Citigroup and Credit Suisse are so damaged by the financial crisis, it seems, that they’ve given up underwriting loans to their biggest and most valuable corporate clients, including Nestle and Nokia. Instead, they’re linking those loans to the companies’ CDS spreads. This is not a good idea, as Sam Jones notes:
Banks are supposed to be arbitrary lenders, in the sense that they perform, in-house, the necessary due diligence on on the creditworthiness of a company, and lend to that company accordingly.
Tying rates to CDS, though, is effectively outsourcing opinions of the creditworthiness of a company to the market. Indeed, it’s more of the same “outsourced” due diligence from banks that in part inflated the ’00-’07 debt bubble in the first place.
I’ve never been particularly impressed by arguments which say that indexing is a bad idea because if everybody did it, there wouldn’t be any price-setters. But this is a clear case of where that kind of an argument works. Banks have more and better information about borrowers than anybody else, they should be the price-setters. If they let the market decide, on the basis of worse information than the banks themselves have, they’re making the whole edifice less robust.
Note that the problem here is one of who’s doing the underwriting, and is not anything related to CDS: the banks could easily have used bond spreads instead, if they were liquid enough. Which is why I hate Bloomberg’s lede:
Citigroup Inc. and Credit Suisse Group AG are among banks tying corporate loan rates to credit- default swaps, raising borrowing costs and exposing companies to derivatives accused of crippling the financial system.
Clearly, the "derivatives accused of crippling the financial system" meme is not one which is going to go away. Even when it has very little place in a story such as this.