The context
People have gotten excited about AI capex and the recent soaring price of Oracle credit default swaps¹ (CDS), perhaps flashing back to the financial crisis and how CDS presaged problems there. There are misunderstandings out there.
💡
¹ Explainer: Credit default swaps, which were "invented" in the mid-1990s at JP Morgan, came into their own during the financial crisis.
Here is how they work:
The CDS “price” is the annual insurance premium, expressed in basis points, of the probability-weighted loss of a thing.
A CDS quoted at 150 bps means, using a house metaphor, you pay 1.5% per year of the house’s insured value. On a $10m house, that’s $150,000 per year. It is a measure of the market's view of the likelihood of the house burning, and of the severity of the damage.
Unlike with normal insurance, however, you can, via CDS, buy insurance on someone else's house. That is what most CDS activity is: people buying insurance on (metaphorical) houses, whether to hedge their own position (perhaps they're also long Oracle debt), or to take a naked position (they think Oracle's debt is a mess).
You might rightly ask yourself why someone would hedge a position they don't like, and there are good-ish reasons for that. For example, they could be a private credit fund or a bank temporarily warehousing the debt before syndicating, and they want to balance their risk. There are many others.
Here is how they work:
The CDS “price” is the annual insurance premium, expressed in basis points, of the probability-weighted loss of a thing.
A CDS quoted at 150 bps means, using a house metaphor, you pay 1.5% per year of the house’s insured value. On a $10m house, that’s $150,000 per year. It is a measure of the market's view of the likelihood of the house burning, and of the severity of the damage.
Unlike with normal insurance, however, you can, via CDS, buy insurance on someone else's house. That is what most CDS activity is: people buying insurance on (metaphorical) houses, whether to hedge their own position (perhaps they're also long Oracle debt), or to take a naked position (they think Oracle's debt is a mess).
You might rightly ask yourself why someone would hedge a position they don't like, and there are good-ish reasons for that. For example, they could be a private credit fund or a bank temporarily warehousing the debt before syndicating, and they want to balance their risk. There are many others.
The move
- Oracle CDS have gone from ~50 bp to ~140 bp.
- Explanations focus on credit fear or AI bubble sentiment.
- A main driver is mechanical, not psychological.