Credit Default Swaps: Once Again, The Tool of the Devil

Lots of people are staking out positions around (and mostly against) investor David Einhorn’s FT-reported anti-CDS musings in his latest investor letter. I agree with David in many ways – and his writing is as fun as usual – but I don’t accept all of David’s reasons (although I agree the ability to so directly influence the path to default can be problematic).

Two of my main CDS issues (which are fixable):

1. They are congenitally under-reserved, which creates asymmetric risks.
2. It is possible to write swaps (far) exceeding the notional value of the thing for which you are writing all the swaps. That’s … not good, like being able to create total policies far exceeding the value of a house, thus making it urgent to burn the house down as soon as possible.

Anyway, here is Einhorn’s original, followed by two takes on opposite sides:

• Einhorn against credit default swaps ((FT))
• Ehrenberg: Deal with it Dave ((IA))
• Yves: First, let’s kill all the credit default swaps ((NC))

Feel free to find yet another position to stake out in comments.

Comments

[athena:]

These are either options on bonds-so list them on the options exchange---- if you can.
Or they are insurance against default- so regulate them like the insurance industry. If you can.
Otherwise these things should not exist.

Nov 09 11:57 AM

[Alan Young:]

thanks for stating the case so succinctly.

Nov 09 12:00 PM

[biomedlives:]

I absolutely agree with the NC comment that "Credit default swaps have no redeeming social value." If you want safe income investments, buy bonds of corporations that are financially strong.

One way to deal with CDS issue #2 is to a CDS to a specific bond or loan, as municipal bond insurance does now.

Nov 10 10:35 AM