All of you who are saying "CDS, whats the big deal? need to listen to the audio clip buylow posted starting at 22:00.
You don't know how the CDS world operates. Listen to the broadcast earlier in this thread, CDSs are insurance with a gimmick. If you don't think they are insurance, then why do holders of corporate bonds buy them for protection against default? Please explain.
I don't know much about the CDS world but if I held a bunch of corp bonds and bought CDS's to protect them against default and then someone came along and decided to declare all CDS's null and void I suspect my balance sheet might not be looking to good, especially if the bonds I bought were with a company that is close to going under....
Yes but I'm not concerned with speculators - no biggie if they get burned. The issue is that folks that did hedge their positions by buying CDS's will be blowing out of the water if someone pulls the rug out from under them and declares the CDS's void - leaving them unhedged.
Tough break. So buy bonds from quality companies like AIG and Lehman. Bondholders are second in line behind secured creditors when a company goes bankrupt though. I think those CDSs are renewed yearly like insurance policies, so don't renew them. By the way, most bondholders who buy the CDSs sell them to someone else to offset. AIG didn't resell their CDSs like most others did. The CDS underworld is a tangled web indeed. Listen to the audio if you haven't already.
This helps my argument that the CDSs are illegal insurance: Former staff member of the Commodity Futures Trading Commission, Michael Greenberger describes a credit swap in brief: "A credit default swap is a contract between two people, one of whom is giving insurance to the other that he will be paid in the event that a financial institution, or a financial instrument, fails. It is an insurance contract, but they've been very careful not to call it that because if it were insurance, it would be regulated. So they use a magic substitute word called a 'swap,' which by virtue of federal law is deregulated." http://en.wikipedia.org/wiki/Credit_default_swap Anyone care to dispute this?
That means that a whole host of derivatives can be considered insurance. I buy a put to protect me on the downside to my stock. I enter into a dividend swap to protect my dividend on a stock. I do a variance swap to protect me against volatility...etc. There is no end to this line of thinking. And clearly you don't know much if anything about how this market works.
What you describe is hedging and not insurance. CDSs are written to specifically protect against default of the bonds. Your nickname explains where you're comming from with that argument though, I understand.
My point is that hedging and insurance can be a very grey area. The main difference with insurance is that CDS is a derivative of a financial insturment and is marked to market which means you have to post margin against your positions. As spreads move, the required margin changes and you can monetize your swap at any time. BTW, you don't write CDS to protect against default, you buy it.