Toxic Derivative: Credit Default Swaps

Love your analogy of how a CDS works.

Very good article – it explains the problem in very simple terms that anyone can understand. Only this website article posts the problem to be over $500 trillion in derivatives: http://www.brockfc.com/lets-understand-this-economy.html, which a third are owned by three major US banks. This is a major problem and it needs to be unwound but not with a $700 billion bailout. Keep up the good work.

Get a CD that is FDIC insured not insured buy anyone else. If FDIC fails there will be more to worry about then you CD….

Great article! I didn’t understand how these worked until now. So the saga of greed and corruption continues. 62 Trillion? That’s almost the value of the entire planet’s GDP!

It’s not the Forclosures- it’s the deivatives;
It is actually related
http://www.FinancialBlackmail.US
Mark Wyatt, September 29, 2008 (Black Monday)
last updated September 30th (Bounce Tuesday)

We are in the midst of the collapse of a roughly $1 QUADRILLION (1000 trillion or 1,000,000 billion) notional derivatives bubble (see here starting page 24, with interpretive help here and here). The Paulson plan is designed to save this derivatives bubble, or at least the underlying bets. Many in congress and mainstreet want to add a component to the plan to help slow foreclosures, possibly by modifying the terms of mortgages. This could include interest rate reductions, principal forgiveness, term increases, freezes/holds, etc.

The problem is that the mortgages were securitized into mortgage backed securities, which were then pooled into collateralized debt obligations, which then tie into structured investment vehicles (the few which are left), hedge funds, and additional derivatives vehicles. Many of the MBS themselves are backed by credit default swaps, another type of credit derivative. Many of the above are highly leveraged. Some depend on a combination of leverage and a small interest difference (say 0.5% or less) to keep the derivative instrument alive. If the terms of the frozen mortgages start getting modified without new counter funds and fees to add new money (i.e., creating new mortgages at prevailing rates and new balancing derivatives contracts), then the whole paper ponzi-scheme could start collapsing under the weight of leverage, negative arbitrage, rating decay, etc. As a chain of counterparties start defaulting the whole bubble bursts. The derivatives bubble, since it is leveraged, will likely burst faster if the mortgages are modified then the slow death of the nation by foreclosure.

What this means is that we appear to be in a situation that pits Main Street against Wall Street (at best to buy additional time to solve the unsolvable problem). We can either save the derivatives bubble (actually opush out its collapse further), but slowly destroy Main Street, or we can save Main Street, but put the derivatives bubble into bankruptcy. It does not seem likely we can do both. I.e., we can have a Great Depression II, or we can have Congress utilize their Constitutional authority to create a new monetary arrangement.

Killing Main Street is not an option. The US has changed national banking multiple times in its history. We can do it again. Right now, though the financial system is failing, the houses still stand and generally are occupied, cars are on the streets, most people are working, food is being grown and distributed, weddings and births continue,etc. In other words, though on the edge, the underlying economy and society are still functioning. With the financial systems of Europe an Asia following in our decline, it seems likely that international cooperation to replace the currently failing fiat based central banking system is obtainable.

Tell your Congressmen to choose Main Street, not Wall Street. Tell them to http://www.TakeBackTheFed.com

[derivatives nominal values from: http://www.bis.org/publ/qtrpdf/r_qt0806.pdf
http://seekingalpha.com/article/82648-thoughts-on-a-possible-economic-crash
http://www.webofdebt.com/articles/its_the_derivatives.php

It’s not the Forclosures- it’s the deivatives;
It is actually related
Mark Wyatt,
September 29, 2008 (Black Monday)
last updated September 30th (Bounce Tuesday)

We are in the midst of the collapse of a roughly $1 QUADRILLION (1000 trillion or 1,000,000 billion) notional derivatives bubble (see here starting page 24, with interpretive help here and here). The Paulson plan is designed to save this derivatives bubble, or at least the underlying bets. Many in congress and mainstreet want to add a component to the plan to help slow foreclosures, possibly by modifying the terms of mortgages. This could include interest rate reductions, principal forgiveness, term increases, freezes/holds, etc.

The problem is that the mortgages were securitized into mortgage backed securities, which were then pooled into collateralized debt obligations, which then tie into structured investment vehicles (the few which are left), hedge funds, and additional derivatives vehicles. Many of the MBS themselves are backed by credit default swaps, another type of credit derivative. Many of the above are highly leveraged. Some depend on a combination of leverage and a small interest difference (say 0.5% or less) to keep the derivative instrument alive. If the terms of the frozen mortgages start getting modified without new counter funds and fees to add new money (i.e., creating new mortgages at prevailing rates and new balancing derivatives contracts), then the whole paper ponzi-scheme could start collapsing under the weight of leverage, negative arbitrage, rating decay, etc. As a chain of counterparties start defaulting the whole bubble bursts. The derivatives bubble, since it is leveraged, will likely burst faster if the mortgages are modified then the slow death of the nation by foreclosure.

What this means is that we appear to be in a situation that pits Main Street against Wall Street (at best to buy additional time to solve the unsolvable problem). We can either save the derivatives bubble (actually opush out its collapse further), but slowly destroy Main Street, or we can save Main Street, but put the derivatives bubble into bankruptcy. It does not seem likely we can do both. I.e., we can have a Great Depression II, or we can have Congress utilize their Constitutional authority to create a new monetary arrangement.

Killing Main Street is not an option. The US has changed national banking multiple times in its history. We can do it again. Right now, though the financial system is failing, the houses still stand and generally are occupied, cars are on the streets, most people are working, food is being grown and distributed, weddings and births continue,etc. In other words, though on the edge, the underlying economy and society are still functioning. With the financial systems of Europe an Asia following in our decline, it seems likely that international cooperation to replace the currently failing fiat based central banking system is obtainable.

Tell your Congressmen to choose Main Street, not Wall Street. Tell them to http://www.TakeBackTheFed.com

Thank you Steve for the most idiotic post on this forum I have seen in a long time. Blame Clinton? My friend, you have lost your marbles. When Clinton left office we had a SURPLUS. We now have a huge, huge DEFICIT and it is absolutely due to Bush and his band of incompetent thieves. His corrupt and incompetent underlings (like that criminal Cheney) have spent money they never had, gotten a lot of people killed in an invasion that should never had happened which was based totally on lies and deceit, and basically brought our country to it’s knees. There is going to be a lot more damage even when that worthless idiot leaves office because they won’t be able to do their daily coverups. His corruption put in place the unregulated and unethical framework for this current financial crisis. Now we and probably our children will have to pay for his inept and criminal rule, while our stature in the eyes of the rest of the world has been hit so bad it will never recover.

Bill Clinton’s role, and all the democrats role in this whole less was trying to make every American a homeowner. He is also responsible for repealing the Glass-Steagall Act

you are write. the cds are a nuclear bomb on the economy

Sorry if question is dumb but how did these instruments come to be if they are so bad and who allowed these instruments to proliferate? Is it state insurance commissioners, state or federal banking examiners? I understand greed motivates (don’t like it but it is what it is) but who was or was not questioning these products? I can understand (don’t accept but can understand) how lax mortgage lending evolved with the desire to enable everyone to buy houses (without responsibility) but I don’t see anything good about the CDS business. What am I missing? Its just that it looks like these instruments are something that belongs in Vegas and not in our nation’s financial system.

I would say that we are watching the fall of the American Empire (Super Imperialists). It sounds like there are quite a few people out there who need to be executed or stoned to death! It looks like the religion of capitalism has reached the point of no returns! Greed and the love (lust) of money has consumed a generation that is destroying everything in its path to nowhere!

This could all be part of the master plan to force economical globalization.

To Steve2.

Your post is incredibly naive and another example of why politicians like Barney Frank stay in office for 30 years (you don’t know enough to make a decision yet you continue to have an opinion- and a vote). Cause and effect is a principle that you should understand before you make any statements.

What Steve1 was pointing out was the Glass-Steigal allowed the investment banks to take on more risk and ultimately to lever themselves out 30-40 times. Glass-Steigal was passed in 1999 by Clinton and a Republican led Congress. The reality is that it has taken almost 10 years for the ramifications of the passage of this law to affect the world economy. The fact that we had a huge SURPLUS when Clinton was in office is a red herring (by the way, the Rep led Congress had more to do with that than Clinton but why let facts get in the way) since decisions (or lack thereof) made in that administration and the current admin have led to this crisis.

The argument that a lack of regulation by the Bush administration is what caused this mess is too simplistic to give much credence. We have been operating under rules and regulations that were put in place, in many instances, in the 1930’s. Neither party has made any serious attemot to do anything about the lack of regulation and although the R’s controlled Congress for a number of years, they have not for the last two. Both parties have fed at the trough of corruption and have led us to this mess. The Dem’s for forcing banks to give millions of mortgages to people that could not afford it and both parties never had the guts to reform Fannie and Freddie (who by the way, set lending standards to all those mortgagees that have defaulted now). Why do you think F&F spent so much money lobbying Congress (and why Obama received the 2nd highest amount ever).

Even the passage of the Community Reinvestment Act in the 1970’s (and its susbequent modification in the 1990’s) had a hand in this crisis by forcing banks to lend money to unqualified buyers. Remember, the leverage in the system did not cause the mortgages to default here (although the impact that leverage applied to these bad loans is what is causing the meltdown).

The real story is that both parties are the causes of this catastrophe. No one can hold their head up here.

Steve2 – did you even bother to follow the links and read up on CDO’s and CDS’s?? Or are you suffering from a case of… my mind is already made up, so don’t confuse me with facts??

#1 – the reason there was a HUGH surplus when Clinton left office is because he sold most (if not all) OUR national parks to overseas interests.

#2 – Bill Clinton is a great salesman. He had everybody (apparently you included) convinced that the economy is in great shape that we’re all fat, happy and stupid and we can spend our money like there’s no tomorrow.

During those years the amount of money (percentage of income) people were putting into their saving accounts, CD’s, etc dropped to the lowest level since the end of WW-2. In fact it actually went slightly into the negative.

Home prices rose at a lightning pace, sometimes doubling in value in 1~2yrs, problem was, it wasn’t “real” wealth, it was just an illusion. But people bought into it and used their houses to finance all the toys (boats, PWS’s, giant motor coaches, etc) they wanted by taking out 2nd’s, 3rd’s, and so on to buy those toys.

When the economy slowed down, they suddenly found themselves being called on to make payments on all those toys and found they couldn’t do it. So they started living on credit and just kept digging themselves in deeper and deeper because their $125k house was not the $250k house they thought was.

#3 – Regarding GW Bush. I made that comment because every forum I visit, goto what-have you wants to blame him for everything that is wrong with our country today. I’m sorry but one man cannot single handily destroy an entire country and it’s economy.

The government does not exactly work at lighting speed, as such it takes time for policies (good & bad) to work they’re way through the system as Steve-3 so correctly pointed out.

The current financial crisis was not necessarily caused by any single entity, institution or situation. It is the result of the American people over spending, shady business practices by investment firms, lack of government regulation of those firms, corporate greed and so on. This is nothing more than history repeating itself, the result of people failing to learn from mistakes made during the 1920’s which eventually led to the market crash of 1929.

#4 – Regarding the war in Iraq… when Bush senior left office, he gave Clinton a Saddam that was in control, having just got his butt kicked in desert storm one. When Clinton left office 8-yrs later he handed GW Bush a Saddam that was out of control again.

In the interest of being fair and balanced, I will admit that GW unlike his father, did rush in hastily and apparently without a long-term plan outlining a specific set of goals and a timetable for accomplishing them.

As things are now, we cannot just up and leave as Obama promises! If we do, Iraq and that whole region of the world will go into chaos and things will really get out of hand.

Why can’t the government nullify all uncovered CDS? That is, all the contracts on cars that aren’t owned by you are now null and void.

Wouldn’t that take care of the problem now while also discouraging future speculation?

I wish everyone would quit blaming Barney Franks for this. Fannie and Freddie were fine 2 years ago and did not need to be regulated. I don’t know what happened in the last two years but Senator Franks said Fannie and Freddie were fine and did not need regulation or investigation and I wish people would quit with harrasing him.

I hope someone comments about the G-20 meeting coming on Saturday, November 15. These Derivatives went from EXOTIC to TOXIC in a matter of weeks. Now we are having Investment Banks as well as credit card comapanies such as American Express trying to qualify as a Commercial Bank just so they can get a handout from the government. This happened almost overnight. Who was watching free enterprise. That’s why Congress should reinstate the GLASS-STEAGALL ACT quick.
Yours truly, Disgusted Middleclass Taxpayer, LaVern Isely

Love your analogy on how a D&C works.