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Topsy Turvy Datapoint Of The Day Fannie Mae Cds Edition

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by Felix Salmon
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Oct 06 2008 5:31pm EDT

Topsy-Turvy Datapoint of the Day, Fannie Mae CDS Edition

Reuters reports on the results of the Frannie CDS auction:

Protection sellers on the companies' subordinated debt were the biggest winners, with contracts on Fannie Mae's subordinated debt recovering 99.9 percent of the sum insured...
Credit default swaps on the senior debt, by contrast, will recover less, with Fannie Mae's senior swaps recovering 91.51 percent the sum insured.

This is what happens when markets go haywire: credit default swaps lose all connection with, well, credit -- and start trading on entirely technical factors. I don't understand why recovery on the senior debt was so low, or why recovery on the sub debt was so high; it probably has something to do with eligibility requirements for cheapest-to-deliver bonds, and the relatively popularity of insuring the sub debt against default rather than the senior debt.

But in any event, instruments with a US government guarantee -- senior Fannie Mae bonds -- are clearing at 91.5 cents on the dollar. Remember that, if you think that the stock markets are ugly.

Update: Alea confirms that it's a CTD artifact:

Some people are surprised that the sub recover more than the senior, this is due to the cheapest to deliver effect, both the FNM/FRE senior have zero coupon on the deliverable list, while there are no zero sub.

Which just goes to show how important it is to know exactly what you're buying, when you buy default protection.

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