dapperdan said

btw...I'll go on record as saying that I have no problem with the basic concept of the credit default swaps, provided that: A) they are listed on a public exchange, and B) the institution writing the swap has to put up reasonably sufficient collateral when they write the swap. Same thing as when you write an option, or the need to have sufficient reserves as an insurance company writing an insurance policy. The problems isn't the swap, per se, imo, it is the amount of leverage that is accompanying the writing of the swap. Just my opinion.

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The problem with simply looking at the difference, or spread, between an issuer's bonds and the risk free rate is that issuers tend to have a lot of different bonds outstanding, each of which could have different prices, and therefore different yields. This means that it's difficult to get an overall, market-based sense of the creditworthiness of an individual issuer looking only to the bond market. This is not the case in the CDS market.

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Without the CDS market, credit quality would be and was a product of subjective models, since we'd have to look at the spreads on the whole spectrum of debt that a given issuer has outstanding, and then use subjective - but not necessarily arbitrary - methods of averaging them. With the CDS market, we have a market-based measure of the credit quality of a wide variety of debt instruments outstanding for a given issuer. This makes the credit quality of an issuer more transparent, not less. Now ask yourself: what kind of issuers does this level of transparency threaten?

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