The Incredible Shrinking Credit-Default Swap Market

Five years after almost blowing up the global economy and eight years after making fortunes for Wall Street traders, the credit-default swap market is quietly fading. Rules introduced in the wake of the financial crisis by U.S. and European regulators have led investment banks to withdraw from the market and made trading credit-default swaps and other derivatives more expensive. And with the Federal Reserve keeping interest rates near historic lows, fewer borrowers have defaulted, which means less demand for debt insurance. As a result, outstanding credit-default swaps on individual companies declined by about half, to $13.2 trillion, from 2007 through June 2013, according to the Bank for International Settlements. Dealers once offered $5 billion trades; now $500 million is more typical.

Firms that built their reputations by trading credit-default swaps, such as BlueMountain Capital Management and Saba Capital Management, are struggling to find profitable ways to invest money in the CDS market. Traders at investment banks and hedge funds are abandoning the field for better opportunities. “It did feel like the situation was a bit of a dead end,” says Dmitry Selemir, who left his job trading structured credit at BlueMountain in June to concentrate on Scriggler.com, a website he co-founded to host essays and discussions of ideas. “I found it increasingly difficult to be excited about what I was doing.”