Monday, June 22, 2009

Shorting a stock, the CDS way

I had just finished comparing the synthetic CDS market to carrying life insurance on a stranger/public personality and along comes a story of the logical next step already in play. I would surmise that the logical next step after buying life insurance on someone you don't care much about would be to arrange for the passing of the said person. e.g. if the person was already admitted to a hospital, and you have some sway there, you would guide matters towards reduced treatment or even euthanasia.

Now the economist brings us news, that is precisely what CDS holders are doing to companies. They have already bet on the demise of the company and stand to gain from that demise, so they now play hardball on their original debt and encourage bankruptcy courts (isn't that the hospital you take sick companies to?) to take actions that will accelerate collapse rather than recovery.

The economist piece proposes solutions like regulation, disclosure etc. really speaking we should apply the existing legal standards. Under current law, one cannot collect the insurance policy above because, the act of accelerating the demise is a crime and you cannot profit from crime so the policy will not be paid out to you. Apply the same standard, the CDS is rendered worthless.

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