Saturday, May 16, 2009

Most Credit Default Swaps Don't Match Up with Accounting Requirements for Risk Management

Credit default swaps are marketed as a risk management tool. The accounting profession sets standards as to what qualifies for hedge accounting, i.e. the CDS covers the risk of underlying debt instruments. The vast majority of credit default swaps don't qualify, according to a Reuters story.

This raises the question, "are CDS's really for risk management or are they for speculation?" Bloomberg reported on speculators buying CDS's for distressed firms with upcoming debt refinancing needs. Huge amounts of corporate debt need to be refinanced from 2010-2014, at least The Carlyle Group's David Marchick told a Congressional subcommittee this fact. He also said credit remain frozen.

The future could show more firms at risk for CDS speculation, something not constrained by President Obama's financial regulatory reform. It looks like Congress may need to intimidate accountants again. The FASB chief may still be quivering from his last Congressional beat down over "fair value" accounting. Relaxing accounting standards to get America out of a financial crisis seems odd. But that's the way it is.