Having given this a couple of minutes thought, naked selling of CDS’s is just short selling of a bank’s bonds (only much more complicated).

If this was a straight gamble between speculators, then so what? Money changes hands, some hedge funds lose, others win.

If a bondholder bought a CDS a while back, he can now offload his new bonds and shares on the seller of the CDS. All things being equal, the market value of the new bonds and shares won’t be much different from the ‘toxic’ bonds beforehand.

I don’t think this CDS stuff is central to the debate. Or perhaps I’ve missed something, and it is?

Your comments on Buiter’s blog are pretty interesting. However, I think most people would balk at restricting the CDS market the way life insurance policies are restricted. Things would have to get a lot worse before we get there. Interesting concept, but not likely to fly I think.

As for Buiter’s debt-for-equity conversion, he’s on to something. Again, I don’t think we’re there yet, but it would be a fair and less onerous way of recapitalizing the banking system than liquidation and bankruptcy.

I think John Paulson made a similar proposal for Fannie and Freddie before they were nationlised. If you were a Lehman Brothers debt holder, wouldn’t you rather take a haircut and get equity rather than go into liquidation? They me a bad example because they were insolvent, but for companies like Morgan Stanley, that might be a good option.

Mark, what are your feelings about Buiter’s comments?

On a more serious note, what do you think of debt-for-equity-swaps?