I finally got some information on these and now perhaps it is time to make someone aware of how totally unregulated these were and are. The show “60 Minutes” put up one very simplified but complete explanation of what CDS are and how they were used to make some banks and people millions on the backs of mortgages, loans, and other money transactions.
In layman’s terms the CDS is essentially an unregulated insurance policy. It guarantees the performance of a security instrument , e.g., a mortgage. The buyer of the CDS pays the maker a fee or “premium” (think insurance) for protection against a loss. Historically the US Treasury has not classified derivatives as “insurance,” and therefore they trade free of any government regulations. Because of that, the firm selling the CDS is not required to set aside any reserves from the premiums received to insure against possible future loss claims. This obviously makes the sale of the Credit Default Swaps extremely profitable and default loss payments very expensive.
These were made against banks themselves, by banks, and if the Swap moves around, banks may end up with Swaps against themselves as well as having other banks “owning” Swaps against each other! With no regulation, no means of tracking these, they remain hidden, still able to take down corporations, banks, and virtually everything with a loan on it, including mortgages still being paid today!
Basically the banks, Bear Stearns, Lehman Brothers and Citibank, along with virtually every bank in the US, along with a few international banks got caught with their hands in the cookie jar, bringing down a really nasty recession on everyone.
Swaps ARE insurance, but because insurance IS regulated, the banks and investment houses used the term “Swap” to blatantly circumvent insurance regulations.
On September 23, 2008, Christopher Cox, Chairman of the U.S. Securities and Exchange Commission, placed the worldwide CDS market at $58 trillion, and stated it was “completely lacking in transparency and completely unregulated.” The U.S. Office of the Comptroller of the Currency reported the notional amount on outstanding credit derivatives from reporting banks to be $16.4 trillion at the end of March 2008. (For reference and perspective, the U.S. GDP for 2007 was $13.8 trillion, while the world’s GDP for 2007 was estimated at $54.3 trillion)
See the problem here? Playing high stakes poker, literally, put the bets beyond the ENTIRE world Gross Domestic Production!
What happened is that the mortgages were turned into “Swaps”, even good mortgages, the resold over and over again, until the hidden market was well over the actual value of the entire world GDP. What is truly scary is that there is absolutely no way of knowing EXACTLY how much of this toxic paper is out there, or the true value of any of it, BECAUSE it is a hidden, secret market.
Why am I reiterating this now? Well, those very “instruments” are now being put on the market this week, and there are still no regulations on creating more right as I am posting this!
“It is an insurance contract, but they’ve been very careful not to call it that because if it were insurance, it would be regulated. So they use a magic substitute word called a ‘swap,’ which by virtue of federal law is deregulated,” according to Michael Greenberger, a law professor at the University of Maryland and a former director of trading and markets for the Commodity Futures Trading Commission. The deregulation of the swaps market is thanks to provisions in The Commodity Futures Modernization Act of 2000. Who was President and Secretary in the US at this time??
One large difference between credit default swaps and insurance, is you do not need to own the bond or instrument being insured in order to obtain insurance on it. If the bond fails, then, theoretically, you get paid, possibly along with many others. Yet the “insurer” of the bond is not regulated and the transaction is beyond federal or state regulation. This allow speculators to make money by purchasing insurance on a company’s bonds and then shorting the stock of the company in great quantity and getting a payoff that exceeds their risk of shorting if the price of the company’s stock increases. The fact that you need not be a party to owning the bond also explains why the total value of credit default swaps is so high, indeed higher than the total value of the bonds issued.
Translation of bafflegab to ordinary language? You and I do NOT even have to put any money or have a stake in this to be paid off! Speculators all cashed in here!
AIG sold them, bought them, moved and split them, and some banks are still making, moving, splitting them right now.
Until the banks can declare openly what they have in CDS, what they risk, and where their money is being invested in, this will be open season on the government funds, central banks all over the world, and I have yet to see any demands on ANY banks to disclose their swaps.
Obviously this has yet to come out with any transparency, any real idea of what kind of real trouble we are all in, all because of some sneaky, coniving, greedy banks, investment houses, speculators, and the government officials who KNEW these were out there and did absolutely nothing.
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