Comments on: Credit Default Swaps Explained

By: John King

John King — Wed, 10 Mar 2010 21:55:15 +0000

Let me pose these two questions. (1) Given that the Federal Reserve substantially discounts risk when it supports it’s “save the economy” role (instead of just “managing inflation”), is the CDS a real proxy? That is, by pricing credit risk at say 5% when the Fed is supporting 1% money? (2) And if the Federal Reserve was not propping up an economy with cheap money, would the need for a CDS be as strong, if at all?

By: Evil Speculators At It Again - The Source - WSJ

Evil Speculators At It Again - The Source - WSJ — Tue, 09 Mar 2010 10:45:30 +0000

[...] seems the credit default swap community is the target of this ire, although people who have the temerity to sell the euro are [...]

By: CBF

CBF — Mon, 08 Mar 2010 02:27:09 +0000

Why not just say that a CDS is “debtor default insurance”?

By: Peter

Peter — Fri, 26 Feb 2010 10:28:47 +0000

Hi,
I don’t understand how to combine arbitrage pricing theory, Mertons theory – the debt and equity can be illustrated as european options and the CDS spread.

By: Christophe

Christophe — Thu, 25 Feb 2010 03:35:43 +0000

Hi,
I read today in the The Wall Street Journal – Asia edition that a Texas hedge-fund bagged millions of US$ using CDS and betting on Greece and other European countries debts.
Beside the “morality” and risks attached to this speculative transaction, how individuals can take advantage of such schemes ?

By: Rupert

Rupert — Fri, 19 Feb 2010 07:26:58 +0000

I have been looking every where for an example of how CDS are traded. If I own a CDS and am currently paying 50bps to the issuer, then the price people are willing to pay for the CDS rises to 80bps and I sell it to John Smith, does John Smith then pay me 80 bps while I continue paying 50bps to the issuer? Or is that not how it works?

By: nourishing obscurity » Economics – it’s all Greek to me

nourishing obscurity » Economics – it’s all Greek to me — Fri, 12 Feb 2010 06:32:35 +0000

[...] Please bear with me here, as the thing will become clear: [...]

By: gene c.

gene c. — Sun, 17 Jan 2010 22:43:36 +0000

Limited liability on CDS payments, meaning the US Govt only payoff swaps that were used to hedge risk (not speculate with swaps) was one option not taken by the Treasury that would have been both fair and economical. But we did not go there. Follow this: The Treasury paid and continues to pay AIG claims 100-cents on the dollar on mortgage defaults (loans). Owners of the loans (banks) who bought CDS insurance have been made whole for any loss resulting from non-payment. But homeowners are still obligated to pay their mortgages (in arrears) even though these non-payments have effectively been paid for, month-after-month, by US taxpayers. So, the banks stand to earn double – should defaulting homeowners become current with their debt and if they don’t, they can foreclose and effectively make a windfall. Doesn’t sound fair to me. Every dollar the taxpayer paid to keep mortgages current should reduce the obligation. If the taxpayer was there to help, the help should go to the distressed homeowner not the banker who has mitigated his risk.

By: Austin Stephens

Austin Stephens — Mon, 11 Jan 2010 02:17:50 +0000

#14 Jan,

JP Morgan had two women (yes women) that came up with the CDS.

They were not in the commercial lending side, they were working Swaps. i.e. you have a fixed mortgage I have a variable. I want the JP to write up a contract so I can make your monthly payments for 3 months as you make mine for 3, trading off and on. We can’t trade our mortgages so JP has to find a way to contractually structure the “Swap”. That’s only one example of a trade/swap.

In 1995 Exxon asked for a $4.8 B dollar line of credit to cover the oil spill. JP was NOT going to outsource the line of credit (who wants to lose Exxon as a customer). But it really wasn’t fair that JP would have to reserve $8.00 on every $100.00. This was a regulation on a bank that had top of the line creditors. So the young ladies, one who drove a Harley , went to work to find a way to transfer the risk of Exxon defaulting on the line of credit should it become a loan. They found an off-shore government source that would take yearly payments to assume the possibility of Exxon defaulting. The government did not require the actual loan be transferred because they felt there was no chance of Exxon defaulting.

The lawyers had the problem stated in an other post of “gambling”. When the contract was completed it covered only the actual default on the part of Exxon. The lawyers in the contract expressly referred to it as a “Credit Default” as opposed to a foreclosure, because only the lender holding the loan could foreclose.

Jan, this is only what I came up with to explain the term: Credit Default Swaps.

Thanks,
Austin

By: Austin Stephens

Austin Stephens — Sun, 10 Jan 2010 02:02:33 +0000

I don’t think anyone has answered #7 Thomas Walsh. His quote: “If a CDS buyer does not own the debt being insured, this is gambling – pure and simple. Banks have become bookie agencies and governments are expected to cover their losses.”

Mr. Walsh I would argue that: My bank holds title to my car. My car is insured, but not with the bank. If my car is totaled the insurance company covers my bank loan. State Farm can pay the bank balance of my loan off AT THE TIME OF THE LOSS (not at the time of purchase).

My question, respectfully, is: Do you believe State Farm is gambling with car insurance?

Thanks,
Austin