There is a bone of contention on these credit defaults no?
As I understand it, if the parameter is breeched, say 5% of the bundled creditors default, the insurer takes possession of the tranch. He then pays the counterparty the full value of the tranch. Aha, but there is no value, or very little value since there is no market.
Who owes who what?
yitbos
Most of the buyers of MBS/CDS were financial institutions. As holders of worthless securities these holders of MBS/CDS became insolvent.
Bernanke/Paulson’s first idea was to make a market for MBS (as long as there was a market for MBS there would be less risk to the CDS market). But making a market for MBS meant buying MBS at a price that was not mark-to-market, thereby leaving the Fed holding worthless securities without an equity stake.
Along comes a brilliant London financier to steer Bernanke/Paulson into taking equity stakes by ‘direct cash infusions’.
The mechanics of the ‘direct cash infusion’ scheme must have involved taking the worthless MBS off the failing bank balance sheet and substituting cash, but how then get equity? Must have been a condition of TARP to cancel the CDS contract. Participating banks had no choice, either TARP or bankruptcy. They could also opt to fight for CDS performance in court but they knew CDS was a scam.
Now which is scarier? A securities market gone bust or a government that doesn’t know what they’re doing with leveraged assets of trillions upon trillions of dollars?