Monday, November 28, 2011

Debt crisis: CDS market loses its appeal after Greek 'haircut'

by Phillip Inman


November 28, 2011

Plenty of us have bought insurance that turns out to be worthless. Travel insurance that excludes flight cancellations was a classic. Payment protection cover with a list of exclusions so long that nine out of 10 payouts were refused was another. After a while, we ask ourselves, "why bother?"

The same question has occurred to investors who lent money to eurozone countries and bought credit default swaps (CDSs) as insurance against a failure to pay back all the loan.

It seems the eurozone authorities cannot envisage a type of default that might trigger a CDS payout. If we call a refusal by Greece to pay back 50% of its loans something more akin to a voluntary gentleman's agreement, then all claims are likely to be redundant.

Eurozone politicians have rationalised this situation. They say the interests of all key institutions are preserved by avoiding a fully fledged, recognised default. Countries avoid contagion and banks that sold CDSs avoid insurance claims from other lenders for some of their money back. Brussels says there are only losers from the knock-on effects through the financial system of a fully fledged default.


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