What is the swaps scandal all about?

Our largest banks now stand accused of mis-selling swaps. Tim Bennett explains how this latest scandal could land them with their biggest compensation bill yet.

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  • mikeT

    As always, very clear and interesting – thanks. However, I feel that you are falling into the trap, like a recent Panorama programme, of demonising swaps. Most of the complainants would be familiar with the consequences, for good or bad, of fixing your mortgage for a time and fixed rate loans “packages” are no different. The real problem, which you referred to, is the option element. These are usually marketed as a means of reducing the on-going cost of the loan; the bank “buys” an option from the client but, instead of paying the premium upfront, the premium is amortised by reducing the credit spread. This naturally appeals to the client’s greed; however, what should be feared is never properly explained. This is part of a much older story; while swap pricing is pretty transparent, options are not and banks profit enormously by understating the fair-value premium. So….it is not the fault of the simple swap (without which the bond and mortgage markets would be much poorer) but the option attached. If you have yet to do a swaptions and collar video, I look forward them!

Merryn

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