A recent article from reporters Salas and Harrington at Bloomberg pointed to a new dimension in the ever expanding saga of credit default swaps and the enormous damage they have done and continue to do to the economy. The crux of the matter is that bond traders who own swaps have a strong incentive to drive distressed companies into bankruptcy. It’s profitable. In something akin to debt arbitrage, traders buy debt at a fraction of its full value, and buy the swap at a fraction of its payoff value, and if the sum of the two is several points less than the full value of the debt, they profit by either waiting for the difference to narrow or by driving the company into bankruptcy. No wonder Buffett called derivatives weapons of financial mass destruction. But it gets even better. According to the article, a strategist at CreditSights Inc. in New York said,
…derivatives are bringing a measure of efficiency to the market…”People point at CDS causing all of this volatility. To me, it’s always been there. People haven’t been able to place the bets they would have liked.”
This is the money quote of our time. Translation: Swaps aren’t causing increased volatility because they allow people to make bets and manipulate the market in ways that they couldn’t do before. What a logical tour-de-farce. More importantly he bluntly states what everyone has been trying to shove under the rug by blathering on about market forces, efficiency, etc. “People haven’t been able to place the bets…”. There you have it. It’s a casino, and a crooked one at that.