Why CDS Buyers Are Not Crazy

U.S. CDS and Paul Krugman :

….The people buying these contracts are crazy. A world in which the US government defaults would be a world in chaos; how likely is it that these contracts would be honored?

No, they are not crazy, the contracts will be honoured, 100%, guaranteed, for a simple reason: Most sovereign CDS are packaged in fully funded credit derivatives first-to-default credit linked notes. Therefore the protection buyer gets the cash upfront and is not exposed to the protection seller credit risk.

Comments

[jptheman:]

Furthermore, one may be buying it on a relative trade or pure trading play.

Mar 11 11:37 AM

[Heaven, Hel...:]

Thanks, good point. Just wondering though, what that fiat-based cash will be worth if the US Gov't defaults.

Mar 11 12:47 PM

[PainfullyAware:]

Only Crazy People Buy Instruments They Do Not Fully Understand.

If the buyers understand these instruments, then I suggest they go into physical science and work on solving the Energy issues. They are obviously more intelligent than most.

Mar 11 05:07 PM

[DiracMan:]

"Therefore the protection buyer gets the cash upfront and is NOT EXPOSED to the protection seller credit risk."

But the taxpayers of the United States ARE exposed to the protection seller credit risk! DUH! Especially to exposures not hedged (gasp) like AIG's breathtakingly mindless plutonium is reputed to be!

We are in a Wall Street circular firing squad led by blindfolded drunk madmen amid empty Vodka bottles firing pistols into armed nuclear weapons in a sealed room.

Just unbelievable!

Mar 12 03:32 PM