Free Republic
Browse · Search
News/Activism
Topics · Post Article

Skip to comments.

FReeper Guide to the REAL economic problem - Credit Derivatives - Lesson 2
politicket | 9/27/2008 | Politicket

Posted on 09/27/2008 9:05:01 PM PDT by politicket

Lesson 1 can be found here: Lesson 1

Welcome to Lesson 2 of ‘The Basics of Credit Derivatives’.

For this lesson I will be referencing the following article: The Ballooning Credit Derivatives Market: Easing Risk or Making It Worse? , which was published in November 2005 by the Wharton School at the University of Pennsylvania.

My comments will be in Red.

Let’s get started:

The Ballooning Credit Derivatives Market: Easing Risk or Making It Worse? (continued) Published: November 02, 2005 in Knowledge@Wharton

Credit Default Swaps

Credit derivatives are contracts that go up or down to track the fortunes of underlying corporate debt, such as bonds the company has issued or loans it has taken out. Typically, the company is not involved in the credit derivatives contract, which usually involves the bond holder or lender paying a fee to shift risk to a third party.

A company that issues bonds usually has no connection to a Credit Default Swap, which is basically an insurance policy (like your auto insurance) that the face-value of the bond will be paid back to the bondholder by the insurance company, in the event of a default on the bond. Just like most any insurance policy, the buyer of the insurance (bondholder) pays a premium to the seller of the insurance. Pretty simple stuff. Let’s go on…

"The market for credit derivatives is mostly dominated by credit default swaps (CDS)," said Wharton finance professor Krishna Ramaswamy. He described them as "an 'insurance' contract in which the buyer of protection pays a periodic and ongoing premium in exchange for a payment from the protection seller when a well-defined event is triggered...."

Again, this paragraph is pretty self-explanatory. Usually, the ‘well-defined event’ would be a cash flow event to where the bond defaulted, or possibly went into partial default. As stated previously, the bondholder pays an insurance premium on a periodic basis to maintain the insurance coverage.

A typical buyer is a bond owner or lender who is expecting to receive payments from the corporate borrower. The CDS can protect that income stream or offset any decline in the value of the bond or loan the buyer owns. Like an insurance claim, the payment is triggered if, for example, the bond issuer goes bankrupt, fails to make its debt payments, restructures its debt or suffers a rating downgrade. In the U.S., these contracts typically run for five- or 10-year periods, and they provide protection in blocks of $10 million to $20 million.

A bond is a debt obligation, as is a loan. A corporation is obligated to meet the terms of its debts. This paragraph is again referencing the insurance nature of the CDS, and it mentions some of the ways that an insurance claim can be triggered. You can also see that these insurance contracts typically provide coverage for a pretty long time, and work in fairly large blocks (in other words, you wouldn’t buy bond insurance on an individual bond that you bought for your grandchild).

Once a CDS is created, it can be traded in the secondary market, much the way bundles of mortgages are traded as collateralized mortgage obligations. Its price will rise or fall as the market assesses the health of the underlying corporate debt. Thus, the risk of a company defaulting on its debt obligations can easily be passed to investors willing to shoulder it. "The system is actually more stable because of these mechanisms," Ramaswamy said. "The losses...are best borne by a wider pool of investors, each holding a diversified basket of these obligations."

This paragraph is the reason that I call credit derivatives, and specifically Credit Default Swaps, “bets”. The underlying function of the CDS is just straight insurance coverage, but now we start getting into the ways that they have been abused. The secondary market, OTC (Over-the-Counter), etc. provides a means of “betting” on whether a company is going to be able to meet its debt obligations. More on this soon… It is believed that ‘spreading the risk’ to a bunch of ‘insurers’ would greatly lessen the risk to any one ‘insurer’, should a given company default on their bonds, loans, or other debt obligations. Sounds like pretty solid thought. You wouldn’t think that anything could be wrong with that logic.

In recent years, many credit default swaps have been assembled into baskets and traded as indexes, much the way stocks can be traded through S&P 500 index funds. This allows investors to use credit default swaps to bet on broad changes in credit markets -- betting that default rates will rise or fall, for example.

This describes another way that investors can participate in a wide-range of Credit Default Swaps. A group of CDS’s are gathered together into what is called an ‘index’ (just like the S&P 500 is an index of companies), and the investor is able to buy shares on the group as a whole. This helps to lessen the investor risk, since the bankruptcy of any one ‘index’ company can be somewhat offset by the remaining ‘healthy’ index companies.

With a CDS, an investor can focus a bet on credit risk, while an investment in a bond or loan entails a much broader assortment of risks -- credit risk, interest-rate risk and currency risk, for example. Credit derivatives also can be used for shorting and hedging strategies. All of that is much more difficult for investors trading in actual bonds and loans.

This paragraph is a very important one to understand. If an investor were to invest in a ‘physical’ piece of paper (a bond, stock, loan, etc.) then there are a myriad of things that the investor would need to heavily consider – because a default on the debt obligation would go directly against them. With a CDS, the main focus is just on the credit risk of the company that the CDS represents. It is a “bet” as to whether the company will be solvent or insolvent over the performance period of the underlying debt obligation. Also, without getting into too many complexities, CDS’s are very liquid when traded in the secondary markets; whereas, company bonds and loans are highly illiquid and cannot be “hedged” as easily. Think of the phrase ‘Hedge your bets’. It’s basically a way of investing where you take a risk, but you also take some form of opposing risk in order to protect you if your first risk goes bad. You need assets that are fairly ‘liquid’ in nature to do this effectively. CDS’s have that as one of their strong points.

Banks are both the biggest buyers of CDS protection and the biggest sellers, using them to reduce their risk exposure to companies to whom they have lent money, thus reducing the capital needed to satisfy regulatory requirements. Other big buyers are securities firms and hedge funds, while re-insurers, insurers and securities firms are the other large sellers.

This is another extremely important paragraph to read, and to understand. Banks (stodgy, conservative, put your down payment on the table) have jumped at the opportunity to use CDS derivatives. They can buy insurance to protect themselves from loans they have given out, and they can also sell insurance, while getting the premiums, to protect other entities against loss. This, in turn, has enabled banks to use the ‘liquidity’ afforded by CDS’s for investments that they otherwise couldn’t have made under regulatory rules. They are able to keep less ‘reserves’ because of the CDS insurance that is in place to protect them. It works great, when it’s used properly and without greed.

In recent years credit default swaps have been bundled together to create collateralized debt obligations (CDOs). Typically, a CDO contains swaps from more than 100 companies. Once put together, the CDO is sliced into several tranches, which are then sold separately. At one extreme is the high-risk, high-yield slice. Owners of these get a disproportionately large share of the income flowing into the CDO. But they also are first to suffer the losses from any companies that default. At the other extreme is a safe, low-yield tranche, with one or two other tranches occupying the middle.

Here is another area where deceit can rule the day. And your thinking cap is going to have to be on tight. Let’s start back at the beginning a little bit:

Joe buys a house, the mortgage loan gets sold up the chain (let’s pretend like it ends up at Fannie Mae). The loan is bundled with a bunch of other loans of the same type (i.e. prime, Alt-a, subprime). Each particular bundle is divided into “tranches” (buckets of ‘stuff’ having approximately the same credit risk). These tranches are rated and sold to the bond market. The best tranche out of a bundle of mortgages is considered “Senior”, meaning it gets paid back first if the ‘bundle’ goes bad, and is usually rated ‘Aaa’. The rest of the tranches are rated and ranked based on their credit risk, from best to worst.

The top tranches are usually easy to sell in the bond market, but the bottom level tranches are difficult, because they are pretty much junk. So, how to fix this problem?

Sometimes, the bottom level tranches are gathered together into what is known as a “Collateralized Debt Obligation” or CDO. This CDO itself is split into a series of tranches, rated, and sold to the bond market. The CDO has its OWN Senior-level tranche, that is often rated ‘Aaa’ since it is the best tranche of the CDO. The other CDO tranches are rated from best to worst underneath the Senior tranche.

So what just happened? Junk level securities were just magically made into ‘Aaa’ rated bonds in the CDO’s Senior-level tranche.

Also notice that any income flowing into the CDO is mainly absorbed by the LOWEST level tranche, since it is taking the highest risk – and therefore gets the highest reward. If the CDO goes belly-up then the Senior-level tranche (which gets the least income while the CDO is healthy) gets paid first, and then on down the line.

The CDO market has mushroomed in the past few years as investors hunted for higher yields than they could get with more traditional interest-paying investments. Last year, an estimated $1.2 trillion in risk was transferred to investors through CDOs.

You can see by this paragraph that CDO’s are being, and have been, heavily used. They offer an attractive higher yield (remember, they were at the bottom part of the original mortgage bundle), but also have the highest risk associated with them (even though many of them are rated ‘Aaa’ due to the ‘interesting’ way in which they were created). You also see that in 2004, one year before this article was written, there was $1.2 trillion of risk assumed by those who invested in CDO’s. That dollar number has mushroomed exponentially since that time.

Another key feature of credit derivatives: leverage. The value of credit derivatives can greatly exceed the value of the debt they are based on. That is because the entity that buys credit insurance does not actually have to own the bonds or loans it is insuring.

Have you ever taken out car insurance on your neighbor’s car? How about house insurance on the guy you saw at the store yesterday? What if you had 1,000 people decide to take out life insurance on you? Would you feel a little paranoid? Maybe lock yourself in your house while heavily armed?

This is the equivalent of what is going on with credit derivatives. You can take out (‘buy’) insurance on debt obligations that you don’t own. And since many, many entities can do the exact same thing it creates a great big leverage factor if that underlying debt obligation goes bad. The seller(s) of the insurance now needs to pay up to a whole bunch of buyers.

You are now through Lesson Two! Wipe that glazed look from your eyes…

The next post will be Lesson Three, where we discuss ‘Short Squeezes’ – and no – that’s not giving your wife a quick hug!. We’ll still be covering the same article – which encompasses the first 3 lessons.


TOPICS: Business/Economy; Editorial; Government; News/Current Events
KEYWORDS: bailout; cdos; cmbs; credit; derivative; finance101
For Discussion...
1 posted on 09/27/2008 9:05:02 PM PDT by politicket
[ Post Reply | Private Reply | View Replies]

To: PAR35; AndyJackson; Thane_Banquo; nicksaunt; MadLibDisease; happygrl; Roy Tucker; GOPJ; dervish; ...

The Money, Banking, and Financial Markets Ping List.

FR Keyword: moneylist

This can be a high-volume ping list at times.

To join, send Freepmail to rabscuttle385.

2 posted on 09/27/2008 9:06:41 PM PDT by rabscuttle385 (No to bailouts, no to amnesty, no to carbon credits, no to Big Government!)
[ Post Reply | Private Reply | To 1 | View Replies]

To: politicket

bump for future reading


3 posted on 09/27/2008 9:26:37 PM PDT by Freedom_Is_Not_Free
[ Post Reply | Private Reply | To 1 | View Replies]

To: politicket

bttt


4 posted on 09/27/2008 9:29:05 PM PDT by combat_boots (God, gun and babies. Justices, taxes and sovereignty. Otherwise known as White Trash. Count me in.)
[ Post Reply | Private Reply | To 1 | View Replies]

To: 444Flyer; supercat; 4Liberty; norraad; Moonman62; freekitty; lonevoice; rabscuttle385; Cacique; ...

Ping to Lesson 2...


5 posted on 09/27/2008 9:44:50 PM PDT by politicket (Palin-tology: (n) - The science of kicking Barack Obambi's butt!)
[ Post Reply | Private Reply | To 1 | View Replies]

To: politicket
You can take out (‘buy’) insurance on debt obligations that you don’t own. And since many, many entities can do the exact same thing it creates a great big leverage factor if that underlying debt obligation goes bad. The seller(s) of the insurance now needs to pay up to a whole bunch of buyers.

Thanks for the illuminating commentary. Of course, the "underlying debt" wasn't supposed to "go bad" any more so than accounted for in the models. Three things come to mind:

1. Fraud: A lot of the MBS used for the CDOs may have been created and marketed dishonestly by realtors, appraisers, LO's, bank officers and Wall Street bundlers.

2. Ratings: Even if S&P and Moodys and Fitch acted in good faith rating this stuff (not a sure bet given the incestuous relationship with the IBs, etc.) you can't model fraud.

3. Exchange: Maybe $60 trillion (notional value) of derivatives floating about, but an unregulated and opaque market at best. Getting these instruments on an exchange with rules and transparency might have discouraged excessive risk taking and would at least have kept bankers, Fed chairmen and Treasury officials from fumbling blindly in the dark.

6 posted on 09/27/2008 9:59:18 PM PDT by kaspergutman
[ Post Reply | Private Reply | To 1 | View Replies]

To: politicket

bookmark


7 posted on 09/27/2008 10:03:56 PM PDT by TASMANIANRED (TAZ:Untamed, Unpredictable, Uninhibited.)
[ Post Reply | Private Reply | To 1 | View Replies]

To: kaspergutman
Getting these instruments on an exchange with rules and transparency might have discouraged excessive risk taking and would at least have kept bankers, Fed chairmen and Treasury officials from fumbling blindly in the dark.

You're correct. But now you see how Paulson will go out after the bailout plan is passed, holding his pail of money, and very likely could do more harm than good if he inadvertently triggers more loan and bond defaults. His mistake of spending a few million too little on a tranche of securities could cause devastating damage in the credit derivatives market.

I believe that a financial tsunami has been unleashed that will swallow up every bit of liquidity that Paulson wants to throw at it. He can buy up billions in loans and it still won't stop the wave.

The market (mainly controlled by investment banks) will be in complete euphoria for awhile this coming week. However, late in the week, or the following week, we will see the credit markets begin to tighten again as companies realize the severity of what was unleashed.

8 posted on 09/27/2008 10:07:54 PM PDT by politicket (Palin-tology: (n) - The science of kicking Barack Obambi's butt!)
[ Post Reply | Private Reply | To 6 | View Replies]

To: politicket
Thanks for the Ping. Your ability to communicate this in layman’s terms still amazes me. You need to be on Fox Business. Most of us have learned about 401k investment, mutual funds/CDs and diversifying and these CDSs are WAY over our heads. Up to a few days ago I thought it was all about bad mortgages, but you've been really helpful in helping to paint the real story and bigger picture.:-)
9 posted on 09/27/2008 10:10:15 PM PDT by 444Flyer (Marriage=1 man+1 woman! Vote "YES" on Prop 8, amend the Calif. State Constitution this November.)
[ Post Reply | Private Reply | To 5 | View Replies]

To: 444Flyer
You need to be on Fox Business.

Was that an insult my FRiend? ;-)

10 posted on 09/27/2008 10:13:40 PM PDT by politicket (Palin-tology: (n) - The science of kicking Barack Obambi's butt!)
[ Post Reply | Private Reply | To 9 | View Replies]

To: politicket

LOL. No, you should replace the entire bunch of them!:)


11 posted on 09/27/2008 10:16:24 PM PDT by 444Flyer (Marriage=1 man+1 woman! Vote "YES" on Prop 8, amend the Calif. State Constitution this November.)
[ Post Reply | Private Reply | To 10 | View Replies]

To: politicket

I need to learn more before opening my mouth. Thanks for sharing your knowledge and experience!


12 posted on 09/27/2008 10:18:28 PM PDT by auboy (Men who cannot deceive others are very often successful at deceiving themselves. Samuel Johnson)
[ Post Reply | Private Reply | To 1 | View Replies]

To: politicket
How do you get this message out to our Congress members before they vote us into this Socialistic scheme called the “bailout”. Do you think they know the real storm coming and know the silly bailout will do nothing to prevent it? Why aren't Paulson and Bernanke talking about this?
13 posted on 09/27/2008 10:39:54 PM PDT by 444Flyer (Marriage=1 man+1 woman! Vote "YES" on Prop 8, amend the Calif. State Constitution this November.)
[ Post Reply | Private Reply | To 10 | View Replies]

To: 444Flyer
How do you get this message out to our Congress members before they vote us into this Socialistic scheme called the “bailout”. Do you think they know the real storm coming and know the silly bailout will do nothing to prevent it?

I honestly don't know. I (and a few others) have been hitting this hard for two weeks on Free Republic and folks are just now starting to realize what is happening.

Why aren't Paulson and Bernanke talking about this?

I don't know. They are either foolish, blinded, or in on the whole deal. I'm beginning to feel the latter.

14 posted on 09/27/2008 10:46:46 PM PDT by politicket (Palin-tology: (n) - The science of kicking Barack Obambi's butt!)
[ Post Reply | Private Reply | To 13 | View Replies]

To: politicket
It doesn't help that the Congress is being rushed and pressured by the Feds, the President and the media. Who can make an accurate assessment and do any thorough research with that kind of pressure. Dave Ramsey (on Fox Business News;)) had a gentleman by the name of Brian Wesbury, he is the Chief economist for First Trust. He proposed that rather than do a bailout, Congress should temporarily relax accounting rules regarding mark to market accounting. http://www.ftportfolios.com Don't know whether its a good or bad idea, but the point is Congress doesn't have any time to get input from outside consultants who don't have lobbying power and aren't part of the establishment. Everything is being beelined to completion and they have only seen the tip of the iceberg.
15 posted on 09/27/2008 11:03:11 PM PDT by 444Flyer (Marriage=1 man+1 woman! Vote "YES" on Prop 8, amend the Calif. State Constitution this November.)
[ Post Reply | Private Reply | To 14 | View Replies]

To: politicket

bookmark


16 posted on 09/27/2008 11:13:20 PM PDT by REDWOOD99
[ Post Reply | Private Reply | To 1 | View Replies]

To: 444Flyer
He proposed that rather than do a bailout, Congress should temporarily relax accounting rules regarding mark to market accounting.

This would allow a really disastrous situation to get unfathomably disastrous in the derivatives market. There are so many triggers set to go off that changing the accounting rules midstream would be insane.

I like Dave, but he needs to stick to household budgets.

17 posted on 09/27/2008 11:18:14 PM PDT by politicket (Palin-tology: (n) - The science of kicking Barack Obambi's butt!)
[ Post Reply | Private Reply | To 15 | View Replies]

To: politicket

I used to play Pick up Sticks when I was a kid. I remember trying to keep my hand from shaking while I carefully lifted those little wooden sticks up one at a time so as not to upset any of the other sticks. One wrong move and you could wreck the whole stack.

It’s hard to contemplate the web derivatives weave through the economy, but it sounds like we are walking on thin ice with any decision or manipulation of the market. Do you think it’s impossible to predict the tipping point or the cause that will send these derivatives crashing down?

Again, thanks for your patient explanations.


18 posted on 09/27/2008 11:43:10 PM PDT by 444Flyer (Marriage=1 man+1 woman! Vote "YES" on Prop 8, amend the Calif. State Constitution this November.)
[ Post Reply | Private Reply | To 17 | View Replies]

To: 444Flyer
Do you think it’s impossible to predict the tipping point or the cause that will send these derivatives crashing down?

They crashed in July 2007. At first it was a snowball at the top of a very tall mountain. As it began rolling it became more massive.
That snowball rolled over some very big companies these last couple of weeks. It's not moving fast, but it's wiping out everything in its way. The bailout money will be consumed quickly and we will be right back where we are, but with a larger snowball.

19 posted on 09/27/2008 11:47:49 PM PDT by politicket (Palin-tology: (n) - The science of kicking Barack Obambi's butt!)
[ Post Reply | Private Reply | To 18 | View Replies]

To: 444Flyer
How do you get this message out to our Congress members before they vote us into this Socialistic scheme called the “bailout”.
////////////////////////
There is only one language D.C. will understand - THE POWER OF MONEY.

TAKE YOUR MONEY OUT NOW

If Americans make a run on the banks and Market and withdraw a trillion dollars Monday, that will stop the BULLSHEET BAILOUT.

The best way to make sure this doesn't happen again is for PAIN to teach the guilty parties that it is not profitable. They will lose millions individually and in the future they will not take part in these types of tactics.

25billion FORD GMC ..wasn’t enough, need more
30billion BEAR .....wasn’t enough, need more
85billion AIG .....wasn’t enough, need more
138billion LEHMAN...wasn’t enough, need more(they tried to hide that one)
200billion FANNIES...wasn’t enough, need more
770billion WHO ELSE? and no one will ask the question,” Will this be the last dollar we have to spend”? ....
...........Because it won’t be.
Spend $700 billion, 5 percent of our gross domestic product?

THERE WILL BE MORE.

They only understand money.

Kill the Bailout and Shoot it in the head.

The Dow was in much worse shape during the 2000-02, when it went down 36 percent. Today its 24 percent down from its high. -— Its all a big Lie -—

Take your money before the banks do!

20 posted on 09/27/2008 11:51:05 PM PDT by TomasUSMC ( FIGHT LIKE WW2, FINISH LIKE WW2. FIGHT LIKE NAM, FINISH LIKE NAM)
[ Post Reply | Private Reply | To 13 | View Replies]

To: politicket

When I think of “crash” I’m thinking of the snowball finally hitting the bottom of the hill and obliterating everything. Bringing the whole market down with it. Any idea where the bottom of the hill is? I keep hearing the word “correction” from all these yahoos on T.V.. It makes me laugh now.


21 posted on 09/28/2008 12:06:00 AM PDT by 444Flyer (Marriage=1 man+1 woman! Vote "YES" on Prop 8, amend the Calif. State Constitution this November.)
[ Post Reply | Private Reply | To 19 | View Replies]

marker


22 posted on 09/28/2008 12:17:43 AM PDT by JDoutrider (Pray for our side!)
[ Post Reply | Private Reply | To 1 | View Replies]

...


23 posted on 09/28/2008 12:45:33 AM PDT by GodGunsGuts
[ Post Reply | Private Reply | To 1 | View Replies]

To: politicket
You can take out (‘buy’) insurance on debt obligations that you don’t own.

??!?!?!?! I was nodding my head and not too worried until I read this line. That's insane. It's like being able to take out auto insurance on a car owned by a guy you don't like, and getting paid if he crashes because you cut his brake lines. And to make things even better, you have a nice handy CDO label of cars whose brake lines are already cut!

24 posted on 09/28/2008 1:01:16 AM PDT by dan1123 (If you want to find a person's true religion, ask them what makes them a "good person".)
[ Post Reply | Private Reply | To 1 | View Replies]

To: hiredhand; NFHale; Squantos
hh, you should be rolling this series as the PRE DETERMINED outcome of your outlining of the political 'set up' ...

It is clear as mud that our 'representatives' knew that they could play the system to the tune of trillions and the only thing that put a halt on their greed was the proverbial well runnin dry...ie worthless paper...

sad fact is that the well has been essentially dry for a very long time, and I believe the smoke & mirrors couldve ran for much longer had it not been for an empty suit needing a bounce...

to me it doesnt really look like theres any 'real' value in the market, all bubble, no solid, unless you can 'bundle' ALL the property in the country to cover it...

premeditated, treasonous thievery by 'elected' scum, all of which need to be stripped of every RED cent they stole and buried under the prison...

25 posted on 09/28/2008 5:56:01 AM PDT by Gilbo_3 ("JesusChrist 08"...Trust in the Lord......=...LiveFReeOr Die...)
[ Post Reply | Private Reply | To 1 | View Replies]

To: politicket
Why aren't Paulson and Bernanke talking about this?

I don't know. They are either foolish, blinded, or in on the whole deal. I'm beginning to feel the latter.

Your article is pretty good, but it's when you start calling people greedy and insinuating conspiracy that you lose me.

26 posted on 09/28/2008 6:33:36 AM PDT by Moonman62 (The issue of whether cheap labor makes America great should have been settled by the Civil War.)
[ Post Reply | Private Reply | To 14 | View Replies]

To: politicket
While your primer accurately summarizes the principles behind the credit markets, it doesn't appear to address a fundamental issue: aren't private legal entities allowed to engage in private legal markets?

That is, you seem to be attacking the philosophy underlying the creation & operation of the derivatives markets. If so, then it appears you are blaming "greed" & advocating greater regulation; isn't this what Barney Frank and other Dems are claiming?

The real issue isn't the derivatives markets - they should be allowed to operate in any legal manner as they choose - these are PRIVATE contracts.

The real issue was government involvement in lighting an inflationary fire. They achieved that by dictating to private markets that they abandon traditional lending principles in favor of public policy driven mandates.

You understand how the markets operates, but you're either waiting for Part 3 to reveal the true driver, or don't care to address this issue.

27 posted on 09/28/2008 6:52:05 AM PDT by semantic
[ Post Reply | Private Reply | To 1 | View Replies]

To: semantic
While your primer accurately summarizes the principles behind the credit markets, it doesn't appear to address a fundamental issue: aren't private legal entities allowed to engage in private legal markets?

Yes, private legal entities should definitely be allowed to engage in private legal markets.

That is, you seem to be attacking the philosophy underlying the creation & operation of the derivatives markets. If so, then it appears you are blaming "greed" & advocating greater regulation; isn't this what Barney Frank and other Dems are claiming?

I have no problem with the original intent of Credit Derivative Swaps. I do start having a problem when investors are able to buy insurance on something that they don't even own and have no root financial stake in.

The real issue isn't the derivatives markets - they should be allowed to operate in any legal manner as they choose - these are PRIVATE contracts.

I see where you're going, but I don't agree with it. You're saying that the "fuse" was mishandled - which I agree, but the fact that CDS's had the type of potential downside that we're now seeing should have raised enormous red flags - and it didn't. CDS's have a very bad side when they're misused, so we can't discount that they're a defective financial instrument in that way.

The real issue was government involvement in lighting an inflationary fire. They achieved that by dictating to private markets that they abandon traditional lending principles in favor of public policy driven mandates.

That is what acted as the 'fuse' and it was insane to do. But the dynamite that the fuse is attached to is what will bring us, and the world economies, down.

You understand how the markets operates, but you're either waiting for Part 3 to reveal the true driver, or don't care to address this issue.

I have revealed the true driver - Credit Derivative Swaps. Lesson 3 will touch on what happens when there is a 'short squeeze' on a CDS.

You keep wanting to make the fuse the same as the explosive. Realize that a bunch of bad mortgages is not what is going to bring down our economy. We could clean up that specific problem with about $300 billion - which is the exact size of the bill that Bush signed on July 30, 2008 - and which takes effect in a few days on October 1st.

28 posted on 09/28/2008 9:20:16 AM PDT by politicket (Palin-tology: (n) - The science of kicking Barack Obambi's butt!)
[ Post Reply | Private Reply | To 27 | View Replies]

To: dan1123
And to make things even better, you have a nice handy CDO label of cars whose brake lines are already cut!

Now you're understanding. And we're being lied to by Bush, Bernanke, and Paulson (and I voted for Bush both times).

29 posted on 09/28/2008 9:21:50 AM PDT by politicket (Palin-tology: (n) - The science of kicking Barack Obambi's butt!)
[ Post Reply | Private Reply | To 24 | View Replies]

To: politicket
I see where you're going, but I don't agree with it. You're saying that the "fuse" was mishandled - which I agree, but the fact that CDS's had the type of potential downside that we're now seeing should have raised enormous red flags - and it didn't. CDS's have a very bad side when they're misused, so we can't discount that they're a defective financial instrument in that way.

So it appears you agree with Barney Frank, and that it was unregulated Wall St greed that got us to this point.

I, and many, many others, believe the underlying premise of the derivatives market is valid: to spread risk & increase liquidity. The problem is that core financial principles were based on faulty economic fundamentals which had been corrupted by poor public policy decisions.

We both agree that there needs to be a bailout; we only differ on the reasons. I think 'we' are collectively responsible because it was 'we' who allowed DC to disrupt an efficient market. If 'we' hadn't engaged in this behavior, we wouldn't be seeing a freeze up in the normal derivatives pricing mechanism.

30 posted on 09/28/2008 10:51:18 AM PDT by semantic
[ Post Reply | Private Reply | To 28 | View Replies]

To: politicket

“Why aren’t Paulson and Bernanke talking about this?”

“I don’t know. They are either foolish, blinded, or in on the whole deal. I’m beginning to feel the latter”

We are way down river.
They had to know.


31 posted on 09/28/2008 6:01:49 PM PDT by Domestic Church (AMDG....)
[ Post Reply | Private Reply | To 14 | View Replies]

To: politicket

“...the dynamite that the fuse is attached to is what will bring us, and the world economies, down”

Okay, how far down will we fall...look into the economic crystal ball you have...roll out how and how soon this is going to trickle down.

How soon will the Swiss start yodeling a different tune?


32 posted on 09/28/2008 6:46:21 PM PDT by Domestic Church (AMDG....)
[ Post Reply | Private Reply | To 28 | View Replies]

To: semantic
So it appears you agree with Barney Frank, and that it was unregulated Wall St greed that got us to this point.

Do you like to put words in people's mouth. It sure seems like it.

There is blame to go around. My one and only point is that the CDS market is the train that is about to run us over. CDS's obviously have a downside risk, albeit one made with poor investment decisions and wholesale greed, and should be re-analyzed. For instance, there should be a ban on buying and selling insurance on an underlying security that you have no direct financial interest in. I can't do it with my neighbors house, the market should not be able to do it with my bonds.

I, and many, many others, believe the underlying premise of the derivatives market is valid: to spread risk & increase liquidity. The problem is that core financial principles were based on faulty economic fundamentals which had been corrupted by poor public policy decisions.

The underlying premise of CDS's are valid, up to a point. The entirety of the risk factors was not completely thought out - duh! and the value of CDS's as a proper financial instrument should be looked at again. Insurance on underlying securities should be limited to those having direct financial ownership.

We both agree that there needs to be a bailout; we only differ on the reasons. I think 'we' are collectively responsible because it was 'we' who allowed DC to disrupt an efficient market. If 'we' hadn't engaged in this behavior, we wouldn't be seeing a freeze up in the normal derivatives pricing mechanism.

I have no clue where you got this idea from. I've only posted about 500 times that this bailout plan is ridiculous and could actually do more harm than good.

33 posted on 09/28/2008 8:44:21 PM PDT by politicket (Palin-tology: (n) - The science of kicking Barack Obambi's butt!)
[ Post Reply | Private Reply | To 30 | View Replies]

To: Domestic Church
We are way down river. They had to know.

I agree.

34 posted on 09/28/2008 8:47:09 PM PDT by politicket (Palin-tology: (n) - The science of kicking Barack Obambi's butt!)
[ Post Reply | Private Reply | To 31 | View Replies]

To: Domestic Church
Okay, how far down will we fall...look into the economic crystal ball you have...roll out how and how soon this is going to trickle down.

Just speculation on my part - based on the data before me:

The G7 countries will all go through economic depressions with bouts of spiraling inflation. I say "depression" because of all of the cooked books that will need to be sorted through, and the respective companies will need to "fall" to their proper level (many which will be insolvency).

I expect the ball to pick up speed by this week, or the end of next week at the latest.

Watch the movement of money between banks. 1-month LIBOR is a good indicator. Also watch the rates on 30-day US T-bills. If the rate approaches 0 then the money market is completely locked up.

If the bailout plan passes then you will see the stock market surge for 3 - 5 days. Liquidity in the overall market will probably loosen a little during this time.

Keep watching the movement of money immediately after the Dow settles down. If it begins to tighten again then our economy will be going down within a matter of days to a week after that.

Just my opinion...I could be completely wrong.

35 posted on 09/28/2008 8:55:55 PM PDT by politicket (Palin-tology: (n) - The science of kicking Barack Obambi's butt!)
[ Post Reply | Private Reply | To 32 | View Replies]

To: mombyprofession

getting informed.


36 posted on 09/28/2008 11:07:58 PM PDT by FreedomHammer (Just ring? ... let freedom ROAR!)
[ Post Reply | Private Reply | To 1 | View Replies]

To: politicket

Hi ya Teach. Please ping me when part 3 is up and running.:)

(It’ll take my mind off the garbage I’m watching on C-Span.)


37 posted on 09/29/2008 8:37:02 AM PDT by 444Flyer (Marriage=1 man+1 woman! Vote "YES" on Prop 8, amend the Calif. State Constitution this November.)
[ Post Reply | Private Reply | To 35 | View Replies]

To: 444Flyer
It's up: Lesson 3
38 posted on 09/29/2008 8:44:33 AM PDT by politicket (Palin-tology: (n) - The science of kicking Barack Obambi's butt!)
[ Post Reply | Private Reply | To 37 | View Replies]

To: Saoirise

Ping.


39 posted on 09/30/2008 9:08:21 PM PDT by 444Flyer (Marriage=1 man+1 woman! Vote "YES" on Prop 8, amend the Calif. State Constitution this November.)
[ Post Reply | Private Reply | To 1 | View Replies]

To: Saoirise

Ping.


40 posted on 09/30/2008 9:12:32 PM PDT by 444Flyer (Marriage=1 man+1 woman! Vote "YES" on Prop 8, amend the Calif. State Constitution this November.)
[ Post Reply | Private Reply | To 1 | View Replies]

Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.

Free Republic
Browse · Search
News/Activism
Topics · Post Article

FreeRepublic, LLC, PO BOX 9771, FRESNO, CA 93794
FreeRepublic.com is powered by software copyright 2000-2008 John Robinson