The CDS Debate Continues
By Arnold Kling
If you buy a bond, you get a steady income stream, while running the risk that you might lose substantially all your money. If you sell default protection, you get exactly the same thing: the only difference is that in some (but not all) cases, you don’t have to put all your money up immediately.
That “only difference” creates another difference. If I buy a bond, and the probability that the bond will default goes from .00005 to .005, nobody can make me post collateral. If I sell default protection, apparently my counterparty can make me post collateral. That is because I did not have to put up all my money immediately.
Look, I don’t think that Dizard or Salmon or Kling or anyone else is in a position to draw rock-solid conclusions about credit default swaps. The history of their existence is just too short for that.
I’m not saying that government should abolish them. As with mortgage-backed securities, I think government should just sit back and let them die a natural death.