This from Today’s Financial News:

The markets were forced to endure one round of default swap payouts last week. Now, the debt from three more companies will hit the auction blocks. Even more trouble is on the way.

On a micro level, yesterday’s 900-point rally looks like a big deal. Many short-sighted investors look at the day as an indication that the worst is behind us. But on a macro-level, the surge barely stands out. After all, yesterday’s bounce did not put us anywhere near the levels we started out at last week. We still have a long way to go and there are some pretty big hurdles to clear along the way.

One major challenge over the next few weeks is three more debt auctions. Yes, three more defaulted credit auctions.

The International Swaps and Derivatives Association has held just nine auctions since 2005. It will hold five of them in October alone. It is a sign of the times.

Last week, we saw Lehman Brother’s debt on the auction block. Selling for about nine cents on the dollar, the market had a tough time swallowing the nearly $400 billion that was suddenly needed to cover the debt’s default insurance.

Now, there are more costly auctions on the way. On October 23, Washington Mutual’s debt will be sold. Again, investors can expect the debt to sell at a drastic discount.

You can count on the equities market taking a shot on the chin that day as credit default swap (CDS) owners are forced to cash in their portfolios to write checks for tens of billions of dollars in insurance payouts.

Just as we saw a “run” on the markets last week, we will see it again as another multi-billion payout comes due.

Big problems overseas

In Iceland, the country that is arguably feeling the credit crunch the most, investors are already flinching at what could be deadly CDS payments.

When Landsbanki and Glitnir were taken over by the Icelandic government, its debt went into default. That means the folks stuck holding the default insurance will be forced to pay up. Even if the debt is auctioned at a fairly substantial rate, billions will be paid out.

Landsbanki CDS sellers are obviously hoping for a highly successful auction. If the debt sells for fifty cents on the dollar (which is highly unlikely), some of them may actually make money. After all, the banks default insurance was selling for nearly a nearly 50% premium in the last few weeks.

I would not expect too many smiles.

Look for strong selling activity on the markets across the globe on November 4 and 5, the dates Landsbanki and Glitnir will see their former debt hit the auction house. Once again, CDS sellers will be forced to liquidate their portfolios (hundreds of billions of dollars worth) in order to pay their insurance guarantees.

It will be an interesting week for the global markets.

Some investors may believe the panic selling is over. It is not. As more and more debt hits the auction block, even more investors will be forced to cash out of the markets, creating another round of harsh sell-offs.

Source: Iceland’s CDS Market Will Create More Turmoil

Given the attention focused on how creditworthy our banks are, some may well be tempted, as The Daily Telegraph’s Stephen Ellis notes, to “stuff it all under the mattress”.

However, that is not only rather risky, but also should be unnecessary, thanks to an investor safety net – the Financial Services Compensation Scheme (FSCS) – which pays out if a bank or building society holding your cash goes bust.

At first glance, the scheme is pretty simple; if a bank goes bust and a customer is unable to recover a cash deposit via the normal liquidation process, then they are entitled to claim 100% of any amount up to a maximum of £35,000. So far, so reassuring. However, there are some quirks to be aware of.

First off, the £35,000 applies per person and not per account. So if you have two accounts with a single bank, say a current account and an online savings account, the balances are combined to test the £35,000 threshold. Also, some banks, such as HBoS, have a single Financial Services Authority (FSA) registration for all of their operations – including the likes of Intelligent Finance, Birmingham Midshires, Halifax and Bank of Scotland. That means you only get a single £35,000 claim to cover balances across the whole group. So a cautious investor should limit single deposits to £35,000 and, ideally, spread them across different banks.

It’s also worth noting that the scheme only pays out if your bank is FSA-authorised. You can check this on the FSA Register, or call them on 0845-606 1234. Be aware too that certain banks, such as Bank of Ireland, ING, Landsbanki and Fortis, get their primary authorisation to operate here from local regulators rather than the UK FSA. Although you would still be entitled to claim from the FSCS should the local scheme pay less than £35,000, the process may take longer, given the complexities of dealing with two different regulators.

If this all sounds like a lot of homework for a simple cash deposit, remember that the Government’s bail-out of Northern Rock suggests a major UK bank is unlikely to be allowed to fail, so the FSCS may never be tested. That’s perhaps just as well, given that under new FSA rules from 1 April it can only raise a maximum of £4bn a year in funding, hardly enough to cover all the deposits in a major retail bank.

But if you still have doubts, consider investing with the Government-backed National Savings Bank instead. One savings product stands out if you don’t mind locking up your cash short-term – index-linked certificates. Running for three or five years, the investment limit for each is £15,000. They each pay tax-free interest at 1.35% above the retail price index (a key measure of inflation) currently sitting above 4%. For a higher-rate taxpayer that’s equivalent to a gross annual return of just over 9%, with your deposit guaranteed by the Treasury.