Now even the U.K. Debt Management Office is defending the use of credit default swaps (CDS’s).
CDS’s are practically irrelevant to a nation’s debt problems, says the nation with a massive debt problem:
“Sovereign CDS spreads are of limited relevance to sovereign risk, especially for those countries able to service debt in their own sovereign currencies,” says Robert Stheeman, London-based chief executive of the UK Debt Management Office.
It sounds absurdly simple, but it has to be emphasised that credit default swaps don’t create irresponsible levels of government debt. Governments, politicians, and blind electorates do. Thus to think CDSs destroy nations’ financial positions is to conflate cause and effect:
Sovereign CDSs bear little relation to true probability of default, says William Porter, the London-based head of European credit strategy at Credit Suisse. Although corporate CDSs are often referred to as the tail wagging the bond-market dog, this is not the case for sovereign CDSs. “The sovereign CDS market is the tail on the government bond-market dog. If you look at open positions on Greece, for example, there are about €10 billion of net positions against a government bond market that is in the order of €300 billion,” he says.
Consequently, critics of sovereign CDSs would be better off focusing on underlying fiscal problems, they write: “As the proverb implies, we would do better to spend our time addressing the defects the mirror shows up than blaming the mirror. After all, banning mirrors does nothing at all to make the world a prettier place.”
If anything, CDSs provide an early warning of debt problems before they get worse. Take away CDS’s and we’d have no idea where a nation’s actual debt ‘cliff’ is, until it has driven right over it.