Re: Way OT Again: Credit Default Swaps - the REAL reason for the financial meltdown

hancock4@xxxxxxxxxxxx wrote:

On Oct 11, 9:56 am, Brent Jonas <brentrjo...@xxxxxxx> wrote:

credit default swaps,

do you have a general link that explains this?

Go to http://www.nakedcapitalism.com/ ; they have numerous links to
financial articles as well as discussions on how we got to this mess,
what's going on right now, and how we hope to get out of it. There's
a lot of smart people there talking about this subject, and they are
keeping up on it daily.

These companies have not been
disclosing the swaps on their balance sheets (as it's an unregulated
market) . . .

Whether something is "regulated" or not has nothing to do with the
very basic financial reporting requirement of balance sheets.

I'm afraid it does in this case.

If you
lent someone money, you have to carry it as such on your balance
***. It is an asset, but not as 'good' as an asset as cash. You
also have to list it appropriately depending on its liquidity and
risk. LIkewise, if you have an obligation you must list as a
liability, short term or long term.

Ok, here's what the banks have been doing while you thought they had
your best interests in mind:

Say you put $100 in the bank. That bank immediately loans out that
money to other banks, and keeps 10% of it as collateral. The next
bank does the same thing (but they've only got 90% of the money in the
form of a loan), and so on, and so on, etc, etc. That $100 is often
"leveredged" up to 10x even though there's only $100 in the system.
The banks used each loan of $100 to make additional loans, such as
mortgages, student loans, car loans and credit card loans. Some of
these loans were questionable, or unsecured; on those loans some smart
financial types decided to buy insurance that guaranteed that if the
creditor defaulted on it, they'd still get the full value of the loan.
Banks began selling these loans to each other, along with the
insurance policies attached to them, creating yet another market where
money changed hands between the banks and increasing the profits for
everyone. Even more smart financial types, realizing that these
unsecured and questionable loans were risky and everyone had handled
them (and the selling/buying of them was very profitable), began
buying insurance on them whether they owned them or not.

In effect, they were EXPECTING them to fail, and wanted to profit off
of their failure.

Remember, in this example there's only $100 invested. Have I said how
much imaginary worth that $100 has created? No, and that's because in
the real world, NO ONE REALLY KNOWS EITHER.

Let's say that several of those questionable investments fail.
Suddenly all the insurance policy holders get their money. But,
there's only $100 in real assets covering the debt, and the payouts
are many, many times that number. When that happens, banks start
defaulting on their loans, and collapsing, which is where we are right
now.


None of this is anything new, and as far as I know, none these very
basic accounting principles were changed by 'deregulation'.

Ahh, but Congress (thanks Phil Gramm) specifically wrote legislation
that actually prohibited any regulation of the CDS market just a few
years ago. IOW, the banks told Congress that they could handle it
themselves, and it was such a profitable house of cards (as long as
people made their payments and their homes continued to appreciate)
that no one needed to watch over them.

Translation:

Say you have a shoe store and you want me to invest in it. As an
investor, I'll look at your books. I'll want to know how much money
your customers owe you and the _quality_ of that debt--are they paying
promptly or not? Again, this is very basic accounting.

So if you have a business and loaned out money as "CDS", you have to
carry them on your balance *** accordingly. If there is evidence
the loans might be bad, you have to show it.

Businesses didn't buy or sell CDS; the banks did, between each other,
and kept it in the background so there wasn't any public accounting of
it. Did you ever ask your bank what their investments were in? Didn't
think so.


Businesses loaning each other money, and banks loaning money and
selling off the loans is nothing new. The methods for evaulating the
qualtiy of such loan packages have been around for ages.

Businesses don't loan each other money; banks loan money, and right
now no one wants to do that for fear of their toxic loans being the
next ones defaulting and them suddenly finding out that they're not
liquid enough to handle the debt.

What I don't understand is, that even if new loan types were invented,
subprime or CDO or whatever, anyone who would sell such instruments is
required by basic fraud law (again, "regulated" or not) to represent
clearly what the package is. Further, anyone who buys such
instruments is required by due diligence to understand exactly what
they're buying into.

Specific law prohibited regulation of the CDS market. Banks lobbied
Congress to pass that law, and they did.

As far as I can tell, Enron got into trouble because (1) they simply
lied, claiming assets that simply didn't exist, (2) their outside
auditor certified those lies as being true, and (3) people bought into
them without properly checking what they got or ignoring the old "if
it's too good to be true, it's not true".


So, it would seem to me the current mess is due to (1) people/
companies misreprenting the qualtiy of securities they sold and (2)
people/companies failing to exercise due diligence on securities they
purchased.


As to 'deregulation', back in 1929 it was recognized that one of the
causes for hte massive stock market collapse was that so many
securities out there were nothing but 'water', there was no SEC or
filing requirements back then so anything could and would be sold and
resold. A major part of the New Deal was new laws to prevent that
sort of thing.

Some have been repealed, some have been watered down, some have been
ignored and investors found other, unregulated methods of trading to
make obscene amounts of money for themselves.

What I don't understand was why the zeal to repeal such smart New Deal
legislation that was obviously necessary and had worked so well to
protect the markets. One newspaper said it was a BI-PARTISAN effort--
the Repubs wanted deregulation and the Dems wanted easy credit for
consumers and home buyers who otherwise wouldn't get it. Undoubteldly
both parties were buoyed by the economic boom it generated, igorant of
the risks.

Basically there you have it; both parties agreed to go along with what
the banks wanted done, because they all thought the banks had our best
interests in mind.

They don't. The new President will need to make sure Congress passes
laws that put stringent limits and regulations on the financial market
to insure this never happens again.

John Lansford, PE
--
John's Shop of Wood
http://wood.jlansford.net/
.