With all the material and moral support for U.S. mega-financial institutions currently on the table, why are bank holding company credit default swap (CDS) spreads at new highs? (For more on how and why you might want to think about CDS spreads, we have a basic guide.)
The most plausible explanation is that creditors – unlike equity investors – are spooked by the new resolution authority that is now sought by Treasury and the Fed. This would, after all, allow the government to manage something akin to (but potentially better than, from a social perspective) a bankruptcy process for our largest financial institutions.
These creditors are right to be worried; the authority, if granted, would almost certainly be pressed by events (and creditors’ self-fulfilling runs) into use.
But, if handled right, this authority can help solve the financial mess at minimal cost to the taxpayer (although there are no magic bullets or easy exits at this stage). The key – as always in any major crisis – is decisive action. Over on wsj.com this morning, Peter Boone and I outline one way forward.
By Simon Johnson