Credit default swaps (CDS) are the cornerstone of the credit derivatives market accounting for more than 98 percent of all credit derivatives. They are difficult to understand, ignored by regulators and poorly reported on balance sheets. In simplest terms, CDS are insurance policies on things like bonds, loans and corporate debt. But there are two big differences: the seller of a CDS doesn't need to have the money to cover losses if the security defaults, and the buyer doesn't need to own the asset it wants to protect.

It's as if hundreds of people could buy insurance policies on houses they didn't own yet still collect the full value if it burns down.

'Credit default swaps' because if it was called Credit default Insurance it would be REGULATED.

"$54.6 Trillion Of Risk "

This is insane.
There are ~100 billion stars in our galaxy.
That's 546 galaxy's worth of stars.

I wrote this up around 2 months ago and the figure then was nearer 57 trillion. Even the house plant can't do anything about that. I'll be kind and just use the lower figure. That is only 54 times the liability that the treasury has taken on so far. That much added on to the national debt would add up to more than anyone wants to think about. That is probably how Shrubbie operate, without thinking.

Double up on the seat belts folks the ride is going to get really bumpy.

"This bill will, in my judgment, raise the likelihood of future massive taxpayer bailouts. if you want to gamble, go to Las Vegas. If you want to trade in derivatives, God bless you." ...That was North Dakota Senator Byron Dorgan's statement on the floor of the Senate - not this week or last, or even during the last six months as Wall Street collapsed - but back in 1999.

I have watched Senator Byron Dorgan's career for years when I was a Republican and found him to be hands down one of THE most honest and worthy politicians in Congress. I have seen him take a stand for the right side of an issue even though most of the Democrats had voted otherwise. He stands up for what is right for Americans and that's all he cares about. He was one of the ONLY Democrats and Republicans to have fought the outsourcing of jobs and numerous other issues for the benefit of U.S. workers.

If only the Democrats had put in a totally trustworthy man like Senator Byron Dorgan to run as their party's nominee the 2008 election would have been locked up more than a year ago. Instead we got stuck with a relative unknown, far to the left Democrat Senator named Obama no one had ever heard of before.

Why is it the good and decent politicians (in both parties) never seem to get a chance to run for President? You folks in North Dakota are lucky to have Dorgan. I wish he was a Senator for California.

'Credit default swaps' because if it was called Credit default Insurance it would be REGULATED.

- 726

Well, that explains it since "regulations" and "rules" are swearwords to Republicans.

Credit derivatives

...Credit default swaps (CDS) are the cornerstone of the credit derivatives market accounting for more than 98 percent of all credit derivatives. They are difficult to understand, ignored by regulators and poorly reported on balance sheets.

In simplest terms, CDS are insurance policies on things like bonds, loans and corporate debt. But there are two big differences: the seller of a CDS doesn't need to have the money to cover losses if the security defaults, and the buyer doesn't need to own the asset it wants to protect.

It's as if hundreds of people could buy insurance policies on houses they didn't own yet still collect the full value if it burns down.

The danger comes when the company defaults and the seller - because he's not required to - doesn't have the money to pay out on the default.

I still don't "get it." My head is spinning trying to figure these swaps/derivities out.

I've done a crash course in finance these past two weeks and have been learning a WHOLE lot about mortgages, mortgage securities, and stocks (options, shorts, longs, limit buys, etc.)

But when they talk of derivatives and how they work I can't seem to wrap my brain around it.

'But when they talk of derivatives and how they work I can't seem to wrap my brain around it.'

Posted by CalifChris

Chris, the idea's as old as money.
They're betting on the future price of something.

It's a chaotic system, and when you remove the stabilizing rules, extreme events will occur.

"It's all so simple."
-Ron Reagan, idiot

Read these lines from the article --

Four years later in a letter to shareholders, billionaire investor Warren Buffett followed with his own warning, calling derivatives "weapons of financial mass destruction" controlled by "madmen."
...
What worries financial insiders most is the $54.6 trillion of risky credit derivatives concentrated among the few banks left standing.

Investment firms that traded various derivatives...collected an average of $2 billion in fees each quarter over the past two years. And traders...said these transactions were the largest cash cows on Wall Street, even more profitable than mortgages.

The newfangled transactions were seen as easy money and many traders had the attitude that when it blows up, it's someone else's problem.

Today, the same commercial banking heavyweights thought to be the most safe, JPMorgan, Citigroup Inc. and Bank of America, hold 92 percent of all the disclosed credit derivative contracts,

That makes the $800 BILLIION we just gave to the bailout package in tax money seem like chump change? I say let JPMorgan, BofA, and the other banks holding these derivatives fall on their swords and fold.

-They're betting on the future price of something.

Something that in this case was such a bad gamble that buyers required insurance before they bought, and were sold unregulated, and, as it turns out, un-financed, "credit debt swaps", instead.

ZAT

They're betting on the future price of something.

Like what? Stocks? mortgage values? or just anything?

Corky

Something that in this case was such a bad gamble that buyers required insurance before they bought, and were sold unregulated, and, as it turns out, un-financed, "credit debt swaps", instead.

So do you mean the PMI borrowers had to take out to get their subprime loans and were then included in with their mortgage payments were these credit derivatives?

Like what? Stocks? mortgage values? or just anything?

Posted by CalifChris

Pork bellies, whatever, it's gambling.

I voted Perot twice.

Clinton squandered the Superconducting Supercollider after spending $2B for a hole in Texas.

"Something that in this case was such a bad gamble that buyers required insurance before they bought, and were sold unregulated, and, as it turns out, un-financed, "credit debt swaps", instead."

Posted by Corky

1929: People are stupid.
2008: Megaditto's.

No Chris,

The speculators of the Hedge Fund and Debit Credit Swap Assoc, big Wall Street investment firms who hired physicists to create new, unregulated financial products out of bundles of very iffy mortgage loans, sold fake insurance as a safety hedge to buyers who otherwise would not have purchased such dangerous products.

Buyers were sold "credit debt swaps", an unregulated form of insurance that turned out to not have the financial backing of regulated insurance.

So when the mortgages defaulted, there was no insurance.

"THIS video is worth seeing, scary as it is, just for the interview with the head of the association that represents hedge funds and credit default swaps.

His, leering, shit-eating grin when asked about how this could happen tells the whole story.

#3 | Posted by Corky at 2008-10-06"

Well, I suggest anyone who now has any kind of account with BofA, JP Morgan (who just bought Washington Mutual), and Citicorp. get their money out of there ASAP.

There is NO WAY the taxpayers of this country can cover $57 trillion MORE in bank losses. Those institutions will have to fall -- just like any other gambler who loses on a bad toss of the dice. Maybe it will teach other banks a lesson.

I yanked my money out of Washington Mutual and put it in a local credit union about three weeks ago even though JP Morgan took it over and the FDIC said everything will be fine with JP Morgan. Looks like that won't be the case when these credit derivatives start to crash, huh? The government wasn't telling the truth again!

I wouldn't leave ten cents in the banks now.
After reading this thread I don't know what's going to happen.

I know following the money boys this week and listening to Jim Cramer and other stock and investment gurus that they ALL have their money and 401ks in CASH. Those guys cashed out a year ago.

It's hard to say what people should do. If you hold your 401k stock then your loss is only on paper and you don't lock in your loss until you cash it in. But then, do you want to lose the rest of it by holding it or hope and pray it builds back up in not too long a time? It's just terrible what people have had happen to their lives now all because of deregulation and corruption allowed to run rampant on Wall Street and with the banks. The ones who allowed this deregulation and "voluntary" following of the rules were all the Republicans but there was plenty of help by the Democrats.

"Those guys cashed out a year ago. "

Those dare devils.

Corky

Thanks! I'll come back and watch the video in a few minutes and re-read your post again too.

oh, and btw --

when you wrote:

big Wall Street investment firms who hired physicists to create new, unregulated financial products out of bundles of very iffy mortgage loans...

Are those the things they refer to as "bundled mortgage securities"?

"I can't seem to wrap my brain around it."
Posted by CalifChris

That is so tempting.

-Are those the things they refer to as "bundled mortgage securities"?

Yeppers. Among other names.

God is a know it all, but yeah, he's right.

I thought for sure that Barack would make sure American voters were aware that the architect of this debacle was none other than McCain's main man Phil Gramm.

Legislation he sponsored directly led to this crisis. His legislation eliminated oversight of the "shadow market".

But it is unnecessary at this point. McCain is toast, along with the economy.

"along with the economy"

Posted by tigerbalm

That's been inevitably fucked since the idiot Reagan was elected by the stupid fools.

Gramm saw the cliff and put the pedal to the metal.

You know how we've been hearing the last few days that banks are hoarding their money and afraid to lend to other banks so that's why we now have a "credit freeze"?

Guess that isn't quite the whole truth.

I just read that the real reason banks are hoarding their cash is NOT because they are afraid to lend to other banks but because the banks need the money themselves. Why? Because they don't have the money to pay off the billions they themselves owe in derivatives.

Also, the $57 trillion this article estimates is owed in credit derivatives? I came across an excellent article (linked below) written in 2002 and at that time just one bank alone owed $19 trillion in derivatives. If that was the amount owed in 2002 by only one bank, you can probably make a safe bet now hundreds of trillions $$$$ are owed in derivatives -- not $57 trillion.

Here is the article and if you keep in mind while reading it that it was written back in 2002, you will see the enormity of the problem we are in now --

"We are in serious trouble."

Posted by CalifChris

So when did you reach this profound conclusion?
For your sake I hope it wasn't post 1954.

"For your sake I hope it wasn't post 1954."

1954? Hah! Try 1848.

Sincerely,
Karl Marx

"Sincerely,
Karl Marx"

Posted by nullifidian

"I don't trust Russians.
Every time Russians get involved, all hell breaks loose."
-Karl Marx

They're betting on the future price of something.

Like what? Stocks? mortgage values? or just anything?

#13 | Posted by CalifChris

Yes -- just anything. A lot of the early derivatives, for example, were bets on stock market indices. You didn't actually BUY the stocks, mind you -- you purchased a security whose value was defined in terms of the Dow, or S&P 500, or whatever.

They brought down Long-Term Capital Management in the late 1990's, Warren Buffett was sounding alarms in 2002, and our fearless leaders did NOTHING to regulate them.

The current crisis erupted because when the gov't did nothing, the mortgage industry figured out they could use this strategy to pass along risk by bundling mortgages into mortgage-backed securities and selling insurance that wasn't backed by anything.

When I was taking B-school finance classes many moons ago, the text we used had a publication date about 2 years LATER than the year we were using it -- it's understood that finance wiz's, like tax accountants, spend a lot of time trying to figure out how to exploit loopholes in existing regulations, and so by the time a finance text goes to print, all sorts of new financial instruments will have been invented. (How they were allowed to print a fraudulent publication date to fool people into thinking the text was more current than it was is beyond me.)

For the government, regulating the finance industry is like trying to keep up with computer hackers -- Microsoft keeps sending out updates to thwart the latest strategies for hacking into Windows. Unfortunately, our government doesn't seem to put much effort into keeping up with the finance guys. It was obvious after LTCM's demise in the late 1990's that derivatives needed to be regulated, and to this day, they've done NOTHING. Nada.

Probably they don't want to enact anything that requires full disclosure overnight, because everyone would pull all their money out of whichever of the big banks is/are holding so much of their assets in derivatives and that would topple the house of cards. But it would be nice to hear that there is some regulatory reform in the works. Even a commitment to require full disclosure and capital adequacy by a certain date would provide some reassurance that the gov't truly believes the problem can be brought under control.

On the bright side, the problem isn't that derivatives are worth nothing. It's that no one is sure how much they're worth, right now too many people are unwilling to take a chance on them, and so probably a lot of these assets are undervalued.

Thanks, Phoenix. Good and thorough explanation.

If that was the amount owed in 2002 by only one bank, you can probably make a safe bet now hundreds of trillions $$$$ are owed in derivatives -- not $57 trillion... We are in serious trouble. --CalifChris

"amount owed" isn't really the right term. Suppose they're all mortgage-related derivatives, for example. If the mortgage-holders don't default, these hundreds of trillions $$$ derivatives will probably make money for the companies/banks that hold them. (Unless these guys were REALLY stupid, in fact, they should make a lot of money if there are no defaults.)

The problem is that they lose money on their derivatives if a certain fraction of their mortgage-holders defaults, and the derivatives are so complicated that no one knows exactly what that fraction is. That's making both potential investors (stock purchasers) and potential lenders wary of dealing with companies holding lots of derivatives, and the concern is that the companies may go bankrupt before the returns from their derivatives come in. That's what happened to LTCM --

Phoenix

You wrote -

The problem is that they lose money on their derivatives if a certain fraction of their mortgage-holders defaults, and the derivatives are so complicated that no one knows exactly what that fraction is.

My naive question is -- how do the holders of the derivatives know what their payoff (or loss) is suppose to be if they make it so complicated no one can figure out what fraction of a derivative might end up being a loss? These bundled mortgage securities (which are what the derivatives consisted of?) bundled up the good mortgages along with the subprime mortgages, right? And then too not all subprime mortgages went into default either so you could have good loans, good subprime loans, and defaulted on subprime loans all rolled into one derivative?

Sounds like the banks and holders of the derivatives were all counting always on a win-win for themselves and never bothered to figure in any potential for a loss at all.

The banks are just going to have to swallow the loss themselves. Unless they really tried to pull a fast one and had ALL their derivatives consisting of nothing but the worst of the subprime mortgages -- the ones they knew were guaranteed to fail -- but figured as long as the housing bubble kept going they wouldn't be stuck with these bad derivatives themselves as they would have passed them on to others.

The problem is that they lose money on their derivatives if a certain fraction of their mortgage-holders defaults, and the derivatives are so complicated that no one knows exactly what that fraction is.

This is exactly it, good job Phoenix. They would be fine if the same historic default rates for mortgages were in play. The derivatives are now based on an unknown default rate. Hard to valuate them.

As I understand it, anyway.

Zat&CC: It is worse, as many of the bond notes underlying are performance based.
Performance that was severly unrealistic.
Based on 20 years+ of bubble markets created to stave off what should have been a deep recession.

Now it's going to work through commercial real estate.

Wait till this hits muni's (already has, actually).

We have global bancruptcy occuring.

Not good.

At least the foggy dawn was pleasant.

Onward!

" 20 years+ of bubble markets created to stave off what should have been a deep recession. "

Can we go back to 1980 and have that recession instead of what's going to happen now?

No?

Oh well ...

Okay, then, in simpler terms for all:

Derivatives = playing the ponies
CDS's = playing the ponies

Making sense now?

Wachovia loaned $8 million to the RNC just before they went under, now if thats no the beanpole of irresponsibility. They weren't loaning to any customers as there assets had been frozen. Wells Fargo should can their management.

I wish we could Zat, I really do.
Some of the numbers I keep coming to, are very disturbing.
The level of dishonesty and flat out fabrication falling from the lips of those whom will do anything not to be wrong.

Amazing.

Private assets over valued, corporate assets over valued, financial assets over valued and people still don't get it.

The assets are dropping the value to the price that people can afford, and with the deminishing of the majority of the wages the assets values will be dropping for quite some time.

Keep those wages going down and the economy will continue in the decline.