/biz/ - Business & Finance

Neat article
https://www.risk.net/derivatives/5532846/fixing-cdss-lots-of-patches-no-magic-wand

According to an oft-used analogy, buying protection via a credit default swap (CDS) is like holding fire insurance on a neighbour’s house – a comparison used by the market’s critics to claim it encourages the financial equivalent of arson.

Traders always rubbished that idea but then, in December last year, Blackstone Group’s GSO Capital Management offered favourable financing to New Jersey homebuilder Hovnanian on condition the company default on a small portion of debt. GSO will receive payouts on CDSs it holds, despite no apparent change in Hovnanian’s creditworthiness.

Suddenly, the fire insurance analogy didn’t look quite so silly: the two firms had found a way to burn down an empty house and split the payout.