Monday, December 01, 2008

Twilight of the Economies Redux…

From Comments on C&L today, this very clear, lucid, comprehensible description of the the 'economic' conditions and their immediate and distant implications.
Mon, 12/01/2008 - 12:50 — Alice X - Choms...
The stock market is a bunch of investors, some very sophisticated, some not, who are in search of a place to park their cash.

It has a tangential relationship to the real economy.

Here is my previous post.

There are between $15 and $40 Trillion in Credit Default Swaps on the books of the world's banks that may come into play.

If they called it 'insurance', it would be regulated. It is not regulated, so instead it is nothing more or less than a super high roller numbers racket.

On a vast scale. It is gambling and the banks are the bookies but they don't have the money to pay up.

Mortgages, Corporate bonds, will this or that stock go up or down, you name it. If it involves substantial money, there are CDS attached. Because it is unregulated and one does not need to even own the underlying security, the amount of CDS are sometimes FIFTY times the amount of the named security.

Every mortgage default, every bankruptcy, every bond default can bring action in the CDS market. Sometimes at fifty to one.

Right now the banks are hoarding cash because they may owe every cent they have. Or more, in which case they are insolvent.

That is why the credit markets are still frozen.

Without the credit markets we spin into a depression.

The banks should be allowed to go bankrupt. The CDS for those who do not own the underlying security might be paid at pennies on the dollar, or nothing.

Instead the central banks are pumping (printing) money into the banks. We are the leader in this by far.

We are not attaching strings to this money, it is akin to free money.

If we pump enough money in to cover all of the potential losses, up to maybe $40 Trillion, we will have wrecked the dollar and hyperinflation will ensue.

Thus far we are at $8.5 Trillion.

Somewhere between zero and $40 Trillion lies a bizarre world of stagnation and hyper inflation.

That is where we are now. Over our heads and sinking.

For most of the twentieth century, Credit Default Swaps would have been illegal.

There was a good reason for this. It is gambling, pure and simple. Unregulated gambling is not a healthy business.

It has gotten to the point where the entire world's economic well being is in jeopardy.

Wherein lies the morality of paying these gambler's debts. I don't see it.
It begs the question a bit with respect to Credit Default Swatps. These 'instruments' are in the form of more or less informal bets between the holders of particular investments on whether the holders of the debts (which are the 'business' of all these so-called 'derivative instruments') will pay or default. Somebody said it was like a huge numbers syndicate, which is an apt analogy too. Vide, Via Wiki:
The numbers game, or policy racket, is an illegal lottery played mostly in poor neighborhoods in U.S. cities, wherein the bettor attempts to pick three or four digits to match those that will be randomly drawn the following day. The gambler places his or her bet with a bookie at a tavern, or other semi-private place that acts as a betting parlor. A runner carries the money and betting slips between the betting parlors and the headquarters, called a "numbers bank" or "policy bank". The name "policy" is from a similarity to cheap insurance, both seen as a gamble on the future.[1]
That clear it up any for ya? The thing to remember is thaqt we've been thrown into a game in which our individual fates are as insignificant as poker chips: valueless outside the game.

Now go have a nice life...

2 comments:

Mr. Pelican said...

For a completely comprehensible explanation of the whole CDS shithouse, I suggest you listen to Fresh Air on NPR April 3rd 2008. This is worth keeping!

Anonymous said...

“There are between $15 and $40 Trillion in Credit Default Swaps on the books of the world's banks that may come into play”.
You are quoting estimates of the “notional value” of the insurance. The actual value is a very small fraction of the notional value. First, most of these contracts are offsetting. $25 trillion in notional value of CDS was recently torn up with not a penny change in actual value. (www.isda.org) Second, the remaining “notional value” is not value. A $100k insurance policy on your house is not worth $100k. It’s value is far closer to zero than $100k as the amount you pay in insurance premiums is roughly equal to the value of the insurance (plus a profit incentive for the insurance company).

“the amount of CDS are sometimes FIFTY times the amount of the named security.
Every mortgage default, every bankruptcy, every bond default can bring action in the CDS market. Sometimes at fifty to one”
This is very misleading. While there may be a vast multiple of CDS before a default, the amount of CDS post default has been a fraction of the bonds outstanding. Why?
Think again of insurance but consider in the CDS market the same investor both buys and sells insurance on the same thing. While a lot of this cancels each other out (note the $25 trillion reference above) even before a default, even more cancel each other out after a default. Why is this? Because after the default, you can cancel offsetting contracts that have different maturity dates.
Need proof? Look at www.dtcc.com at the amount of money lost of Lehman Brothers CDS ($5.2 billion). This was a small fraction of the notional value of Lehman CDS ($72 billion).