Thursday, May 14, 2009

Credit Default derivatives to be traded on an exchange

Well, my hypothetical swath at being US Treasury Secretary for a day a few months ago perhaps bore fruit (okay, I'm kidding). I posited that since pricing of credit default swaps (CDS) was so opaque, perhaps an exchange could be created where trading of those derivative instruments could be transparent, liquid, and regulated.

The US Treasury is now pursuing this strategy, which is huge considering it's a $700 trillion market. I explained at length this market in previous blogs last year, so I won't go into the details again, but this action will only make trading these vehicles more transparent, and spreads will narrow. Regulatory control will confirm margin amounts and counterparties can make good on their contracts.

These credit derivatives insure against default of corporate America. The CDS market for collateralized mortgage obligations (CMO) is another animal, as the mispricing of insuring home mortgages against default is still being played out.

Shares of the Chicago Mercantile Exchange Group have been soaring as they take on the trading of these credit derivatives.

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