CDS Market Calms After Bear Stearns Deal

The credit default swap, or CDS, market in essence lets investors place bets on the likelihood that companies will default on bond payments. On Monday investors scaled back their bets on the likelihood that major financial companies will teeter into bankruptcy.

In early trade Monday it cost $240,000 to buy a contract against a default on $10 million in JP Morgan bonds, according to Phoenix Partners Group. But the cost narrowed to $195,000 by midday. Similarly, stock of JP Morgan was rallying about 6 percent in midday action as investors warmed to the Bear Stearns deal, at least for the moment.

The Bear Stearns deal was well-received by fixed-income investors because it will remove several of the market's most pressing worries. In addition, the Fed Sunday offered to extend lines of credit to an unprecedented list of firms that included many nonbank financial services firms, effectively providing another new cushion for the hard-hit sector.

Investors also have been fretting that Lehman Brothers Holdings Inc. could be in trouble, because it also has substantial exposure to the toxic subprime debt that led to Bear Stearns' demise. The cost of buying protection against a Lehman Brothers default soared to a new high of $585,000 per $10 million in bonds in early trade Monday, but fell to $470,000 at mid-afternoon. The same protection cost $450,000 on Friday.

A CDS bet on a default on $10 million in Goldman Sachs Group Inc. bonds narrowed to $195,000 at midday from $220,000 at the opening. Goldman Sachs is another of the brokerages that has worried investors. The company is scheduled to report its first-quarter earnings on Tuesday.

The CDS market provides strong clues as to the futures of companies. Prior to the credit crisis that began in August, CDS activity was parsed for indications as to which companies were most likely to receive buyout offers. However, in the current dire market these assets tip off investors as to where the greatest default risk lies.