Monday, August 13, 2007

The Credit Default Swap Market

The WSJ has an excellent article on the credit default swap market that is worth a read. The article requires a subscription to read it on-line, so for those of you that do not have a subscription, obtain a copy of the paper, like at the library. Try section C1 of the 8-13-07 edition:

The credit default swap market has become a microcosm of shaky investor confidence.

Credit default swaps are like fire insurance for debt. Insurance holders are compensated by the seller if a company defaults on a loan. When the threat of default rises, the insurance becomes more costly.

There's smoke billowing in this fast-growing market now. The cost of credit default swaps written on investment banks . . . . have soared in the past few months amid worries that troubles in the subprime-mortgage market and the leveraged-buyout market could damage their balance sheets.

A CDS contract that offers $10 million of credit protection on Bear Stearns debt over five years cost about $30,000 per year in January. That same insurance now costs more than $130,000. If Bear goes under, the holder of the protection gets $10 million. . . . .

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