Felix Salmon testifies in defense of credit default swaps.

I just had a long conversation with Kai Gilkes of CreditSights, who confirmed for me that it’s pretty much impossible, in this market, to back out implied default rates from CDS spreads. There are so many technical factors in the market, so many reasons beyond expected default that people are buying protection on certain credits, that it’s impossible to isolate expected default probabilities. So I don’t know what implied default rates Dizard is using, but I do know that they’re unreliable to the point of uselessness, since right now CDS spreads tell us precisely nothing about expected default rates.

The prosecution rests.

During the Q&A at the hearing yesterday, I said that those of us in economics and finance do not yet fully understand credit default swaps. They’ve only been around a few years. I said that I suspect they are behind some of the anomalies in asset markets, such as the negative yield on short-term U.S. Treasuries. In my written testimony, I expressed my suspicion that CDS are the explanation for the mysterious multiplier in this crisis–the one highlighted by Brad DeLong.

Salmon says that credit default swaps have “other uses” than price discovery. Those other uses seem to me to consist primarily of creating systemic risk and huge swings in liquidity preference in response to revaluation of out-of-the-money put options.