak dollar carry trade, especially in areas with large Asian populations. We’ve seen what happens when this trade unwinds following a credit crunch and a flight to safety unwinds the trade in Northern Europe and it isn’t pretty.

  • Yohay

    There is definitely serious trouble with these banks. According to their own figures, SocGen are leveraged 28:!. Lehman was leveraged 31:1. According to other estimates, their leverage is closer to 50.
    I believe the French government will intervene to save the French banks, and eventually lose the AAA credit rating. And then, the ECB will have to buy more bonds. If the ECB’s bond buying program becomes too large, it will not be able to sterilize it – full Euro-QE.

  • The Dork of Cork

    Cullen – the euro banks will buy Gold.

    The Banque de France has that culture – hence when the French banks go down they will hit the red button.
    It has been flickering on & off now as Soc gen gets into trouble.

  • gf


    It almost seems that the FED is the more likely provider of a EU Tarp than the EZ and that is not really a joke.

  • Martin

    An interesting post in relation to the FED as a lender of last resort:

    “loans and cross currency swaps are the “leverage of the leverage”, so to speak. With them, other central banks give up their sovereignty and the Fed effectively becomes the world’s lender of last resort. For instance, when the Fed loans US dollars to a German bank, as it did, the European Central Bank can no longer act as lender of last resort, should the German bank default on its obligations with the Fed. But, would this in reality occur? Of course not! If the German bank was not able to repay its US dollar denominated loans, the Fed would simply roll over the liquidity line. This is a very troubling scenario because the Fed in fact expands the supply of US dollars worldwide (global leverage), without any counterbalancing reduction of credit in the US currency zone.”

  • DH Dell

    I fully agree, but such such action won’t be such a new concept. The fed was also last lender of resort for the global banking system in 2008.

  • prk

    If French CDS is at 160 and Spain CDS is 370, it’s only natural that those countries’ banks trade at similar levels. The culprit is the risk attached to European sovereigns.

  • jt26

    If I saw what was happening since 2008, I would definately pay anything for the CDS. Compare …

    2007-08 = fear + 4->0% FFR + still a global new era (e.g. BRICs)

    2011 = fear + 0% FFR + several (failed) Fed kitchen sinks + ineffective governments + worsening global imbalances (remember, Krugman said way back the Asian miracle was just debt … he’s right again, this time it’s just the corollary, the trade deficit)

    I thought the IMF was supposed to be the global lender of last resort?

  • D

    I believe it was here that Cullen posted an outside article that deduced as much as 90% may be written by US institutions. Would seem about right….

  • Markus

    Isn’t it possible that part of the reason that CDS prices are higher this time around is because the CDS market was so poorly understood the first time? In 2007, banks were selling CDSs for far lower than the value they should have been sold for, given the amount of risk behind the mortgage-backed securities. Is it possible that the banks have learned at least a little bit and realize that they should be charging more for CDSs, even if the risks aren’t as great or greater (which they may very well be)?

  • Andrew P

    I think formal “legality” as we know the meaning in the USA is irrelevant. There is no higher authority who can overrule the ECB. As far as I know, there is no analogy to impeachment in the EU’s half-ass imitation of a federal system, and the governors of the ECB have fixed terms. The EU Parliament is essentially powerless, and the Commission does not have authority over the ECB. I suppose the German State Police could try to arrest ECB governors for doing something illegal, and that would cause a Constitutional crisis. The real question is – what is politically possible in the current EU structure, without the Germans withdrawing from the EU or trying to personally prosecute ECB governors? I suspect the answer is quite a bit. The Germans may complain, but they won’t leave the EU, and they won’t precipitate a Constitutional Crisis. But I could be wrong…

  • Andrew P

    250K actually. And the FDIC has unlimited authority to borrow from the US Treasury to make up any shortfall. If you have 250K in insured deposits you will be fine. Anything above that level will probably be lost if a major bank fails.

    At least we have the option of buying US Treasury Bills/Bonds to safeguard large dollar deposits. Euro holders do not have that option. There are no EU Treasury Bonds. Therefore, there is no absolutely secure place to hold Euros in any amount too large to hold in printed notes. At least the Euro has 500 notes, which allows quite a bit of money to be packed into a briefcase or knapsack.

  • beowulf

    $250k per account, there’s no limit on the number of accounts one can hold. Of course if you have that much cash, cut out the middle man already.
    In other words, you could invest as much as $5 million in each security listed below — in every auction offering — without violating the purchase limit. For example, you can purchase:
    $5 million each in 4-, 13-, 26-, and 52-week Treasury Bills,
    $5 million each in 2-, 3-, 5-, and 10-year Treasury Notes,
    $5 million in 30-year Treasury Bonds, and
    $5 million each in 5-, 10-, and 30-year Treasury TIPS.

  • DGC

    There was an article by Jahn Mauldin on June 12, 2011,

    He said that 2010 year-end data was that 30% of the cost of PIIGS total potential exposure was covered by default insurance and US banks & insurance companies backed 56% of that default insurance.

  • GCT

    I believe the Fed still has it swap lines open to Europe and most likely will bail them out. They are out of dollars as I read this. Can’t the Fed do more swaps as they never closed them. Last week didn’t the Fed do a 500 mil swap with a undisclosed European bank?

    The Eurobond cannot happen until countries change their constitutions. I do not think that is going to happen anytime soon.

  • D

    That was the one. 90 was a little much haha

  • Sam Deprist

    Cullen, could you modify the chart and put CDS current data for european banks and american banks of 08-09 period together?
    Then we probably will be able to derive some conclusions about timing of european crisis in progress.
    Also, do you have any estimates of european counter party failure impact on american financial system at a crisis peak?


  • Oz

    I would have thought the Euro would go up if weaker members started leaving (i.e. Greece, Portugal)…

    It would be quite a rollercoaster however

  • Romeo Fayette

    The Euro has dropped in value, my friend. Look at EURCHF EURJPY EURAUD. You’re just looking at the same EURUSD convention that everyone else is. EUR is only relatively strong to USD because of QE & the lingering American economic malaise… To put it simply.
    Sorry to post another link, Cullen, but I discussed this on July 26: if you’re watching EURUSD, your eye is on the wrong ball…

  • Romeo Fayette

    I know you’re cognizant of this, Cullen, but it’s important for everyone to remember a huge pitfall of the EMU, a specific pitfall that’s lumped in the broad infliction known as “lack of fiscal unity”: the ECB has no Treasury a la the Geithner wonderkind. More exactly, there is no supranational Eurozone entity with the ability to generate revenues (via taxation). The ECB is capitalized with a mere Euro10B, and supranational funding is derived from fees assessed from memberstates. I hope we all acknowledge the bureaucratic hurdle faced by supplementary funding approval–it has to pass due process in every national parliament. Beyond that, the ECB can buy what it pleases, whether via moral hazard or SIVs.

    I truly think they’re best disbanding the EMU–at very least the fringe. Anyone care to explain how this currency union differs from ERM I (beyond the single coinage)? Painful, yes, but not indentured servitude long-term.

  • dan k

    The EMU would be wiser to suggest that Greece request to pull out of the EMU.
    Then Greece could devalue about 30% and afford to service their debt. They would then become to locost EU vacation destination. And lid on the pressure cooker would release the steam. Then Germany and France would not have to flush another round of cash down the toilet.

  • NukemHill

    Wasn’t it just revealed in the last couple of days that the Fed actually gave out $1.2 trillion in “secret” TARP, and that several Euro-banks were major beneficiaries? What’s to keep us from doing that all over again? Given the almost complete lack of oversight over and accountability with the Fed, it seems like Helicopter Ben has the opportunity to act unilaterally if he sees fit.

    Yeah, here it is:

    “It wasn’t just American finance. Almost half of the Fed’s top 30 borrowers, measured by peak balances, were European firms. They included Edinburgh-based Royal Bank of Scotland Plc, which took $84.5 billion, the most of any non-U.S. lender, and Zurich-based UBS AG (UBSN), which got $77.2 billion. Germany’s Hypo Real Estate Holding AG borrowed $28.7 billion, an average of $21 million for each of its 1,366 employees.
    The largest borrowers also included Dexia SA (DEXB), Belgium’s biggest bank by assets, and Societe Generale SA, based in Paris, whose bond-insurance prices have surged in the past month as investors speculated that the spreading sovereign debt crisis in Europe might increase their chances of default.”

  • WellRed


    It is interesting that while CDS spreads are screaming bloody murder, bank debt spreads (despite having blown out) are much, much lower than at the apex (nadir?) of the crisis. While I recognize that liquidity premia were a large proportion of bank debt spreads in late 08/early 09, I maintain that the CDS market does not transact enough volume (I am talking net notional exposure) to really be relied upon for price discovery. Every now and then I come across data points for net notional exposure in CDS markets (I am thinking both GGBs and USTs in low single digit billions) and wonder why we even bother monitoring these markets. I recognize the various problems with price discovery in debt markets, but it strikes me that when it becomes time to hedge exposures (ie crises), there just aren’t enough natural sellers, (I would suspect) given the asymmetry of the payoffs. Maybe I am wrong, I would love to hear your thoughts.

    Also, I read your primer on MMT the other day and was intrigued. Is there something maybe 10X the length that is shorter on the convinving and a lot longer on the ‘guts’ of the paradigm? I have Misnky gathering dust on a shelf – should I start there?


  • PG

    “If any European readers know the process of a Euro TARP (legality, etc) I’d love to know…”

    The Modest Proposal of Yannis Varoufakis:

    Varoufakis’ site:

  • Dismayed

    “I wonder who is holding the other side of the CDS trade that is about to blow up in their face.”

    My fear is that AIG has found a new market opportunity . . .

  • Steve S

    I’m one of those assinine, ignorant fools who thought that TARP was a mistake. If Europe goes through this without a TARP-equivalent, we may find out which side of the argument was correct.

  • Joshua

    Yeah, its called let em all fail and then pick-up the pieces afterwards… the only way these banks are gonna learn is if they lose the shirts of their backs… America loaned out BILLIONS to European banks the last time this shit happened… We are not in a position to do it again…

  • Cullen Roche

    I thought TARP was the wrong approach also. Let me be very clear about that. But it was better than doing nothing…..

  • jaek117

    We’re trying to organize a Revolution Super Concert.. please help spread the word. Additional info is available on the Thank you.

  • Anonymous

    Euro= D-mark

  • Dr. Oliver Strebel

    What about US-Banks ;)?

    IMHO ECB will not let crash a major european bank No way!

  • Sediment

    …but at least on the ground you can fall no further.

    This defiance of gravity through endless air pumping into baloons is madness. Eventually you will run out of air…and the things will pop, and you might find you’re a lot higher than if you had let things fall earlier.

    How’s that for an analogy??

  • Anjon

    Great Post! I think we could be in for a dozy!

    I re-posted and linked from my blog

  • Tim in Albion

    CNBC ranked Santander as the 10th safest bank in the world:

    So, are the CDS spreads indicating high risk to the Bank, or just to the instruments they insure? Is there any way of knowing what the bank’s total exposure is, if these things go haywire again?

  • Correction To User SS

    I highly disagree with the comment made by SS – “The problem is that these banks all need to be re-capitalized.” While I do not track most of these banks, I do closely watch STD (banco santander). STD is extremely well capitalized, it has limited exposure to Greece (STD would lose around 3B euro if Greece defaults on ALL its debt), and it is widely diversified outside of Europe. Thus, saying that “all of these banks need to be re-capitalized” is not a true statement.

  • Walk The Talk

    Historically speaking, Europeans are much more amenable to outright nationalization.
    It has much to do with past successful socialist democracies.
    My first guess is that any ugly bank failure would mean a complete immediate takeover by the state.
    The funds could come from sovereign debt which would then be backstopped by macro-euro intervention with a fat USD/EUR swap glueing it all together.
    ECB through the back door.

  • bluebare

    Seems like a high stakes poker match to me. Too rich for my blood.

  • theta

    Quite the opposite. If any of these banks defaults, it will be because their assets’ value is less than their total liabilities, which are all denominated in these “worthless” currencies. Hence, demand for these “worthless” currencies will soar. Just like USD in 2008.

  • BIGC

    I would be willing to bet that GOLDMAN SACS bought CDS’s against the worst European countries debt, since they also arranged currency swaps for those same countries that are is trouble now. They did the same thing when they sold all those MBS’s that weren’t any good and they bought CDS’s from AIG knowing they would default!!!! What SCUMB BAGS!!!!!