'Michael Lewis Doesn't Know Squat About CDS'

Yesterday we pointed out Michael Lewis’ interview at The Atlantic, in which he reasserts the common viewpoint that credit default swaps are useless financial instruments that did nothing but compensate traders to blow up the financial system. He says that in talking to people, he’s never heard a single compelling use for their existence.

Our friend Felix Salmon at Portfolio.com thinks Lewis needs to get out more, or talk to a few more people:

And yes, there is “a really useful reason for a credit default swap” — it’s pretty much the same as the really useful reason for the existence of equity markets. In the stock market, there are lots of sellers, and lots of buyers, and the public visibility of the market-clearing price creates a lot of value. The bond market, by contrast, has always been much more illiquid: bond investors tend to be buy-and-hold types (remember those pension funds and insurance companies) who buy up bonds at issue and then hold them to maturity. As a result, it can be very hard to short any given bond, or to get a useful bead on exactly what the market-clearing price on any given company’s debt might be. Unless you have a liquid CDS market, which is very useful indeed when it comes to price discovery.

I’m pretty sure that Lewis understands the importance of short-sellers to the stock market; it’s weird he doesn’t understand that the existence of short-sellers in the credit market can serve an equally useful purpose. But if demonizing short-sellers is a popular and easy sport these days, demonizing the CDS market is easier still. More’s the pity.

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