GOOD NEWS: If A European Sovereign Default Triggers CDS, Then US Banks Would Come Out On Top

U.S. financial institutions would be net recipients of credit default swap payouts in the event of a large-scale European sovereign default, Federal Reserve Chairman Ben Bernanke will say to Congress tomorrow.

Bernanke said American banks' exposure to stresses in Europe's banking sector remained a "concern," despite U.S. firms' moves to allocate offsetting capital.

In his full remarks, Bernanke details those actions.

One caveat is that CDS counterparties could squelch on their obligations, he says.

However: "such risk is mitigated by the fact that the counterparties to large U.S. dealer banks for sovereign CDS trades are dispersed, primarily across large financial institutions," he says.

Here are Bernanke's remarks on the matter:

U.S. financial institutions do have some gross exposure to potential losses arising from sales of credit default swap (CDS) protection referencing European sovereign debt. However, for the large U.S. dealer banks, these sales have been more than offset by purchases of protection, which would imply that in the event of a sovereign default, U.S. financial institutions would be net recipients of CDS payouts. These positions still carry some risk in that some U.S. banks' counterparties might conceivably fail to make good on their obligations, but such risk is mitigated by the fact that the counterparties to large U.S. dealer banks for sovereign CDS trades are dispersed, primarily across large financial institutions. And in the vast majority of cases, these institutions post collateral to each other to help minimize possible losses.

Read Bernanke's full prepared testimony here.

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