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Saturday, October 29, 2011

European Banks’ 50% Write-Down: Discounting Debt Insurance (CDS)?

In “Europe’s Rescue Plan,” The Economist (October 29, 2011) opines on the “fixes” that had been announced just days before by E.U. leaders on the public debt crisis. I find three points of note that are particularly worth elaboration. "Bond markets may be suspicious of guarantees made by countries that would themselves be vulnerable if their over-indebted neighbours suffered turmoil." This downside is that of systemic risk. When Wall Street banks began to tank as the value of their CDOs declined, so too did AIG, which was to fund the insurance policies (CDSs) on those CDOs. In other words, we tend to discount the possibility that the entire ship could tank.

The full essay is at "Essays on the E.U. Political Economy," available at Amazon.