Though energy funds and insider trading often steal the spotlight, Forbes.com’s Daniel Fisher thinks people should be focusing on credit default swaps. In a recent article Fisher delves into the risk hedge fund’s have taken by trading credit default swaps, citing that though the progression toward these easy-money options is natural, it’s unlikely most hedge funds are socking away sufficient funds in the event of defaults. Fisher cites a Greenwich Associates report that says 58% of hedge funds are trading credit default swaps, a market he reports has a notional sum of $26 trillion. The market is ruled by 14 dealers, which include big boys like JPMorgan Chase, Citigroup, Bank of America, Goldman Sachs, and Morgan Stanley. Revenue from the derivatives market will reach $34 billion among U.S. banks and securities companies, the TowerGroup told Fisher. Though some, like Kathryn Dick of the Office of the Comptroller of the Currency, are sure back up will cover any potential default payouts, others who’ve experienced losses in the field beg to differ. Charlie T. Munger, vice chairman of Berkshire Hathaway, recounted the $404 million loss Berkshire took unwinding credit, interest rate, and FX derivatives positions. “When we ran it off, it didn’t run off at anything like book value. I would bet a lot of money there are some terrible valuations on the books of corporate America,” he said. In a frank note, JPMorgan admitted that a worst-case scenario could result in a $65 billion loss for them if all their counterparties when bust. However, Fisher notes that given the size of JPMorgan and their competitors, it’s highly unlikely something so catastrophic would occur. Even still, many doubt committed hedge funds or involved investment banks have sufficient collateral to protect themselves if a large-scale disaster struck. As a Fuqua School of Business professor, David Hsieh, told Fisher, “No one has good facts on these things, because hedge funds are private investments.”
