Government Buys Bonds to hedge credit risk

The idea of this article is for the government to issue bonds at points where their credit default swaps are trading. Some companies, such as John Deere, are doing this, and the government bank, or state-owned bank, could do the same but even at lower rates. They could fully hedge the associated credit risk in the CDS market. Companies who need the money would then receive it, instead of banks keeping the money and doing nothing with it. Arbitrage exists in the current CDS market, so this new CDS exchange to include the government could possibly change the amount of arbitrage, or inefficiencies in the market.

The risk that the CDS market is facing is an illiquidity premium, which would not be a problem for the government. The government has limitless liquidity. This will also encourage spending becaus ehte government can hold cash bonds and loan out money to companies that need it without the compnaies having to pay a large premium or loading, as we discussed in class.

Many comments were posted about this article, some agreeing and some disagreeing. I think it is a good idea to help the current financial crisis, but the government can only help so much. The government spends so much more money than it has. We have increased the deficit more and more, and this hedging would only increase it more. The government is already bailing out companies. One comment addresses my complaint: this proposal does not justify spending government money wastefully and unwisely.

http://www.portfolio.com/views/blogs/market-movers/2009/01/29/let-the-government-buy-corporate-bonds