Why cost of financials' debt insurance has soared

NEW YORK—Over the past week and throughout the downturn in the credit markets, the cost of insuring financial services firms' debt has consistently increased.

A rise in the cost of the insurance, known as credit default swaps, indicates debt holders believe there is a greater chance of default by the financial companies. Especially over the past week, those insurance costs have been increasing rapidly as more debt holders fear companies like Lehman Brothers Holdings Inc. and Washington Mutual Inc. could collapse and not be able to repay their debt.

In fact, on Wednesday, when Lehman Brothers first disclosed plans to sell assets and look for new capital, the cost of insuring its debt skyrocketed -- an indication debt holders and speculators did not believe the New York-based investment bank would be successful in its plans to shore up its capital base. With the company now on the brink of bankruptcy, it now appears those assumptions were correct.

During the past week, the cost to insure Washington Mutual's debt was rose to a level that indicated debt holders believed it was more likely than not the Seattle-based bank would default.

Swaps on most financial firms are likely to get even costlier during the upcoming week, said Len Blum, managing director at investment bank Westwood Capital.

"I think you'll see credit default swaps at historically wide levels this week," Blum said in an interview.

The insurance is often purchased for similar reasons to homeowners or car insurance -- to protect the holder of the asset in case of losses.

But, some investors also use it to essentially place bets on a company's performance, similar to shorting a stock. Those additional investors can affect the cost of insurance, just like short sellers impact the price of a stock.

The Bank for International Settlements estimated that as of December 2007 -- its most recent data -- there were $57.894 trillion in credit default swaps outstanding.