Euro Area

[phonicsmonkey]

who backs the CDS?

Other banks who do not hold the underlying debt, sometimes the same banks that hold the underlying debt (because they earn a trading commission from writing the contracts) but largely those who are 'short' CDS (ie. in the position of the insurers) are speculators in the shadow banking system: hedge funds and SPVs owned by banks and insurance companies (like AIG who wrote many of the CDS on the sub-prime mortgages).

The CDS market is only lightly regulated and while there are some entities which track CDS volume (like the DTCC), not all speculators in CDS report their trades in this way so it's pretty opaque as to the exposure levels.

The DTCC tables I linked to show the gross notional USD value of outstanding CDS on (eg) Italian debt to be 312bn, with the net amount 21bn. This is compared to 2.2trn of outstanding Italian government debt. So my statement above was hyperbolic, I apologise - there will not be many multiples more losses as a result of CDS contracts, but in the event of default the losses will exceed the value of the outstanding debt and it is unclear by how much.