A default by any other name…

May 15, 2013

Among the things they didn’t teach me in grad school: for markets to work, we need to know (1) what the object is and (2) who owns it. Too obvious? Well, not in the real world. Credit default swaps were designed to provide insurance against bond defaults, but investors found out the hard way that European bonds could lose a lot of value without triggering a CDS “default event.” Some European actions seemed intended to produce precisely this result.

Kim Schoenholtz passes on this WSJ piece suggesting that the International Swap Dealers Association is trying to close the loophole. From the article: “the [proposed] newly imposed credit event would include any action taken by a governmental authority leading to a write-down; expropriation; conversion, exchange or transfer of debt obligations; or any action that otherwise affects creditors’ rights in a way that reduces what they are owed.” Well, duh!

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