Sunday, March 27, 2011

EU battle ahead over CDS ban proposal

Financial Times
March 27, 2011

In some circles at least, credit default swaps have emerged as one of the bogeymen of the global financial crisis.

These contracts, which promise a pay-out if a given company or country defaults on its debts, are blamed by some for helping to stoke the eurozone sovereign debt crisis.

In this version of events, unscrupulous speculators bought sovereign CDSs – even though they did not own the underlying bonds or other relevant securities and thus did not have an “insurable interest” – in the hope of profiting from default. This pushed up CDS prices, heightening the perceived risk of default and in turn driving up borrowing costs for troubled peripheral nations such as Greece, Ireland and Portugal, making default more likely.

But not everyone agrees which this narrative. “Empirical investigation . . . provides no conclusive evidence that developments in the CDS market causes higher funding costs for member states . . . CDS spreads for the more troubled countries are cheap relative to the bond spreads. This implies that CDS spreads can hardly be considered causing the high bond yields for these countries.

“In the light of the evidence . . . it may not seem entirely appropriate to consider a ban as a permanent rule.”

These words come not from some rabid, free market hedge funder, but from the European Union, in an unpublished but widely leaked document, Report on Sovereign CDS.


Read the Report

No comments: