Let Europe kill municipal CDS

The solution to Greece’s debt crisis that Europe’s leaders announced on Thursday has market participants and commentators howling. It includes a provision that changes long-established rules for credit-default swaps mid-game. Mike Dolan, Reuters’ Investment Strategy Editor in Europe, said this:

For all the ifs and buts about the latest euro rescue agreement, one of its most profound market legacies may be to sound the death knell for sovereign credit default swaps — at least those covering richer developed economies.

I’d suggest that death knell just rang for U.S. municipal credit-default swaps (CDS), too. They’ve recently been on their last legs amid collapsing volumes, but actions in Europe just might have delivered the deathblow.

Credit-default swaps play an arcane role in financial markets. Firms allegedly buy them for protection against the default of bonds they hold in their portfolios. For example, if XYZ Investment Group owned $10 million worth of Greek government bonds that matured in 10 years (GGGB10YR:IND) and the Greek government couldn’t pay their obligations, then the seller of the CDS would step in and pay the CDS owner. Think of the CDS seller as a guarantor or insurance provider of sorts.

CDS are marketed as protection against the risk of default of the cash bond that they reference. Contrary to standing convention though, when the announcement was made that Greek bondholders would be asked to take a 50 percent haircut (or markdown) on the value of their bonds, the CDS governing group announced they would not be triggered. Their rationale was that the bond swap would not be compulsory and that CDS sellers would not need to make payouts to make up losses. Here is how a twitter user responded:

Chris Christie’s “too big to fails”

Chris Christie, the Republican governor of New Jersey who has consistently been championed as a “fiscal conservative,” has a real soft spot for several of his state’s “too big to fail” private projects. These projects include the massive retail/entertainment/sports/dining complex at the Meadowlands and the Revel casino project in Atlantic City. Governor Christie has made his state, which is in perilous financial condition, equity partners in the two projects.

Meanwhile a court order is forcing Governor Christie to increase the state’s contribution to public schools:

The New Jersey Supreme Court ordered the Christie administration on Tuesday to increase state education aid by $500 million in the coming school year, saying it had failed to meet its constitutional obligation to provide adequate educational resources for poor and minority children…

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