Defenders and Demonizers of Credit Default Swaps

[Joanne98]

The recent difficulties faced by Greece (and some other eurozone states) in rolling over their national debt has let some to blame hedge fund involvement in the market for credit default swaps. These contracts can be used to insure bondholders against the risk of default, but when purchased naked (without holding the underlying bonds), they can serve as highly leveraged speculative bets on a rise in the cost of borrowing faced by the sovereign states.

A cogent case for prohibiting the use of credit default swaps to make directional bets has been made recently by Wolfgang Münchau in the Financial Times:

I generally do not like to propose bans. But I cannot understand why we are still allowing the trade in credit default swaps without ownership of the underlying securities. Especially in the eurozone, currently subject to a series of speculative attacks, a generalised ban on so-called naked CDSs should be a no-brainer...

A naked CDS purchase means that you take out insurance on bonds without actually owning them. It is a purely speculative gamble. There is not one social or economic benefit. Even hardened speculators agree on this point. Especially because naked CDSs constitute a large part of all CDS transactions, the case for banning them is about as a strong as that for banning bank robberies.

http://rajivsethi.blogspot.com/2010/03/defenders-and-demonizers-of-credit.html

[dixiegrrrrl]

1. One will notice that the definition of bank robbery is when

the bank GETS robbed, not when it does the robbing.

[On the Road]

2. Yes, It is a Very Sensible Control

to allow CDSs only as a hedge to owners of the underlying securities. I can't believe it's running into resistance. As the article says "even hardened speculators agree."

[Grand Taurean]

3. Speculators are a major cause of this crisis.

[customerserviceguy]

4. I like how the author of this piece

doesn't shy away from the word "bets".

When you don't fully, completely, and thoroughly understand the rationale behind an investment, it is gambling. I'm sure that the weasels who thought up all of these fairy-dust 'securities' knew them inside and out, but their greedy, stupid bosses didn't, and I hold them responsible for letting the inmates run the asylum.

[On the Road]

5. That is True,

but most speculators are not investing in or making money in this kind of derivative.

Go to a place like clearstation.com, where most of the frequent posters are daytraders, and try posting in Volcker amendment. You'll not only find a lot of kindred spirits, but a much more detalied understanding of the reasons it's needed.