- Patrick Young
- Derivatives:Giving Credit Where It is Due
- www.economist.com
Summary
CDS trading is a very useful tool for risk transfer. However, the fundamental precept of building houses on weak foundations or muddy ground remains an issue. There is a future for the marketplace without needing to resort to bans or major restrictions. A sound (and ideally open) CCP regime is a pre-requisite for the future of the marketplace.
Analysis
Doubtless there will be flat earth debunkers out there but the CDS market has a future and does provide a very valid piece of risk transfer. It is only a pity that the marketplace has been based on the fundamentally unsound foundation of bilateralism which always left the market subject to a huge potential disaster.
There is no point crying over spilt milk or pointing out “I told you so!” a decade or more back…although it is very tempting.
As the market devlopped it was always obvious that banks would endeavour to keep as much of the profit to themselves without seeking to commoditize the marketplace as it would be against their own short-term best interests.
At the same time, it would be daft to point all the blame at CDS contracts as the key failing in what has been the rapid deflation of a property bubble / mortgage fiasco. Regardless of how one views the various political activities, there is also the highly questionable political inactivity of serial US regimes to reorganise Fannie and Freddie.
The Economist has the correct tone. Portfolio hedging was rather absurdly vilified by those who didn’t understand the crash of 1987 and this time around scapegoating CDS will only stifle future financial innovation.
The one issue for the future is just how open the CDS ccp will be. Banks seem keen to maintain an “adults only” environment restricted to certain counterparties as opposed to a more democratic fully transparent platform open to anybody with the capacity to post margin. Then again the whole process of creating this CCP requires an entirely separate article or three…
True the aftermath of the CDS fall-out has parallels with the South Sea bubble where in the wake of the stock market crash, the government outlawed the purchase of life insurance policies by third parties…but nowadays politicians are much more enlightened, aren’t they?
Hmmm.
Follow Frontier Financier
