$13.7 Billion in Credit Default Swaps on Russia’s Debt Were Executed in 61-Day Span of 2021 as It Amassed Troops Around Ukraine

By Pam Martens and Russ Martens: March 22, 2022 ~

MoscowAs the headlines in mainstream media grew ever more alarming in late 2021 regarding Russia’s troop buildup around Ukraine, approximately $225 million per day (or $13.7 billion over a span of 61 days) had been waged in bets that Russia might default on its sovereign debt. These bets are known as Credit Default Swaps and can be used to hedge exposure or simply speculate on a debt default in hopes of making a profit.

This information resides in a publicly-available swap repository maintained by the Depository Trust and Clearing Corporation (DTCC). For the period of September 20, 2021 through December 19, 2021, the DTCC shows that an average of 26 trades per day were being made in the Credit Default Swaps on the Russian Federation’s sovereign debt, for a daily total of $225 million notional (face amount of credit default swaps).

The $225 million daily notional is defined as follows by the DTCC:

“The transactions covered in this analysis include only transactions where market participants were engaging in market risk transfer activity. Risk transfer activity is defined as transactions that change the risk position between two parties. These transaction types include new trades between two parties, a termination of an existing transaction, or the assignment of an existing transaction to a third party.

“It was specifically designed to exclude transactions which did not result in a change in the market risk position of the market participants, and are not market activity. For example, central counterparty clearing, and portfolio compression both terminate existing transactions and re-book new transactions or amend existing transactions. These transactions still maintain the same risk profile and consequently are not included as ‘market risk transfer activity’ transactions.”

The trading activity for the period of September 20 to December 19, 2021 was 4.5 times the daily notional volume of $50 million in Credit Default Swaps executed on the Russian Federation’s sovereign debt for the equivalent period in 2020 according to the DTCC database.

A small sampling of the numerous headlines that ran in the last quarter of 2021 regarding Russia’s troop buildup around Ukraine include the following, as trading surged in its Credit Default Swaps:

October 30, 2021 – Washington Post

Russian Troop Movements Near Ukraine Border Prompt Concern in U.S., Europe

November 1, 2021 – Politico

Satellite Images Show New Russian Military Buildup Near Ukraine

December 3, 2021 – Washington Post

Russia Planning Massive Military Offensive Against Ukraine

December 17, 2021 – CNN

Russia Continues to Amass New Troops Near Ukraine’s Border

The big problem with the DTCC’s swap repository is that it fails to share with the public the names of the parties (typically megabanks) that are buying and selling protection via the Credit Default Swaps on Russian debt. Thus, the public does not know if the bank where they hold their life savings in federally-insured deposits might be on the hook to pay out billions of dollars if Russia defaults on its debt. (Russia’s debt is currently rated “junk” by the three major credit rating agencies – S&P, Moody’s and Fitch – with Fitch saying Russia’s default is “imminent.”)

Credit Default Swaps have been compared to buying insurance on your neighbor’s house and then hoping it will burn down. They played a major role in the financial collapse of Wall Street in 2008. Wall Street megabanks did not know how much exposure to Credit Default Swaps each other had in 2008 but they knew there was approximately $41 trillion notional outstanding. So the banks simply backed away from lending to each other, which seized up the credit markets. As it turned out, the giant insurer, AIG, was one of those that had amassed giant exposure to Credit Default Swaps. AIG failed and the U.S. government was forced to take it over to prevent a domino effect of more failures.

The unit of AIG that was “writing,” that is, “selling” the Credit Default Swap protection to the megabanks was AIG Financial Products (AIGFP). AIG also owned Banque AIG, a bank it registered in France. Banque AIG was part of AIG Financial Products. Senator Elizabeth Warren’s Congressional Oversight Panel reported the following regarding the dubious role of Banque AIG as a “balance sheet rental” facility:

“The regulatory capital swaps allowed financial institutions that bought credit protection from AIGFP to hold less capital than they would otherwise have been required to hold by regulators against pools of residential mortgages and corporate loans. A hypothetical example helps illustrate how this worked. According to the international rules established under Basel I, which generally applied to European banks prior to AIG’s collapse, a bank that held an unhedged pool of loans valued at $1 billion might be required to set aside $80 million, or 8 percent of the pool’s value. But if the bank split the pool of loans, so that the first losses were absorbed by an $80 million junior tranche, and AIGFP provided credit protection on the $920 million senior tranche, the bank could significantly reduce the amount of capital it had to set aside. Importantly, AIG’s regulatory capital swaps were sold by an AIGFP subsidiary called Banque AIG, which was a French-regulated bank.

“Under Basel I, claims on banks such as Banque AIG were assigned a lower risk weighting in the calculation of required capital reserves than the loans for which the counterparties were buying credit protection would have been assigned. This formula worked to the advantage of the counterparties, which could then use some of their regulatory capital savings to pay for the credit protection from AIGFP, and could use the remaining amount to make more loans, increasing their own leverage and risk. Because these swaps allowed banks to take on greater risk by shifting their liabilities to AIGFP, former AIG CEO Edward Liddy has referred to the deals as a ‘balance sheet rental.’ This business grew to become the largest portion of AIGFP’s CDS [Credit Default Swap] exposure, reflecting the demand for regulatory capital savings among European banks.”

One would have thought that the lessons from the financial collapse of 2008 – the worst financial crisis since the Great Depression – would have led Congress to outlaw Credit Default Swaps. It hasn’t. And that’s because Wall Street’s campaign money, revolving door, and legions of lobbyists mean that Wall Street continues to get what it wants from Congress – the national interest be damned.

If you have any doubt about the dangers still lurking in the Credit Default Swap arena, consider our article from March 22, 2020: JPMorgan Chase and Citibank Have $2.96 Trillion in Exposure to Credit Default Swaps.

Instead of being a source of strength as the pandemic raged in March of 2020, we reported at the time that “JPMorgan Chase had lost 39.3 percent of its common equity capital in the past five weeks while Citigroup, parent of Citibank, had lost 51.7 percent.”

For Congress and federal regulators to be allowing Citigroup – of all banks – to be selling Credit Default Swap protection is beyond the pale. Citigroup received a far larger bailout than AIG during the 2007 to 2010 financial crisis – in fact, it was the largest banking bailout in global banking history. The U.S. Treasury injected $45 billion of capital into Citigroup; there was a government guarantee of over $300 billion on certain of its assets; the FDIC provided a guarantee of $5.75 billion on its senior unsecured debt and $26 billion on its commercial paper and interbank deposits; and secret revolving loans from the Federal Reserve funneled a cumulative $2.5 trillion in below-market-rate loans to Citigroup from December 2007 to the middle of 2010.

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