What would happen if a government (not this one, surely, but some US government) declared all credit default swap contracts null and void?
Just killed them all. No more payments, no more indemnification.
What would happen?
Notional Slurry
Pontification without all the gritty gravitas
Presumably a larger version of what would have happened had AIG gone under, right?
Ummm, no, not if I understand what you mean.
I think what would happen would be a sudden jump in the accountable risk experienced by all these huge firms, but a compensatory steadying of their returns. That is, on the books they would not be hedged as well, but at the same time they would not be linked, and the failure of one would not impact any others, beyond the normal bounds of commerce.
One of the major factors in the crisis seems to be the deep and secret linkage among the firms: they all hold paper on one another insuring against one another’s failure. Nullify that paper, and the failures would (I think) be disconnected.
That is, on the books they would not be hedged as well…
But aren’t there other things that depend (legally, mechanistically) on what their books say? Things like credit ratings, that affect how much you can borrow, and how easily?
Also, can the government simply declare a class of contracts “null and void,” with one stroke of the pen?
But, as you know, I’m neither a lawyer nor an economist, so I likely don’t know what the hell I’m talking about.