CDS are now almost useless except as a fear gauge

Contagion: Default probabilities blow out right across Europe | Credit Writedowns

Contagion: Default probabilities blow out right across Europe MARKETS | EDWARD HARRISON | 14 NOVEMBER 2011 12:00 Look at this chart of the sovereign credit default swap wideners today. Every single name is European. The only one with a sub-10% default possibility is Sweden, and they are not in the euro zone. That tells you something, doesn’t it? I think Warren Buffett is on to something. I like CDS as a gauge of market distress. For example, Belgian, French and Spanish CDS are at record highs. That tells you contagion is getting worse. But these sovereign CDS are products that are dangerous though. Europe has already eviscerated the sovereign CDS market with its ‘non-default’ in Greece. The Council on Foreign Relations blog thinks we should kill sovereign CDS off. Imagine life insurance contracts that wouldn’t pay off if officials declared heart attacks to be “voluntary.” Welcome to the world of sovereign credit default swaps, or CDSs.  When the Greek debt deal was announced on October 27, the eurozone leadership insisted that the banks were taking a 50% write-down “voluntarily,” meaning that Greek CDS contracts would not be triggered.  This was done to protect official creditors like the ECB and IMF, to avoid rewarding speculators, and to prevent possible financial contagion.  In response, Greek CDS prices plunged 20 percentage points.  Policymakers didn’t seem to care, but they should.

CDS in general were called weapons of financial mass destruction for a reason.

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