Thursday, February 11, 2010

Citigroup offers a Derivative to bet against Citigroup

Isn't this a little like your doctor buying life insurance that pays if you die - right before you go into surgery?


Excerpt from Risk Magazine:

Author: Laurie Carver

Source: Risk magazine | 08 Feb 2010

Credit specialists at Citi are considering launching the first derivatives intended to pay out in the event of a financial crisis. The firm has drawn up plans for a tradable liquidity index, known as the CLX, on which products could be structured that allow buyers to hedge a spike in funding costs.

Like a swap, the contracts envisaged by Citi would be entered into without an up-front premium, with money changing hands according to the index's movements around a fair strike value.


However, there is concern from academic circles that the counterparty risks involved in such a product could create moral hazard. Chris Rogers, chair of statistical science at Cambridge University, said the only participants able to sell CLX-based products would probably be those who are too big to fail.

"This is basically a kind of insurance product. The main issue is: how good is the party issuing it? If it's going to be paying out huge numbers in the event of a crisis, will it be able to meet it obligations? Insurers can buy reinsurance for their liabilities, but the buck has to stop somewhere – there's a limit to how much a private insurer can pay out. Only the government can cover unlimited losses," he says.