Credit swaps lose crisis stigma as confidence returns

A year after the bankruptcy of Lehman Brothers Holdings Inc, credit-default swaps (CDS) have lost their stigma for disaster and are contributing to the growing confidence in the credit markets.

The cost to protect against a failure by New York-based Goldman Sachs Group Inc, Charlotte, North Carolina-based Bank of America Corp, and 12 of the other biggest derivatives dealers dropped 66 per cent in the past six months, according to an index of swaps compiled by Credit Derivatives Research LLC. While the US struggles with the slowest recovery since 1945, the market where investors protect themselves from default and speculate on corporate debt shows confidence is the highest since June 2008.

Credit-default swaps worsened the biggest financial crisis since the 1930s as the meltdown of Lehman and American International Group Inc, two of the largest traders, caused a seizure in lending. Now, Wall Street is accelerating reforms Treasury Secretary Timothy Geithner started in 2005 when he was president of the New York Federal Reserve to increase transparency in a market lawmakers plan to regulate.

“A functioning credit-default swaps market contributes to more efficient extension of credit” by giving investors and lenders confidence that the industry won’t implode, said Alexander Yavorsky, a senior analyst at Moody’s Investors Service in New York. The consequences of Lehman’s failure “were astronomical, broadly speaking, but the CDS market worked well,” he said.