HEY HEY, HO HO, CDS HAVE GOT TO GO
Conversations around the office give me the sense that Steve Gandel and I may be the only ones on the planet who believe credit default swaps should be outlawed. Oh well. You have to start somewhere. CDS apologists seem to think swaps are no different than other types of derivatives such as options or futures, and want to know why, in our zeal, we aren’t lobbying to ban those, too. But when options and futures prices get out of whack relative to their underlying securities, they can be arbitraged back in sync. Not so with CDS. The CDS market is a tremendous random-noise machine, that (worse) only gets more random and noisier when anxiety is running high and things are most uncertain. That’s not helpful at a time of high crisis. Nor are CDS always effective at protecting from default risk. Just ask holders of Greek debt. The banking industry somehow managed to find a way to manage credit risk for seven centuries prior to the invention of CDS in the early 1990s. Its experience since then is hardly evidence that CDS have finally helped lick the problem. Ditch ‘em, I say. . . .