Credit Default Swaps Are Back in the News

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Credit default swaps are in the news again:

An unidentified market participant has asked a committee of the International Swaps and Derivatives Association to rule on whether the passage of legislation approving collective-action clauses for Greek debt should trigger payouts on credit-default swaps tied to Greek sovereign bonds.

At stake are payouts from sellers of a net $3.2 billion of CDS on Greece currently outstanding, and the stigma associated with lending credence to an instrument policy makers have long reviled.

I hope the ISDA takes the case, and I hope they rule in favor of the CDS holders. I’m not a big fan of CDS, and I suspect the world would be a better place if CDS were banned outright, but for now they’re legitimate contracts bought and sold in a legitimate way. So if Greece has defaulted, the contracts should pay out — and Greece has defaulted. The European claim that the haircut on Greek bonds is “voluntary” is the worst kind of sophistry, and allowing it to stand because of bullying from the EU would be a travesty. The ISDA shouldn’t be a party to this fiction, and shouldn’t encourage other governments to expect a continuing supply of get-out-of-jail-free cards in the future. That’s moral hazard for you.

Default is part of the latest European deal. Part of the price of that deal is the cost of CDS payouts. Everybody should stop pretending otherwise.

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