It is generally acknowledged that our current economic crisis was precipitated primarily by the collapse of Fannie and Freddie.

As an example of the actual impact of CDS to date, CDS which totaled trillions (as the Time article calculates them) for the $100 Billion Lehman Brothers collapse were settled for a few billion dollars. And as everybody is aware, it turns out that even Democrat Paulson has decided there is no pressing need to immediately allocate much of the $700 billion bailout money that was voted for by Congress, which certainly would not be the case if CDS were significantly contributing to our current woes.

In the final analysis, the obsession with CDS resulted from a mixture of ignorance and a desperate attempt by the Left to deflect criticism from Democrats in Congress for causing the real estate bubble and the current economic collapse. We should not exempt CDS from regulation, but insisting on being distracted by an obsession with them to the extent that we don't deal with the primary issues threatens to kill us economically.

I have no idea what this all means, but it was an easy read and very instructive.

AIG’s Dangerous Collapse

& A Credit Derivatives Risk Primer

by Daniel R. Amerman, CFA | September 17, 2008

Overview

While it may look superficially similar to the recent implosions of such investment giants as Fannie Mae, Freddie Mac and Lehman, the takeover and bailout of AIG is quite different, and means that the market is entering the next and even more dangerous phase. What is driving the fall of AIG – and potential government losses that may far, far exceed the $85 billion bailout announced late on September 16th - is not mortgages or real estate (directly), but fears that AIG’s huge, global credit-default swap positions will unravel. The $62 trillion dollar credit derivatives market is 50 times the size of the subprime mortgage derivatives market, and is indeed larger than the entire global economy.

Unfortunately, few people understand credit derivatives, or the full risks to the United States and global markets and economies. In this article, I will take a Credit Derivatives Primer that I published in the spring of 2008 - which anticipated this exact type of event - and update it for the current situation. Through reading this article, you should be able to greatly increase your knowledge of what credit derivatives are, and why they are a far greater danger than subprime mortgages. We will end with introducing some concepts about how individuals can protect themselves and even profit from these unprecedented market conditions – something you won’t find in recent financial history or conventional investments.

The Rapid & Dangerous Collapse of AIG

“The particular risks that brought the company (AIG) to the brink of bankruptcy seem to lie not with its core insurance businesses but with its derivatives-trading subsidiary AIG Financial Products. AIG FP, as it's called, merits a mere paragraph in the nine-page description of the company's businesses in its most recent annual report. But it's a huge player in the new and mysterious business of credit-default swaps: derivative securities that allow banks, hedge funds and other financial players to insure against loans gone bad.” Time, September 17, 2008

On September 1st, few knew that AIG, the largest insurance company in the world with over $1 trillion in assets, was in deep trouble. By September 12th, the rumors about major trouble were everywhere. By September 15th AIG’s corporate life expectancy was being measured in days, and the question was: bankruptcy, buyer or bailout? By the evening of September 16th, the federal government had massively intervened, making an $85 billion loan to AIG in exchange for a controlling 79.9% equity share of the company.

Welcome to the brave new world of credit derivatives driven collapses. A world that is far more dangerous than the world of subprime mortgage derivatives. A complex world that because of its sheer size can potentially cause more damage in a matter of days than the subprime mortgage derivatives caused in their first year in the headlines. The chart below shows the relative size of the credit derivatives and subprime mortgage markets.

How great is the real danger? The bulk of the remainder of this article explains the extent of the danger. With a few market changes, this is the credit derivatives primer as published at numerous websites on May 2nd of 2008. There is also new material at the end of the article, talking about what could be anticipated, and introducing some solutions.

Read the rest at: http://www.financialsense.com/fsu/editorials/amerman/2008/0917.html