Arcane Market Is Next to Face Big Credit Test (credit default swaps)

New York Times ^ | Feb 17, 2008 | Gretchen Morgenson

[PugetSoundSoldier]

If B of A writes off $100,000 on your defaulted mortgage, they claim a $100,000 loss. You claim a $100,000 gain. Zero sum. Just like swaps.

Except for the taxes. If BoA keeps the $100,000 as profit, then they pay 35% taxes on it, meaning $65,000 stays in the economy.

If the default happens and the defaulter gets a $100,000 gain the tax rate will probably be closer to 15%, meaning that $85,000 stays in the economy.

[jas3]

If the insurer doesn't pay your claim, then the insurer paid $0 and you received $0. That too is zero sum.

The same money stayed in the national economy. Zero sum. Except that you paid the premiums and lost your house. You probably won't consider that to be zero sum. And the national economy just lost $500,000 in asset value from the housing stock.

jas3

[jas3]

Except for the taxes. If BoA keeps the $100,000 as profit, then they pay 35% taxes on it, meaning $65,000 stays in the economy.

BoA lost $100,000. They have nothing to keep.

jas3

[Pelham]

“Leverage is causing catastrophic losses. Where will this end? “

Deflation is a good bet. Think Japan since about 1990.

[jas3]

Deflation is a good bet. Think Japan since about 1990.

Give the man a SEEEE-GAR !

jas3

[PugetSoundSoldier]

No default, BoA makes $100,000, pays 35% taxes leaving $65,000 in the economy.

Default, BoA makes nothing, defaulter makes $100,000 pays ~15% taxes, leaving $85,000 in the economy.

Taxation should always be considered. The government is always going to get their cut, and since their cut is different depending upon who ends up with the gain affects how much is actually left for the economy.

It’s like if you’re an S corp, and make $200,000 in profit. Better to pay yourself a $50,000 salary and $150,000 dividend than take the full $200,000 as salary. Lower taxation, meaning more in your pocket and the economy.

[Toddsterpatriot]

The government is also part of the economy.

[Toddsterpatriot]

Doesn’t change the fact that the swaps themselves are zero sum.

[PugetSoundSoldier]

Sure, but I’d argue the next effect to the economy would be better if private industry or individuals had $85,000 rather than $65,000. Private industry and individuals will be more efficient in growing that money than the government will be.

[jas3]

Default, BoA makes nothing, defaulter makes $100,000 pays ~15% taxes, leaving $85,000 in the economy.

I think you need to go back to the books on capital formation. Credit defaults destroy capital. Plus we are off topic. This thread is about how credit default swaps are a giant Ponzi scheme that is going to burn a lot of folks...

jas3

[Toddsterpatriot]

You bet. Couldn’t agree more. Still zero sum.

[Freedom_Is_Not_Free]

Ever feel like you are talking to a brick wall? You are...

[jas3]

Doesn’t change the fact that the swaps themselves are zero sum.

Doesn't really matter. You can persist in your belief that the sun is green and made of cheese too. What matters is that large defaults in the credit default swap market will have extrordinary and very negative effects on the global economy. Already the iTraxx and Markit indexes are at record highs, implying the highest corporate default rates since records have been kept. So already the cost of debt capital is dramatically higher over the risk free rate than last year, which is why Fed action has been marginally helpful at best.

jas3

[jas3]

Ever feel like you are talking to a brick wall? You are...

The sad thing is that the guy has such passionate beliefs about something he knows almost nothing about.

jas3

[Freedom_Is_Not_Free]

One picture is worth a thousand words. Or in this case, 2 pictures. Devastating... but I’m STILL BULLISH! Not.

[PugetSoundSoldier]

OK, I see. So a swap is zero sum for the economy, regardless of the tax bite the government takes. In that case, what would be the impact on the economy with a 90% flat income tax? Or a 5% flat income tax?

I’d argue the swap may be a zero sum between the two parties in terms of GROSS effect, but in terms of net effect if would NOT be zero-sum. And the effect of taxation will also affect the total funds in private hands in the economy which will affect the economy.

So gross numbers, sure zero sum. Net effect decidedly NOT zero sum.

[Southack]

"Wow..your post is factually incorrect in so many places and speaks to your complete ignorance of CDS markets that I don't know where to begin. So let's start here: YUP. You lost your net worth because your bond defaulted. Saying NOPE doesn't change that fact."

Nope. You didn't lose your net worth because your bond that defaulted was insured.

Or...

You didn't lose your net worth because your (effectively) uninsured bond didn't default.

To lose your net worth TWO things would have to occur simultaneously:

#1. Your bond would have to default, and
#2. You bond insurance would have to default.

Both of those things aren't going to happen simultaneously to any large section of investors. Those investors are going to reinsure with someone else as soon as they see a problem with their current insurer, after all, and they have plenty of time to reinsure because all of their bond investments haven't already defaulted.

So all that is at risk is that these bond investors are going to have to make a new insurance payment.

[Freedom_Is_Not_Free]

That is not unfathomable at this point. The FED is trying to inflate but it is not working.

[ex-Texan]

[Southack]

"Except that you paid the premiums and lost your house. You probably won't consider that to be zero sum. And the national economy just lost $500,000 in asset value from the housing stock."

The loss of your house is independent. The economy suffers the same whether you were insured or not.

What changes if you are insured is that *you* come out whole should the insurance company pay...but then the insurance company has a loss for the amount that they paid.

The insurance itself is zero sum; what the insurance company pays may well go to you, but that same money remains in the national economy. It just moved from their bank account into yours.

And that's a net "zero sum."