By Joe Cardone
ANZ and NAB banks shocked the market by losing money in investments that most people – as well as some seasoned investors – don’t understand.
Banks are complex organisations and are at the core of our modern lives and economy. So when they venture into things such as swaps and the collateralised debt obligation market and lose money (or to be more accurate, make a provision for a loss) the complexity of these organisations dawns on investors.
They should know what they are doing, but commercial imperatives and pressure to maintain earnings can cause problems if the unexpected happens. And it did.
The ANZ and NAB were caught out in commercial arrangements that, in theory, are not supposed to fail (to a statistical extent, of course). At the heart of modern banking is a pledge by the other party (called a counterparty) to honour the other side of a financial commitment. When there is a risk of failure, it’s called a counterparty risk.
ANZ, in particular, participated in a part of the collateralised debt obligation market called credit default swaps. As a seller of one of these swaps the risk of default is transferred to the ANZ. Sounds involved? You bet.
Where it all went wrong for ANZ was that the credit protection was issued by some insurance companies that also got swept up by the US sub-prime tsunami. As a result, ANZ could not rely on these insurers and had to declare that the bank was on the hook for any potential loss.
So why does this matter? The global collateralised debt obligation market is huge, with a notional value of around $US45 trillion. Banks around the world have used it to augment their plain vanilla income from housing loans. However, the ability to value or trade these credit default swaps portfolios has diminished dramatically due to the global credit crisis, and the risk of counterparty default has increased.
What was once a moneybox of cosy, unregulated arrangements, has turned into a black box of the unknown.

Stockbroker Joseph Cardone is an experienced adviser and the Canberra branch manager for Patersons, “The Australian Stockbroker”. Any advice provided in this article is general in nature and should not be solely relied upon when making any individual investment decision.