Idiots on Wall Street
The Financial Times reports that the price of credit default swaps, insurance for corporate debt, has been going up again. The FT interprets this as meaning that the credit crisis is worsening. I interpret it as meaning that Wall Street, London’s City, and the other financial markets are finally learning what they are doing when they make credit default swaps. They are insuring that a company will pay its debts, and they are saying, “If that company doesn’t pay, we will.” For years they have been blithely issuing these swaps as if they were just cheap ways to make money with no consequences. The horrendous failure of AIG due to the issuance of these CDS’s shows that they do have consequences. Finally, after years of failing to understand the business model for CDS’s, Wall Street is learning. As a result, CDS’s are becoming more expensive as they should have been for the last decade, or however long they have been around. The markets may be bad, but for years the CDS’s were priced incorrectly by idiots who did not know what they were doing. The whole credit crisis was created not so much by the sub-prime mortgages, but by the ridiculously under priced CDS’s sold to cover them, which now have the issuing institutions on the hook for trillions of dollars. The banks don’t have enough capital to stand behind these promises; so, the Federal Government has had to step in to prop them up.