If this is allowed to happen then who in their right mind would ever again underwrite a CDS for a companies debt if some other company can so easily force a default event.
Would this be terrible?
Would this be terrible?
CDS's are a form of insurance. It can be hard for someone not in the industry to see the importance of these as it doesn't affect yoru day to day life.
Just imagine your day to day life where you can't get any isurance at all.
No car insurance, no house insurance, no medical insurance.
That's the extreme case, in all likely hood the more likely scenario would be all your insurance tripling in price as no provider can hedge their risk vai reinsurance, etc.
To me issuance is very important and one of the pillars of modern society. If insurance going away, or atleast being inaccessible to 99% of the population that doesn't seem to be "terrible" to you then I'm not sure what explanation I can give you to help you understand :)
CDS's are a form of insurance -- that's true. But in the case of a regular property/casualty insurance, you can't typically insure something you have no financial interest in. For CDS's, that's the base case.
It is claimed that CDS's originally were created to allow investors to insulate themselves against the economic shock of defaults. That's barely true. CDS's are, and have always been, instruments of leverage (gearing). They allow credit traders to earn a higher return by taking on the credit risk with a smaller outlay of capital.
I certainly don't want them to go away, but let's not kid ourselves that 1) they are fundamental to the credit market, or 2) they're not subject to potential abuse.
I fully agree with this.
> 2) they're not subject to potential abuse.
But to be fair, no one claimed otherwise;)
I'd appreciate it if you can change my mind but you really haven't' laid out a good argument yet.
My thesis is that CDS's allow the credit markets to be larger than they would be without them, not that credit markets can't function without them. Obviously credit markets have existed before the ability to easily hedge out risk
I mean I think you'd have to agree that hedging and risk minimization is a good thing and something that allows the market to be alot larger and more liquid due to the ability to hedge out risk with them.
If swaps go away tomorrow, what replaces them? How do people hedge out credit risk without any form of swaps?
It is argued that this actually allows for better price discovery more efficiency in the credit markets. But that has be balanced with the fact that the CDS's have become untethered from the actual bonds that they purport to insure, and the tail has begun to wag the dog (as evidenced in the original article.)