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A Wall Street Invention That Almost Blew Up the World Five Years Ago is Falling Out of Fashion

businessinsider.com | February 2, 2014

By Linette Lopez

Going the way of scrunchies and jerry curls, credit default swaps (CDS) are falling out of fashion on Wall Street, reports Bloomberg's Mary Childs.

Outstanding CDS has been cut in about half in the time from 2007 to June 2013. Part of the problem is that new post financial crisis regulation is making it too expensive for banks.

Credit default swaps had a huge hand in financial crisis. Back in the 90s, they were invented at JP Morgan as a mechanism to insure loans. In a nutshell, the buyer of the CDS pays the seller installments with a guarantee that if the borrower of the loan defaults, the buyer is made whole.

Of course, 5 years ago, a whole lot of people defaulted, so a whole lot of CDS had to be paid out, and that had a domino effect on our whole banking system.

And that's another problem with CDS now. Since the Fed has kept rates so low, fewer people are defaulting, and that means fewer payouts.

Since then, though, some really smart people have continued playing in this muck. Guys like Boaz Weinstein od Saba Capital Management and Andrew Fieldstein over at BlueMountain Capital Management made a killing betting against the London Whale (who traded CDS) and even before that, during the Euro debt crisis.

But now those guys are changing their strategies — hiring equity traders and bringing down their CDS assets.

Of course, Wall Street has never had a shortage of toys to play with, so don't lose too much sleep over this.

 

Back to February 2014 Archive

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