Pope's CDS Criticism Could Apply to All Markets
On Thursday, Pope Francis delivered a wide-ranging speech about financial markets. General thesis: Modern finance is exacerbating global inequality by subjugating the value of actual work to the work of speculation. It’s not a positive Wall Street review. You can read the whole speech here.
Credit default swaps get a particularly harsh rebuke from the Holy Father, who calls the debt derivative market “deplorable from the moral perspective,” a form of gambling that is “unacceptable from the ethical point of view,” as well as a “ticking time bomb” that is “poisoning the health of the market.” It will explode “sooner or later,” the Pope adds — so he’s not strictly calling a top.
It’s not all bad. For those Wall Streeters who are worried about their soul, and believe the Pope has some insight into the matter, the speech does lay out a sort of ranking of financial behavior, from acts that will bring likely salvation to those that promise almost certain damnation. Microcredit and municipal lending, especially in emerging markets, is close to godliness. Direct lending is a worthy calling. And the Pope is all for financial instruments that represent a portion of equity, so stock fund managers and traders still have a shot at the pearly gates. High frequency traders, though, are likely headed south. The Pope says HFT removes “capital from circulation with the real economy.” Worse are all forms of securitization, with the logic that the moral corruptness of a financial activity can precisely be measured by the distance it is from the actual asset. Over-the-counter CDS contracts, and CLOs for that matter, therefore, are instruments of the devil.
The Pope seems to hate CDS contracts because he says they are nothing more than a bet on someone else’s demise. But the problem with the Pope’s financial market moral hierarchy is that pretty much all of investing, no matter how you do it, is a bet. Initial public offerings do fund companies. Regular stock trading doesn’t. Bill Ackman called his short against Herbalife Nutrition Ltd. a moral crusade, but just like CDS traders, Ackman positioned himself and his investors, as all short sellers do, to benefit from a company’s demise. Local payday lenders are about as direct a financial transaction as you can get, and yet many wouldn’t put it in the moral category. And even microcredit can, at times, be predatory. There is plenty wrong with Wall Street, but it’s not market or financial–instrument dependent.
Yes, CDS contracts are used by speculators, but the derivatives also lower borrowing costs and allow some companies, and countries, to get credit they wouldn’t have been able to in the past. A 2012 study found that as the CDS market has matured, more of it is being used for hedging, and less for speculation. A 2014 study found that the existence of the CDS market led to more defaults, but that’s likely because the debt of companies on which people wanted to trade CDS were more likely to end up in default.
For better or worse, there have to be buyers and sellers. There can’t be people willing to risk their money to improve someone else’s chances of success, without those who are also betting on failure — just like, in Catholicism, you can’t have a heaven without a hell. Pope Francis may not fully understand financial markets. But that’s one thing you would think he of all people would get.
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