Credit Default Swaps…world financial crisis #2?

Sunday, 25th May 2008 11:22 - by Resident IFA

I saw Credit Default Swaps (CDS) on a recent BBC programme, the presenter seeing this as possibly the next global financial instrument to go wrong. A Credit Default Swap is a contract that insures losses on certain financial instruments in the event of default. Hedge funds, Banks, et al sell these to protect such as mortgages and corporate debt. The problem arises in that the two markets regulation status has polar differences – one is regulated and one is not. So, no-one is looking over the CDS market, it being a ‘free-for-all’ where contracts can be sold and re-sold with no checks as to whether the buyer has the resources to meet their obligations if this insurance is claimed upon in the event of default. This makes CDS’s hard to realistically value…sound familiar to any other financial instrument that blew up in the financier’s faces in the last 12 months?! - CDO’s (Collateralised Debt Obligation) and their ‘bundling’ and re-selling of US sub-prime mortgage debt. It seems that the ‘Perfect Storm’ could be brewing. Problems in the CDS market could affect liquidity in the lending market even further. Judging by the difficulty mortgage borrowers are now having in obtaining loans and the continued lack of inter-Bank lending, difficulties in buying Bond insurance could well exacerbate this problem. An article I read in Time magazine summed it up well by saying that “On Wall Street, innovators are always ahead of regulators”. I will leave the final word with one of the sages of world finance, George Soros. In April he said of the $45 trillion (!) CDS market “This is a totally unregulated market hanging like a Damocles Sword over the financial system”. We have been told. 50,000 pages are being looked at each month on lse.co.uk’s Personal Finance section – a dramatic rise. Please respond to this Blog using the box below or on the General Chat section on the site. Until next time…