July 22, 2009
The arcane world of credit default swaps may seem a very curious subject to stimulate the mind of a life-long medical technology man. My thoughts turned to these strange and questionable instruments, which appear to be one of the roots of the financial crisis, during a week when they were seldom far from the front of the financial pages of the serious newspapers. What is a credit default swap (CDS)? Well, to my lay understanding it is effectively the cost of insuring a debt and it has been applied to government debt as so-called sovereign CDS’s. An example of this was quoted in last Monday’s Financial Times where, using this instrument, the effective cost of insuring £100 million of UK Government debt was around £10,000 at the start of last year whereas at the peak of the financial crisis this had risen to something around £169,000.
What has this to do with the medical technology industry you may very well ask? Well sovereign debt is the way that Governments around Europe raise money to pay their bills. Our sector is largely funded by the public sector so we have a very strong interest in the perceived stability and ability to pay of our primary customers. Looking at how the financial world views our customers may be a barometer for the challenges that our businesses face in getting their bills paid. One interesting graph that I came across translates the denomination of these swaps into percentage likelihood of default in five years.
This suggests that Greece has an 18% chance of defaulting on Government debt in the next five years. Italy and Ireland come in a 14% and formerly rock solid UK at 10% – bailing out the banks has disproportionately hit the UK.
So what, I hear you ask again? Well, it is probably no coincidence that those countries with the poorest ratings (highest CDS rates) are those where we can expect the most difficulty getting our bills paid. These are also the countries that will have to take the most drastic action to contain public spending as the European debt mountain first rises and then has to be both serviced and reduced.
So we may very well be interested in CDS if they truly reflect the challenges that Governments are facing managing public finances although many a commentator has made the point that if the UK Government, for instance, defaults it is highly unlikely that any of these ‘insurers’ would be sufficiently solvent to pay out.
John WilkinsonAuthor : MedTech Europe