The Social Function of Credit-Default Swaps - Philipp Bagus - Mises Daily

The Social Function of Credit-Default Swaps - Philipp Bagus - Mises Daily: "Due to this self-reinforcing spiral of distrust in banks and rising funding costs, people have regarded CDSs as one example of Warren Buffet's infamous financial weapons of mass destruction. Indeed, CDSs can be used to take down banks by lowering the confidence in them.

Yet, such an attack can only be successful if banks are vulnerable. Only if banks violate the golden rule of banking, i.e., if they mismatch currencies or maturities or engage in a combination of both, they become vulnerable to attacks through CDSs. Only then will the distrust spurred by higher spreads translate into funding problems that threaten a bank's liquidity."

"CDSs are powerful corrective instruments that discipline banks. CDSs are not weapons of mass destruction but instruments of providing discipline and order. It is possible that without rising CDSs spreads, Icelandic banks would have survived longer. They would have had time to cause additional distortions and make the collapse even more disastrous."

"By anticipating the future, speculators may bring about events earlier and reduce their potential harm. Speculators anticipate a sovereign default and speculate in this direction via CDSs. Thereby, they put a limit on the reckless fiscal behavior of the government."