Source:
ReutersNEW YORK (Reuters) - An argument is emerging over Fannie Mae (FNM.N: Quote, Profile, Research, Stock Buzz) and Freddie Mac (FRE.N: Quote, Profile, Research, Stock Buzz) credit derivatives contracts, and the losers could end up facing billions of dollars of unexpected losses.
Participants in the $62 trillion credit derivative market held conference calls on Friday to discuss a thorny question for credit derivatives: what debt can be used to settle the contracts. The International Swaps and Derivatives Association (ISDA), a trade group, said it plans to offer guidance on the matter shortly.
Settling credit default swaps may seem like an abstruse matter, but billions are at stake. Any previously unexpected losses that participants suffer could be a tough blow to financial markets already rattled by the U.S. government's rescue of Fannie and Freddie.
Investors, banks, and others use credit derivatives to insure their exposure to a company's bonds and loans, or bet on an issuer's credit quality. When a company defaults, derivatives buyers receive a payout, and deliver the company's bonds or their cash equivalents to sellers of the protection.
At issue with Fannie and Freddie are the type of securities that buyers can deliver when they receive their payout. Buyers usually want to deliver the cheapest possible security, to maximize their return from the credit protection.
Some credit protection buyers are looking to deliver "principal only" obligations for their Freddie and Fannie securities, which can be worth around 30 cents on the dollar, compared with regular bonds from the two companies, which are worth closer to 100 cents on the dollar.
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http://www.reuters.com/article/bondsNews/idUSN1257757720080912
Ruh-roh!