The need to strengthen market infrastructures for credit default swaps (CDS) stems from the importance of CDS markets for overall financial stability, for three reasons. First, the systemic importance of CDS markets comes from the high degree of interconnectivity between CDS markets and credit and cash securities markets, the embedded financial leverage of CDS, and the significant level of CDS exposures in relation to the total assets and capital cushions of the banks involved. Second, the associated financial risks, for example when compared to interest rate and foreign exchange derivatives, are more difficult to manage. This stems from the greater underlying complexity and the correlations between different CDS exposures when market-wide strains occur. Third, specific risks to financial stability stem from the high degree of market concentration where very sizable financial risks are held by a small group of major market players. Therefore – as we have seen not only with the default of Lehman Brothers, but also the earlier near-defaults of Bear Stearns and AIG – the default of one major CDS counterparty can put these markets under very severe strain. A natural inference from our experiences during the current turmoil is, therefore, to improve the resilience of OTC derivatives markets through a more widespread adoption of central counterparty clearing or exchange trading.
Changes in the Swedish mortgage market Although no large-scale market for lending to the subprime sector has developed in Sweden, there have been a number of other changes in the Swedish housing market – changes that have affected and may continue to affect developments in household indebtedness and property prices. This year new rules were introduced regarding how much capital the banks must hold in relation to the assets linked to risks, which includes lending. These rules are called Basel II. The new capital adequacy rules will take into consideration the actual risk in lending to a better extent than the older version. As lending is considered to have a fairly low risk, it will enable the banks to hold less capital in relation to their lending. This entails a lower cost for the banks. Lower costs will enable the banks to cut their margins on lending rates and compete for loan volumes. The fact that the banks have been aware that this rule would be introduced has probably contributed to the institutions cutting their lending rates in advance. It is probably in turn the increased competition that has led to banks and mortgage institutions now allowing higher loan-to-value ratios. If one can borrow a larger amount with the same collateral, the need for a down payment declines. This makes it easier for households with good incomes but little wealth to enter the housing market. Typically, this often applies to younger households who do not already own their accommodation.