<http://zerohedge.blogspot.com/2009/02/some-more-facts-about-how-cds-market.html>
from which:
<snip>
Zero Hedge argues that CDS has been probably the most efficient way to hedge credit risks in the past 3 years. The fact the insurance companies took Buffett's example 10 steps too far, and just kept on selling and selling protection (kinda analogous to how the U.S. is printing and printing $$$ now) assuming six sigma events would never occur, thereby exposing the entire financial system to systemic risk, is solely their mistake and the appropriate punishment should have been default. An efficient market would have eventually picked up the pieces from AIG's failure, so the course that Paulson departed on when he bailed AIG out just takes that mistake even further as it merely leverages the faulty disbelief in fat tail events. The argument goes that CDS and equity markets are self referential when gossip picks up and companies like Bear and Lehman get shorted to death as fear is rampant. There are many more pieces to this argument, but we think it is totally meritless (in Lehman's case CDS traders would not purchase protection blindly as they were worried a Bear Stearns bail-out type event would reoccur making all CDS contracts virtually worthless; the government is as much to blame for being unable to hold a consistent policy course w/r/t how to deal with bank failures). The flipside is that CDS provide the only mechanism to hedge credit risk, which at implied 40% default probabilities, will need to be hedged even more so in the future
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I'm attracted to this argument because it avoids the usual sermonizing about risk (a series of secular fire and brimstoners which always start by pillorying average Americans for incurring debt and conclude by ascending the heights to link supposedly out of control household debt with instruments such as the CDS).
Risk management (as opposed to risk aversion) is accepted as a given. ZH redefines the CDS problem as being excessive and indiscriminate use rather than, as many put it once it became of topic of mass media comment, the existence of such derivatives.
This also speaks to Michael Pollak's question, 'why kick out management?'
Ideally, the highest flying, most culpable managers would be subject to a tightly targeted reign of terror (great, and avoidable, failures impacting multitudes deserve ruthless replies.) Since that's not in the cards, it'll do for them to, as Doug wrote, "face consequences" (firing) so it's understood the reward for screwing up on this scale isn't a prolonged stay in cushy gigs.
.d.