Time for a little honest disclaimer. So, I've been pounding away at the credit default swap market for some time, saying all sorts of nasty things about it - many of which have come to pass. I'm switching camps now. And putting my money where my mouth is.
Why am I now sleeping with the enemy? Because unlike last year, credit default swaps are going to be regulated, and traded with transparency through one or more clearing houses. For that reason, the chance of an implosion (the likes of which basically took out AIG (NYSE:AIG), and nearly brought down the entire capital markets last year) is likely to be reduced going forward. So too is the prospect of market manipulation - transparency is anathema to manipulative traders.
Credit default swaps offer a crucial adjunct to the credit markets generally, fostering stability and allowing the market, rather than a bunch of idiots at some rating agency, to establish the relative creditworthiness of borrowers. I'm all for credit default swaps - as long as you give me some transparency and oversight.
How am I implementing my changed view? I am investing in the Chicago Mercantile Exchange (CME Group) (NASDAQ:CME). This is one of the places where the credit default swaps market. will reside, going forward. And this is a big marketplace - with notional principal in the tens of trillions of dollars range. A trading platform for credit default swaps certainly has an enormous potential to benefit those who invest in such a trading platform. And the credit default swap market is likely to grow because now as a consequence of transparency, oversight, greater liquidity, and a reduction in counterparty risk thanks to the clearing function CME Group (and in time, others) offer. This will benefit CME Group directly, regardless of the direction in price of these instruments.
I've change my view of the credit default swap market because the structure of this market has changed, rendering the core assumptions of my previous argument obsolete and my conclusions innacurate.
Disclaimer: the author owns shares in CME group.