Could CDSs be neutralized by guaranteeing bonds?

[jimmygu3]

I was listening to an NPR interview with Satyajit Das yesterday.

Das says that during his time in the industry, the amount of credit default swaps that were speculative grew to dwarf the amount that were used for insurance. The numbers are staggering. There are $5 trillion worth of bonds issued in the world, but the total amount that people have bet on those bonds is $60 trillion. For every one person insuring a bond with a credit default swap, there are more than 10 people betting on it.

My thought was: Why can't the government just guarantee the $5T worth of bonds, essentially neutralizing the huge $60T in 'bets' via CDS? Basically say, we screwed up by not regulating this, from now on it's going to be regulated, thanks for playing. It would only cost the taxpayers when companies actually defaulted, a fraction of the $5T, and probably a much smaller fraction due to the elimination of the current uncertainty about counterparty risk, etc. Maybe it could be a 100% guarantee, or you could subtract out the bond's spread over Treasurys at the time of the guarantee. So a bond yielding 15% wouldn't instantly become a Treasury, it would be guaranteed at 88% or something.

Could this be an option?

Jimmy

[we_are_toast]

Re: Could CDSs be neutralized by guaranteeing bonds?

I had the same reaction when I heard this story on "this american life" several weeks ago, and posted the same question.

Why can't the gov declare all bets are off!? If you don't have the instrument that the CDS was written against, YOU take the hit. And it wouldn't be a big hit, basically an insurance premium. Anything other than this just appears to be a taxpayer give away to a bunch of gamblers.

[metalman]

Re: Could CDSs be neutralized by guaranteeing bonds?

I had the same reaction when I heard this story on "this american life" several weeks ago, and posted the same question.

Why can't the gov declare all bets are off!? If you don't have the instrument that the CDS was written against, YOU take the hit. And it wouldn't be a big hit, basically an insurance premium. Anything other than this just appears to be a taxpayer give away to a bunch of gamblers.

it's what martin mayer said ten friggin years ago. in the otc cds market the risk gets concentrated in the weakest hands. the impact of negating all of the contracts is asymmetrical.