Posted on 09/30/2008 1:33:18 PM PDT by BGHater
The financial crisis has put a spotlight on the obscure world of credit default swaps - which trade in a vast, unregulated market that most people haven't heard of and even fewer understand. Will this be the next disaster?
If Hieronymus Bosch were alive today to paint a triptych called "The Garden of Mortgage Delights," we'd recognize most of the characters in the bacchanalia and its hellish aftermath. Looming largest, of course, would be the Luciferian figures of Greed and Excessive Debt. Scurrying throughout would be the Wall Street bankers who turned these burgeoning debts into exotic securities with tangled structures and soporific acronyms - CDO, MBS, ABS - that concealed the dangers within. Needless to say, we'd see the smooth-tongued emissaries of the credit-rating agencies assuring people that assets of lead could indeed be transformed into investments of gold. Finally, somewhere past the feckless Fannie Mae executives and the dozing politicians, one final figure would lurk in the shadows: a hulking and barely recognizable monster known as Credit Default Swaps.
(Excerpt) Read more at money.cnn.com ...
They were caused by writedowns on portfolios of CDOs - very different instruments.
whatever term the bankers use to deceive the public with
Just because you're not clear on the difference between these contracts and structures doesn't mean that anyone intends to deceive anyone in naming them.
"Credit default swap" is a succinct and accurate description of the instrument.
“Derivitives, credit default swaps,....whatever term the bankers use to deceive the public with.....are inocuous as long as their notional values remain notional. The danger comes quickly as a company defaults and makes a demand on the derivitive contract.”
True, I think, but:
Correct me if I am wrong, but I also think that your scenario is only true when the rate of “default” is extremely out of wack with the discounted risk of default that was built into the cost/price of the derivative at origination and such defaults were occurring on a volume/scale among a whole class of those derivatives AT THE SAME TIME; that an entire class was in question.
What does that right now is the burst of the real estate market bubble and the as yet, unsettled - where will it land (bottom) - housing market that sits at the foundation of the mortgage market; which does not produce a demand that derivatives so based MUST be settled, now, but if demanded to be settled now, then at what “value”; and, until this afternoon, ANY auditors operating under FASB would demand that value be “mark to market”. Some may view today’s SEC rule change as implying the “failure” at Lehman may not have been so large if its “derivatives” had not been needed to be assessed until tomorrow morning.
That was the point which I was trying to make. Derivitives have been around for over 20 years. You and I have known little or nothing about them. That is because, like Options, or Insurance, they usually expire worthless. But the notional values are so staggering that if even one large entity is triggered (ie.Lehmans) it begins to destabilize IMMEDIATELY other buisnesses associated with the company who sold the derivitive (ie. AIG). AIG has its buisness in EVERY LARGE BANK IN THE WORLD!!!!!!!! To stop the flames Bernanke broke the law and gave AIG $85 billion IMMEDIATELY. If he had not done this, the entire banking world would have immedialtely destabilized. As it was only the 4th largest US Bank on Sept.16 failed. Think....The CEO of Lehman got up that morning, not knowning of impending doom of his company. By 1PM Lehman was no more. Billions of dollars in assets disappeared. DISAPPEARED. Common stockholders, preferred stockholders...not sure about the Bondholders....up in smoke. So now, the Fed got in the buisness on Sept 16 of underwriting insurance for banks by buying 79.9% of AIG. That is the story of which books will be writtten. PhDs will write their dissertations on Sept.16. Movies will be made about what happened in those few hours. This will be remembered as distinctly as 9-11 or Black Tuesday October 29, 1929. It is that remarkable.
You make too much good sense - any chance anybody in DC is listening to ideas like yours?
I am not so sure how the Feds role with AIG will play out in the long run.
Separated from the one AIG unit that wrote most of its derivatives, the overwhelming rest of AIG, including its underwriting business, is very sound, and very profitable.
I don’t think the Fed is going to, directly, manage or direct any of AIGs units, but they will give a large dose of high-level financial direction; but, I think that too will not be permanent and will change whenever any “bailout” is finalized. Eventually, and that means as soon as possible, AIG needs to rejoin the fully private business world.
Do you find it odd that the Federal Reserve allowed Lehman to fail and AIG had to be saved?
I don’t know enough to see any conspiracy in it.
I do know that the scale of the reach and complexity of AIG, world wide, makes Lehman look like Payless Shoe Stores by comparison; maybe that had something to do with a difference in actions taken.
I also noticed that no sooner had Lehman filed for bancruptcy, Barclays was able to buy all of certain segments of Lehman, which local papers say will mean most of Lehman’s former NY employees will just have a new employer, not new jobs.
Which also pleads the question, why not simply bankruptcy for many of these other outfits?, instead of bailout.
If it won’t hurt the U.S. Treasury to buy “the toxic assets” for pennies on the dollar, and hold them until more favorable markets prevail, then why can’t consortiums of private investors buy the ailing Wall Street houses holding the “toxic assets” on the same basis, with the possibility of selling the toxic cum bargain assets later as the Treasury will?
I find that hard to believe. If true, the CEO of Lehman must beincredibly stupid. The fact is these folks knew it was coming. They have depended on their contacts and behind the scenes machinations with the Congress and the Fed. Reserve to save them. Now they have found looting $700 billion from the American People isn't that easy.
Per wideawake, it seems that the CDS play a reasonable, if not valuable (from a social perspective), role in ‘normal times.’ However, we are faced with a tsunami of defaults in mortgage-backed securities that might overwhelm the capacity of protection sellers to gain control of the underlying securities - bankruptcy might be their better business decision.
It seems a matter of scale, and as said, that scale may be abnormally large as well as highly unexpected (or at least ignored while we let the good times roll).
Henry Paulson, while at Goldman Sachs, was apparently involved, present with the creation of every type of derivative known to man....therefore, the most credentialed person to serve as US Treas Sec. The first hedge fund, in London, was estb by a Goldman Sachs person who went to London to begin the experiment ...the rest is history. Goldman Sachs is at the epicenter of the derivative world. Lehman later took on the mantle of having the greatest involvement with credit default swaps. All the bad stuff strangling the world was an American invention, augmented by all the central banks of the industrialized world jumping in.
October 2008 is a big month, in the midst of worldwide crisis, for a formal test of credit default swaps: Freddie and Fannie will be settled on 6 October, with Lehman on 10 October and Washington Mutual on 23 October. Much rides on the results.
Lots of excellent posts on this thread. Several have alluded tot the AIG $85 billion bailout. I have read further explanations in the last few days noting that Goldman Sachs had a $20 billion exposure if AIG failed, and that a crisis at GoldmanSachs was avoided by the bailout.
You don’t understand what you’re talking about. They are legally enforceable contracts. If you had a contract with someone to pay you money if something happened and you were paying them ahead of time for that benefit, you’d be pissed to have it invalidated.
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.