Derivatives Danger?

Lately, owners of Enron's (ENE ) equity, bonds, and loans have been struggling to understand how exposed the company is to risks of losses that they didn't know about before. Now, as a fuller picture of Enron's entanglements with partnerships begins to emerge, investors have something else to worry about: credit default swaps, known as CDSs for short.

That's financial marketspeak for insurance on bonds and bank loans. Their owners pay a premium for coverage that reimburses them for any losses they have if their investments go bad. The CDS market has existed only for about two years, but it's growing fast. Goldman, Sachs & Co. (GS ) and others estimate that bonds and loans with a face value of between $1 trillion and $1.5 trillion are covered. Not surprisingly, big banks with hefty balance sheets such as J.P. Morgan Chase (JPM ), Merrill Lynch (MER ), and Deutsche Bank (DB ) dominate the market.

Enron, however, is a player--and the only significant one that isn't also a bank. Competitors say that although Enron has issued only between $500 million and $700 million worth of CDSs so far this year, it had ambitious plans to offer them online. "They don't belong in this market," says one trader. "They don't understand the implications." Enron did not return calls seeking comment.

Of course, neither Enron nor others will have to pay out unless the loans and bonds they're insuring turn bad. Trouble is, this year is potentially a doozie for losses on corporate debt. Corporate defaults could reach a record of $100 billion, says Standard & Poor's, like BusinessWeek a unit of The McGraw-Hill Companies. Regulators say shaky bank loans hit a record $193 billion by early October.

If Enron has insured any of the bad debt, it might have to take charges for losses if they exceed the premiums it has been getting. With all that has been happening in recent weeks, that's the last thing it needs.

By Heather Timmons in New York

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