Defusing the Credit-Default Swap Bomb

Barrons ^ | November 15, 2008 | Jonathan R. Laing

[CutePuppy]

Reforms are defusing the danger in the credit-default swap market.

AS THE GLOBAL CREDIT CRISIS GRINDS ON WITHOUT seeming relief, worries grow that a mishap in the once obscure credit-default swap market could trigger an even more lethal financial meltdown. .....

It's easy to understand why credit-default swaps, which have been called financial weapons of mass destruction, can engender hysteria. These quasi-insurance policies allow buyers to insure all manner of debt instruments, including corporate and sovereign-nation bonds, various bond indexes and securitizations, against any credit losses from defaults. Demand for them grew explosively during the past decade's credit boom. According to the International Swaps & Derivatives Association, or ISDA, the outstanding "notional" value of debt insured by these swaps soared from under $1 trillion in late 2000 to a peak around $62 trillion at the end of 2007.

The sheer reported size of the market, many multiples of the actual total value of corporate, mortgage and government debt outstanding, has led many to conclude that a lot of folks who don't even own the underlying debt are buying the swap insurance as cheap lottery tickets to bet on the demise of some debt issuers. The swaps are default-insurance policies, and their prices rise when it appears that the issuer of the stock or bond being insured is in trouble. Swaps thus have become handy tools for short sellers seeking to drive down the prices of equity or debt securities by convincing investors that the issuers are going belly up. New York Attorney General Andrew Cuomo and the U.S. Attorney's office in Manhattan are investigating whether shorts artificially drove up swap prices by reporting bogus trades that were never completed, in order to push down the prices of stocks they were short, particularly financial issues.

[org.whodat]

We don't need more regulation, there's plenty already. Just call CDS's for what they are: it's a form of gambling and whoever wants to issue them better have a gaming license. And you better believe the casinos will be a lot better at setting the odds than the investment bankers. Added benefit is that anyone who tries to unduly influence the market will get their knee-caps shot off by angry bookmakers. Problem solved, everybody wins.

LOL