Wednesday, May 13, 2009

they were mostly used for pure "speculation" rather than hedging

From The Economics Of Contempt:

Tuesday, May 12, 2009

2 + 2 = CDS Are Evil!

I love the logic of the anti-CDS crowd.

First, they claimed CDS were evil because protection buyers weren't required to own the underlying bond—they were mostly used for pure "speculation" rather than hedging. The anti-CDS crowd frequently cited Eric Dinallo's claim that 80% of CDS are held by investors who don't own the underlying bond ("naked CDS") as proof that CDS are evil.

Now that it's fashionable to blame CDS for pushing companies into bankruptcy, they look at the net notional CDS outstanding on a company attempting a restructuring, and assume that 100% of them are held by bondholders. What happened to all the anger about naked CDS?

If the problem is that you can buy CDS without owning the bond being protected (gambling vs. legitimate hedging), then CDS should be a non-factor in restructurings. After all, aren't 80% of CDS held by investors who don't own the underlying bond? And wasn't that supposedly the problem in the first place?

You can't have it both ways.


Don said...

It is not gambling. If I believe that a company is being poorly run, then I can invest accordingly. If I believe that a company is overvalued, then I can invest accordingly. The idea that you can only invest on success is preposterous. You want the market to reflect the best information available. Period. If you don't, then you're going to encourage the overvaluation of stocks and bonds, which works for a while, but ends badly.

Frankly, even gambling is fine with me. In sports gambling, a hell of a lot of knowledge and expertise goes into it. The main problem with it is fixing the event, which is illegal.

I can understand why people don't like gambling, but I think that it should be legal. I don't ever gamble. However, I would short stocks or buy CDSs because they are investing, if I had secured the majority of my portfolio. It's riskier investing, not necessarily stupid investing. For most investing, stick with Graham, but a little investing on such risky picks is sensible, if you do the research and know what you're talking about.

If I buy a CDS or CDO, then someone had to sell it to me. That means that they see the future differently. That's how prices and worth are determined.

As for bondholders, actual bondholders hedging their investments, that's to decrease the risk of their losing money. Their losing their own money. They've loaned money to the company, or purchased the bond from someone who did. There was a huge story yesterday about how high interest rates on bonds issued on companies are hurting the recovery. You can only make them more expensive if you make them riskier. You're losing the war to win a battle. Good luck going forward.

Don the libertarian Democrat

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