Wither CDS?

Something I have been wondering about in the context of the supposed “voluntary” writedowns being forced upon holders of Greek debt – what exactly is the point of the credit default swap market for sovereign debt if politicians will act to ensure that any default never triggers a credit event?  The FT provides an answer:

Now, politicians are seeking to take their revenge: not just with the recent introduction of bans on some trading of credit default swaps but also in their attempts to ensure that any haircut on Greek government bonds does not trigger a credit event.

Combined, these two events could spell the end of the credit default swaps market, say bankers.

The end of the credit default swap market might not be without consequences:

But these aims could backfire. Some bankers believe, rather than lowering borrowing costs, these moves will have the reverse effect and also restrict lending to their banks and companies.

In the wake of the CDS ban, some banks are already pushing alternative strategies that risk driving up government bond yields even further. Last week Citigroup, the leading US bank, recommended selling the bonds of France, Italy and Spain because of the trading ban while other banks have warned they could unload peripheral bonds if CDS payouts are ruled out on Greece.

Not exactly a good time for higher rates in the periphery.  Will the loss of the CDS market ultimately improve or undermine financial market functioning?  This is outside my area of expertise, leaving me particularly curious on how events unfold.

This post originally appeared at Tim Duy’s Fed Watch and is reproduced with permission.

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