Feb. 11 (Bloomberg) -- Banks are driving the cost of protecting corporate bonds from default to the highest on record as they seek to hedge against losses on collateralized debt obligations, according to traders of credit-default swaps.
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Banks are facing mounting writedowns on CDOs, securities that package credit-default swaps, bonds or loans, as the fallout from the collapse of U.S. subprime mortgages spreads across financial markets. The Group of Seven estimates banks worldwide will suffer writedowns of $400 billion on home loans, German Finance Minister Peer Steinbrueck said at a weekend meeting of officials and central bankers in Tokyo.
Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates worsening perceptions of credit quality; a decline, the opposite.
It isn't clear that this interpretation is correct. Rather than reevaluating appropriate risk positions, it's possible that they're simply reevaluating the underlying risk of the assets.