The rate-manipulation scandal has shown banks
will collude with one another for their own benefit. Banks didn’t report the rate at which they
were borrowing from other institutions. They could report a made-up rate that,
not surprisingly, turned out to serve their economic interests at the time. So, it might come as a worry that there is
another, multitrillion-dollar market — the credit-default swap market — that
operates under a similar principle.
Credit-default swaps are insurance-like derivatives, or side
bets, that protect investors from bad events like a company going bankrupt or a
country failing to pay its debts. Whether
a company has defaulted on its debt might seem unambiguous to some naïve souls
out there. But that’s hardly the case, especially when there are lawyers
involved and billions of dollars at stake. Because credit-default swap
contracts can be worthless when they expire, the timing of insolvencies can
make the difference between making and losing a great deal of money. Decisions about when a swap pays out are made
by a trade group called the determinations committee of the International Swaps
and Derivatives Association. The mere fact that a determinations committee
exists is evidence that “insolvency” is not simple to define.
Sure, credit-default swaps are products for grown-ups.
Sophisticated investors play in this market. Foster children and the infirm are
not putting their life savings into this market directly. But they matter to corporations and
countries. When Europe tried to bail out Greece, an enormous debate sprang up
about whether the restructuring of Greece’s debt was technically considered a
“default.” Initially, the committee said it wasn’t. Then, after some details
shifted, the committee ruled it was.
A proper market would want an organization that was
impartial, regulated, transparent and open to appeal. No such luck…..
Read all about it at http://dealbook.nytimes.com/2012/07/18/behind-credit-default-swaps-market-a-cartel-left-open-to-collusion/
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