From http://www.nakedcapitalism.com/2010/03/so-why-hasnt-the-credit-default-swaps-casino-been-shut-down.html">Naked Capitalism:
Credit default swaps played a much more central role in the financial crisis than is widely understood, and they continue to get a free pass in financial reform proposals that they do not deserve. As we have discussed on this blog, and recount in more detail in the book ECONNED, central clearing and/or putting them on exchanges are inadequate remedies. . . .But perhaps more important, the idea that CDS have legitimate uses is questionable. They are used to hedge credit risk (sometimes) yet their pricing, per Bloomberg or any of the common commercial models, price CDS based on volatility, which is not based on any assessment of the underlying credit. So the idea that the pricing reflects default risk is spurious; indeed, CDS failed abysmally in predicting financial firm default risk during the crisis (Lehman was a particularly vivid illustration). But they serve to perpetuate the erosion of proper credit analysis (why bother if you can just lay off the risk?).
In the last two days, Gretchen Morgenson of the New York Times and Wolfgang Munchau of the Finacial Times have both launched salvos at CDS. Munchau’s is even more vituperative than Morgenson’s, which given the sober sensibilities of the Financial Times, suggests that opinion on the other side of the pond may be coalescing against the product. Morgenson points out that even Ben Bernanke has started to question the legitimacy of CDS, but peculiarly is not as hard on his remark as she should have been:
“Using these instruments in a way that intentionally destabilizes a company or a country is — is counterproductive, and I’m sure the S.E.C. will be looking into that.”
Yves here. Huh? How, pray tell, is the SEC, of all regulators, going to look into CDS? CDS are specifically exempt from SEC regulation. If anyone has (or could decide it has) jurisdiction, it’s the Office of the Comptroller of the Currency, and the Fed. So saying that swaps are a problem, and saying that someone who cannot possibly look into them will handle them, is just a fancy form of regulatory three card monte.
But perhaps more important, the idea that CDS have legitimate uses is questionable. They are used to hedge credit risk (sometimes) yet their pricing, per Bloomberg or any of the common commercial models, price CDS based on volatility, which is not based on any assessment of the underlying credit. So the idea that the pricing reflects default risk is spurious; indeed, CDS failed abysmally in predicting financial firm default risk during the crisis (Lehman was a particularly vivid illustration). But they serve to perpetuate the erosion of proper credit analysis (why bother if you can just lay off the risk?).
In the last two days, Gretchen Morgenson of the New York Times and Wolfgang Munchau of the Finacial Times have both launched salvos at CDS. Munchau’s is even more vituperative than Morgenson’s, which given the sober sensibilities of the Financial Times, suggests that opinion on the other side of the pond may be coalescing against the product.
Morgenson points out that even Ben Bernanke has started to question the legitimacy of CDS, but peculiarly is not as hard on his remark as she should have been:
“Using these instruments in a way that intentionally destabilizes a company or a country is — is counterproductive, and I’m sure the S.E.C. will be looking into that.”
Yves here. Huh? How, pray tell, is the SEC, of all regulators, going to look into CDS? CDS are specifically exempt from SEC regulation. If anyone has (or could decide it has) jurisdiction, it’s the Office of the Comptroller of the Currency, and the Fed. So saying that swaps are a problem, and saying that someone who cannot possibly look into them will handle them, is just a fancy form of regulatory three card monte.
Much, much more at the link. This was a difficult article to get a good sense of from the limited number of paragraphs I can repost. But go check it out. There's some technical jargon there, because all this stuff is ridiculously complex. But its very worth reading.
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