Is This A Bad Thing? Sane Economists would say No.
Yes, I’m working with the null set again, but Peter Bockvar, chez Ritholtz, raises the most common objection to the Greek restructuring’s likely effect on the CDS market:
[I]t will…potentially destroy [the sovereign CDS] market to the point where it will go away. The unintended consequence of what will be next will be those looking to hedge sovereign exposure, mostly banks, will then have to short sovereign debt or outright cut credit to the region. EU officials better be careful what they wish for the holders of Greek CDS.
The English translation of this is that Mr. Bockvar suggests—I can’t swear that he believes, though I know which way to bet—that the current prices for sovereign debt are artificially high because of the existence of the Sovereign Debt CDS market.
So, unless you are trading acvtively in both markets, as a buyer, you are being charged too much for sovereign debt.
Wouldn’t it be better to know that up front?
Need to be careful with notions like “artificial” and “too much”. We pay more for houses because there is a market to insure them against catastrophic loss, but that alone doesn’t mean houses are too expensive of that prices are artificial. Insurance markets are a good thing.
The problem with the CDS market is that it is not an insurance market as much as it is a speculative market. We don’t know that the CDS market will go away, but if it does, it will be a loss to participants in the sovereign debt market for the reasons Bockvar cites. That does not, however, mean Greek debt is misprices. What it means is the ability to lay off risk will be reduced, so that the fundamental value of Greek debt will fall. Change the market, you change the price. Simple as that.