Instructions
- Read the following article.
"Are Credit-Default Swaps a Cardinal Sin?" By Gabriel T. Rubin, Wall Street Journal, July 21, 2018
- Answer the question listed below.
- Include and cite additional resources.
Discussion Questions:
- Proponents of CDS contracts argue that the CDS market benefits financial markets in two basic ways. 1) It makes a relatively illiquid market (the debt market) liquid and 2) it makes a relatively opaque market more transparent. (In other words, CDS markets reveal information about the credit market).
- Some opponents of CDS contracts argue that these contracts are not used to hedge risk, but rather to speculate. While other opponents argue that when lenders hedge a borrower's credit risk with a CDS contract, they no longer have an incentive to monitor the company and no longer care whether the borrower remains solvent because the contract will pay out if the borrower fails (this is called the empty creditor hypothesis).
- What are your thoughts on CDS contracts?
10/23/2020 Are Credit-Default Swaps a Cardinal Sin? - WSJ https://www.wsj.com/articles/are-credit-default-swaps-a-cardinal-sin-1532174520 1/3 This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers visit https://www.djreprints.com. https://www.wsj.com/articles/are-credit-default-swaps-a-cardinal-sin-1532174520 BUSINESS Are Credit-Default Swaps a Cardinal Sin? The CFTC chairman tangles with the Vatican over Pope Francis’s criticism of the derivatives product J. Christopher Giancarlo, a top U.S. markets regulator and a devout Catholic, takes issue with the pope’s position on derivatives. PHOTO: PATRICK T. FALLON�BLOOMBERG; TONY GENTILE�REUTERS By July 21, 2018 8�02 am ET Gabriel T. Rubin WASHINGTON—Can a good Catholic trade credit-default swaps? A top U.S. markets regulator and the Catholic Church are debating the issue, after a May treatise from the Vatican criticized derivatives—specifically credit-default swaps—as a kind of “economic cannibalism” that leads to profit from the misfortune of others. J. Christopher Giancarlo, a devout Roman Catholic and chairman of the Commodity Futures Trading Commission—which oversees derivatives and most swaps products— took issue with the church’s position. With the help of his (non-Catholic) chief economist and his hometown priest, Mr. Giancarlo drafted a lengthy rebuttal. “We write to you as finance professionals striving to lead moral lives,” he and CFTC chief economist Bruce Tuckman wrote in a nine-page July 19 letter. “We also feel obligated to https://www.wsj.com/news/business?mod=breadcrumb 10/23/2020 Are Credit-Default Swaps a Cardinal Sin? - WSJ https://www.wsj.com/articles/are-credit-default-swaps-a-cardinal-sin-1532174520 2/3 respond and defend derivatives and, in particular, credit default swaps, from various censures” in the May document, they added. The missive was addressed to the two Vatican departments that crafted the document calling derivatives a “ticking time bomb ready sooner or later to explode.” Credit-default swaps act like insurance against bond defaults. The products are used by financial institutions and investors to protect their investments from losses or to make bets on the perceived risk of companies, countries and mortgage debt. Use of products by financial firms to guarantee risky mortgage investments made the agreements a big factor in the 2008 financial crisis. Messrs. Giancarlo and Tuckman, in the letter, argued for the social utility of derivatives, saying that rather than preying on the vulnerable, derivatives are actually a boon for “the world’s poorest farming communities.” The two backed up their rebuttal of the Vatican with detailed descriptions of how, for example, derivatives can help stem boom-and-bust cycles in Madagascar’s vanilla-crop prices. They also included nods to the rhetoric of Pope Francis, including a discussion of how agricultural derivatives help feed the billions of people who live on the global “periphery,” a top priority of Francis’s tenure. Pope Francis’s tenure has been marked by several Vatican documents critical of capitalism, including his first apostolic exhortation in 2013, which denounced the “idolatry of money” and “trickle-down” economics. The Vatican didn’t respond to a request for comment. Popes have been writing and speaking publicly about the morality of capitalism since at least 1891, with Pope Leo XIII, said Father Stephen Fichter, Mr. Giancarlo’s priest at St. Elizabeth’s in Wykoff, N.J., and a sociologist at Georgetown University. READ THE LETTER Letter from CFTC chairman to Vatican• https://www.wsj.com/articles/your-passion-for-fancy-vanilla-ice-cream-is-creating-world-wide-havoc-1513264731 http://online.wsj.com/public/resources/documents/CFTC_Giancarlo_Response_to_Bollettino-07-19-2018.pdf 10/23/2020 Are Credit-Default Swaps a Cardinal Sin? - WSJ https://www.wsj.com/articles/are-credit-default-swaps-a-cardinal-sin-1532174520 3/3 Copyright © 2020 Dow Jones & Company, Inc. All Rights Reserved This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers visit https://www.djreprints.com. “Jesus didn’t talk about derivatives and swaps. This is a 2,000-year-old institution trying to be faithful to the teachings of Christ, and applying it to the modern-day situation,” Father Fichter said. The disagreement over credit-default swaps isn’t likely to be settled by a discussion of agricultural derivatives, which make up only around 10% of U.S. derivatives markets. One such area is the use of derivatives for speculative purposes, which the Vatican criticized as betting on the misfortune of others. “The growth of a finance of chance, and of gambling on the failure of others... is unacceptable from the ethical point of view," the Vatican said in the teaching document, which was personally approved by the pope. It also suggested that greater regulation of the world’s financial markets was necessary to contain “predatory and speculative” practices and economic inequality. “Debate about the role of speculation is likely as old as markets themselves and will not be resolved here,” Messrs. Giancarlo and Tuckman write, though they note that “profiting from the misfortune of others” isn’t unique to credit-default swaps. They compared the product to “unobjectionable” corners of the financial markets, such as annuities, where an insurance company makes a greater profit if a customer dies sooner rather than later. The debate between derivatives advocates like Mr. Giancarlo and skeptics in the Church is likely to continue. Mr. Giancarlo offered to visit Rome during one of his frequent trips to Europe for regulatory meetings to discuss the issue face-to-face. The Church also is likely to continue making pronouncements about the morality of various vagaries of modern finance that even recent popes couldn’t possibly have fathomed, Father Fichter said. “I’m sure eventually they’ll make a statement about bitcoin,” he added. Write to Gabriel T. Rubin at
[email protected] mailto:
[email protected]