by Calculated Risk on 1/18/2008 12:21:00 AM

Counterparty risk really hit the markets today.

From the WSJ: Default Fears Unnerve Markets. A few excerpts:

Today, a struggling bond insurer, ACA Financial Guaranty Corp., will ask its trading partners for more time as it scrambles to unwind more than $60 billion of insurance contracts it sold to financial firms but can't fully pay off ... The problem is that the insurer itself is teetering -- with repercussions across the financial world. ...

Yesterday Merrill Lynch & Co. wrote down $3.1 billion on debt securities it had tried to hedge through ACA insurance contracts, as part of a larger Merrill write-down. Earlier this week, Citigroup Inc. set aside reserves of $935 million to cover the likelihood that trading partners won't make good on trades in this market. ...
...
The issue is raising broader concern among regulators and investors over what Wall Street calls "counterparty risk," the danger that one party in a trade can't pay its losses.
...
Bill Gross, chief investment officer at Allianz SE's Pacific Investment Management Co, or Pimco, recently told investors that if defaults in investment-grade and junk corporate bonds this year approach historical norms of 1.25% (versus a mere 0.5% in 2007), sellers of default insurance on such bonds could face losses of $250 billion on the contracts.