Wednesday, April 1, 2009

Credit-Default Swaps to the Rescue?

Oliver Hart, professor of economics at Harvard University, and Luigi Zingales, professor of finance at University of Chicago's Booth School of Business make the case that credit-default swaps could be the key to getting banks out of the very trouble these instruments helped create. In short, the professors state that to prevent systemic risk, large financial institutions should have to increase their capital reserves when assets the institutions hold lose value, and that the best way to track the value of these assets is provided by the market through credit default swaps. But could turning CDS prices into a trigger for a mechanism that lowers the likelihood of default corrupt the effectiveness of CDS asset pricing? And didn't these swaps already fail to accurately value mortgage-backed securities in the first place?


  1. Nick Holland said...

    That's a really interesting idea. But who will be the parties to the CDS? Could or would AIG be a counterparty again?

  2. Drew Kelly said...

    I believe they mean credit default swaps being sold by anyone to anyone. Assuming regulation is passed that CDSs must be cleared, the Treasury would be able to track the market price of a CDS on an asset.