Credit-Swap Traders Think Sears Will Fail In The Next Year

Image courtesy of Scott Miller

Credit default swaps are a confusing concept, since some forms resemble gambling on the failure of a company without even owning any stock in it. As a consumer, especially if you’re someone who likes to shop at Sears, you should know that now that Radio Shack has declared bankruptcy, the hot retailer that credit swap traders are betting will fail is Sears.

Credit default swaps can be used as a backup by investors who hold, say, a loan taken out or a bond issued by a company with a shaky future. It’s a fancy form of betting on the future of a company, and can be used to balance out risk for debtholders. The party seeking to make money if the company defaults makes regular payments to another investor who believes that the company won’t fail. If the company does fail, the investor on the other end of the swap makes a one-time payment to the investor who took out the swap. It looks a little bit like taking out a term life insurance policy on a company.

This may be the most excited that anyone has been about Sears since approximately 1992. The cost of a credit default swap can be a good proxy for the credit risk of that company, and Bloomberg reports that it’s now more expensive to take out a five-year swap than a one-year swap. That means that the market believes Sears will declare bankruptcy sometime in the next year.

Traders Are Betting Sears Will Be the Next Big Retailer to Fail [Bloomberg]