J-Ro

CDS: What If There Was a Crack-Up and Nobody Came?

There is a reason the govt. didn't let Bear fail but let Lehman. Bear was so intertwined in the CDS market that it would have destroyed it in one fail swoop. Banks are allowed to choose how they want their CDS' valued, either in-house or via independent valuations. This is an obvious problem that they will not want regulated. The whole CDS industry has a wild west feel to it and easily manipulated by both sides of the trade. Valuation models need to be standardized as well as spread sources, as there isn't enough liquidity to truly value these assets. Going forward there will be much talk about regulation and a lot of push back by banks using ISDA as a transparency shield. If counterparty risk would have been used to value these we may not have seen the govt bail out Bear since risk departments would have taken care of it themselves.