“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.