Comments on: Are CDS a good thing? A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: Dan Sat, 13 Jun 2009 05:48:02 +0000 “Soros Says Default Swaps Should Be Outlawed” 6/12/soros-says-default-swaps-should-be- outlawed/?ref=business

“The more I’ve heard about them, the more I’ve realized they’re truly toxic,” Mr. Soros said Friday, according to Reuters. Later, he added: “It’s like buying life insurance on someone else’s life, and owning a license to kill.”

By: Dan Hess Fri, 01 May 2009 21:49:04 +0000 Charlie Munger has come out on Bloomberg favoring a ‘100% ban’ of credit swaps.

“If I were the governor of the world, I would eliminate it entirely — 100 percent,” Munger said in a Bloomberg Television interview today. “That’s the best solution. It isn’t as though the economic world didn’t function quite well without it, and it isn’t as though what has happened has been so wonderfully desirable that we should logically want more of it.”

“The national policy that allowed the derivative markets to develop as they did was a stupid policy and we think the derivative markets as they evolved have done more public damage than public benefit,” Munger said. “That said, if they exist and they are legal and some opportunity therein is presented to us that we think makes sense to the shareholders of Berkshire, we would seize that opportunity.”

“The whole mass of incentives created is quite counterproductive,” Munger said. Buyers of the swaps get a “vested interest in the destruction of some business.”

By: Nate Tue, 28 Apr 2009 15:59:37 +0000 I agree that the bankruptcy negotiation scenario is problematic. Perhaps that could be solved by a standardized CDS contract clause in which the bond-owner who buys protection transfers their bankruptcy negotiation rights to the protection seller.

By: Doug Tue, 28 Apr 2009 11:42:35 +0000 The CDS instrument creates the wrong incentives in bankruptcy. Normally, bankruptcy is a negotiated process by which debtholders are vying for a fair stake in a going concern. CDS put the wrong negotiators at the table. Instead, while the debtholders are negotiating, the CDS holders are really on the hook.

So, as a result, where workouts in a business would normally be found, now we are almost certain to always enter into bankruptcy. In addition, the prices in bankruptcy are likely to represent severe conflicts of interest and potentially fraud.

By: Daniel Hess Tue, 28 Apr 2009 05:19:33 +0000 Nate —

“Banning CDS’s because they enabled the current crisis would be akin to banning stocks because they enabled the 1929 crash.”


Stock – A fractional ownership in a business. Businesses need owners.

CDS – The financial utility is quite clear to me. Warren Buffett explained it nicely (referring to derivatives generally) as did Nicholas Weaver above. Buyer and seller both book a nice profit today and go on their merry way, leaving losses for the future. This is great; lets meet again tomorrow and do it again!

No, Nate, we really do need to put our feet on solid ground and ask whether what we do serves a helpful purpose. The credo “first do no harm” doesn’t apply only to doctors but all professionals including financial ones. That is what it means to be a professional. Contrary to our recent experience, banking and finance as properly practiced can and ought to bring good benefit generally.

Wall Street has done a fine job convincing the world that it has no professional ethics. Questions of “what net benefit does instrument X bring” are now more relevant than ever.

By: Charles Tue, 28 Apr 2009 04:24:57 +0000 CDS was a less than perfect fix to a problem that is recurring in big companies balance sheet : the balkanisation of debt.
Big corporates should issue like governments : regularly, in a standardized way, and with a view of matching the duration of assets and the duration of liabilities. They don’t do it because funding short term is cheaper and cheating pari passu debt holders by pledging asset ex post by various means is a winning strategy. Banks encourage this situation because it preserves their turf and provide an easy justification of their own practice of maturity transformation on a great scale (an activity that a Nobel economies qualifies as counterfeiting money). In capitalization terms, the corporate bond market is of similar size than the equity market, yet, it is much more opaque. By comparison, CDS market was a hallmark of standardization and liquidity. This is why it was more efficient in information dissemination.

What has not been properly thought out and need a serious fix is the ramification of Credit Event Clause in Derivatives contract. I am not talking here only about CDS’s but ALL derivatives under ISDA. It is not the CDS’s written on Citigroup that causes systemic risk. The real source of systemic risk is the fact that all derivatives contract (fx, bonds, equities,commodities) would have to be unwound in a short amount of time together with their hedges. The only way to make derivatives safe and indeed useful for the economy is to tame them through exchange cleared contract,like financial futures, with robust enforcement of position limits. Exchange cleared CDSs, or even better, exchange cleared futures and options on liquid pari passu bonds have a place in a sound financial environment

By: Mbuna Tue, 28 Apr 2009 02:25:25 +0000 A metaphor I’ve seen before about CDS. They are like buying insurance on someone else’s house so that you collect if it burns down. So wonderfully motivating, don’t you think?

Credit Default Swaps are financial crack, and I see that Felix is hooked. If you could put down the crackpipe for a minute (and there are very very few who, once hooked, can)and listen to that very rare commodity these days called REASON you can easily see that CDS is a piece of financial engineering that adds absolutely NOTHING to the economy. It’s brilliance is the sheer vertical market it creates in allowing financial institutions to skirt capital requirements in order to be able to participate in for what is now essentially a worldwide floating casino. Probably even more brilliant is how many crackheads it has created. The CDS market is not defensible under ANY circumstances but there are far too many glazed over eyes in smoked filled rooms full of drooling mouths thinking about how that new risk model is gonna make millions…..

By: carol Mon, 27 Apr 2009 21:12:11 +0000 Felix, how can you not be against naked CDS?

Would you like anyone being able to take out a fire insurance against your house? Having plenty of people paying a small fee and …. throwing a burning candle in your house?

I have read estimates of 80% of CDS’s being naked (no underlying bonds). Congress apparently knew what would happen, because the “Futures modernization act” (heavily lobbied by Greedscam, Rubin, Summers, Levitt et al) explained that all the gambling laws would not be applicable to (the gambling with) CDS.

How convenient that lobbying by wall street resulted in removal of the uptick rule (June/July 2007; a few months later the stock markets would peak): now they could buy CDS AND shorts of firms they knew were heavily loaded with subprime toxins, or gas guzzling SUV manufacturers, etc. And then they prevent an orderly restructuring as they get more profit by letting the firms go fully belly-up.

And what about the rumored side letters? Both parties knew there would not be any payment, but one party could bamboozle the sleep-at-the-wheel regulators.

By: Anonymous Jones Mon, 27 Apr 2009 21:11:10 +0000 As analogies go, I’d think you might want to say “akin to banning margin debt because it enabled the 1929 crash.” Even then, spouting analogies with no explanation of why two things are analogous and/or why either restriction would be a bad thing is not too helpful.

By: Seth Mon, 27 Apr 2009 20:44:53 +0000 Probably the key problem with CDS — especially as AIG approached them — is the lack of a reliable DIVERSIFICATION strategy. The AIG execs probably figure, heck its just another line of INSURANCE. But writing insurance on property on the Gulf coast can be diversified by writing uncorrelated insurance on ranches in Montana. But credit markets are intrinsically much more linked than local weather ‘markets’.

Regulation of CDS should take account of the correlation risks inherent in writing a large net exposure (to say nothing of the various counterparty risks involved in the netting process itself).