No More CDS? At All? Ever? Maybe So.
That’s CDS (as in Credit Default Swaps), not the computer disks or Certificates of Deposit. But David Einhorn the well-known chief of Greenlight Capital has come out unequivocally against their existence in a letter to his investors documented in this FT Column. I never thought I would see this coming from a well-known hedge fund manager. But I appreciate his candor. I’ve been thinking all along that all we need to do is get them cleared by a well-capitalized third party clearing house, and, ideally, also get them traded on a listed exchange with publicly available time and price data. Taken together those two things would go a long way to making these instruments respectable.
Einhorn claims there is no way to properly capitalize such a clearing house, however, and I wonder why this is. I assume that if you trade and clear and require margin on CDS like futures contracts, why wouldn’t that work? After all, we believe our futures markets are properly functioning and properly insulated from market shocks.
Part of his reasoning is that a bondholder hedged with CDS may actually want a company to formally enter bankruptcy or liquidation, so they can collect 100 cents on the dollar through the CDS contract, rather than some lesser amount through a distressed debt exchange or some other quasi-defaulting, quasi-bankruptcy process. I am very sympathetic to this last argument and think he is right on.
Another possible concession for those who feel they absolutely must have CDS available is to make a law that if a creditor hedges some or all of their exposure in a CDS then they give up or lose proportionally their voting rights in a reorganization plan. Hmmmm. Hard to predict if that would have the desired effect in real life. And, trying getting that one passed in Congress.
