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23rd Oct

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niemand
Contributor
What do you guys think? Article copied from http://www.chron.com/disp/story.mpl/nation/6050283.html The $45.6 trillion Credit Default Swap Crash vs. the $700 bil Sub Prime Crash . All of this because 5% of U.S. mortgages are defaulting? This 5% isn't that big a number compared to the world financial markets. After all, the other 95% are still paying and yielding a cash flow. So if sub primes didn't cause this what is going on? . What is going on is a Credit Default Swap caused crash. A CDS is a form of insurance on loans that pays off if the loan defaults. CDS are totally unregulated and un-monitored by any government agency. CDS are not called insurance because insurance is regulated. If it was called insurance, and regulated, the issuers of the policies would be required to have assets enough to cover any claims. But it isn't insurance. And it turns out the issuers of CDS never had the assets to cover any claims - even a small claim like the sub prime mortgage defaults. If they had paid off the sub prime defaults everyone would have their money and there would be no bailout. . The banks and financial institutions that issued unregulated CDS made billions collecting the premiums (but they are not called premiums because it isn't insurance). But when the sub prime backed instruments started to default they couldn't pay off because they had no assets to pay off with. AIG is one example. And everyone noticed and started to worry. . The real problem is that CDS were not sold to cover just mortgages loans. They were sold to cover almost every kind of lending instrument. Obviously, a bond that is insured against defaulting is more valuable and higher rated than one that is not insured. So once the CDS began defaulting on the subprime market it became obvious they were worthless insurance on everything else they insured, which is just about everything else out there. So the value of every bond, hedge fund and other investment instrument dropped on the books of every institution holding them. And they dropped fairly sharply. . And then there are the CDS themselves. They were on the books as an income producing investment instrument just like a bond from a legitimate insurance company. Now they are virtually worthless. How much were they worth before the truth about them was revealed? $42.6 TRILLION. For perspective, this is equal to the entire household wealth of the U.S.; the U.S. stock market is capitalized at $18.5 trillion. So what really has happened is that the global financial markets have just taken a $42.6 trillion dollar loss of assets. . Our recent bailout is only $700 billion, a tiny fraction of the outstanding CDS and not enough to make a tiny tiny dent in the debt the financial institutions are now holding. So what did our elected officials just do? They bailed out their campaign donors and gave them a chance to cash in their chips and leave the game with some cash in their pockets. . The sub prime defaults are just a minor diversion that takes your eyes off what has really happened. Huge companies, here and abroad, (CDS started in Europe) committed a fancy complicated form of fraud. They sold insurance that wasn't really insurance, collected billions in "premiums" that pumped up their books and made billions for their executives and brokers. They often issued a CDS to a buyer to pump up the price of a bond or financial instrument they were selling and thus increased their profits two ways. . If a real regulated insurance company had done this the executives would all be indicted, prosecuted and put in jail for a long time. It was fraud and I hope our government will go after these weasels and put them in jail. But I doubt that will happen. . The problem right now is that no one knows who is holding what or even how to begin to value holdings. The value of holdings of all kinds have clearly dropped. But by how much? In the sub prime mortgage market, for example, the houses are still out there and clearly they have some considerable value. But how much? The same holds across all the markets. The tangible assets securing most of the loans are still out there. But what are they worth now? We are about to see a huge 100 year shake out on the value of everything and everyone is going to take a hit. The more leveraged any business or individual is the more they are going to devalue. And that is another new aspect of this crash. . Super low interest rates made borrowing possible - smart - at rates that would have been unthinkable 20 years ago. 20 years ago being leveraged at a 5 to 1 rate was the normal limit. Today 30 to 1 is normal. 4% interest rates simply could not be ignored and go unused. Hedge funds with 4% interest rates made extreme leveraging even more extreme for large investors and funds. It turns out some hedge funds had 100 to 1 leveraging. (Hedge funds are another unregulated market) So our entire economy, the businesses, the banks, individuals are credit extended like never before in history. So they are all going to be devalued like never before. This is going to be the perfect financial storm. And it isn't going to end anytime soon. . A lot of companies are going to fail - unavoidably. There is going to be a lot of unemployment. A lot of retirement funds are going to fail - including government backed retirement funds like state funds. And the U.S. government cannot bail them all out. But it will try at first. And the government will have unemployment claims and welfare claims like never before. And all this will cause another problem that will cause more pain. Inflation. . Inflation like we haven't seen in decades. Because the only way the government will have to pay off its debts - and they are going to be huge, even compared to our present huge debt - is to print money. Lots of money. . We are going to see something unthinkable in the past. High unemployment, bankruptcies, banks closing and a very slow economy, BUT with high inflation because every government in the world is going to print money to try and bail things out. . What to do? Getting out of debt would be a good idea. Cash is good - but vulnerable to inflation. Gold is better. Start minimizing your expenses in every way possible. If you are about to retire don't. Keep the job if the job is still there. If your retirement fund doesn't go bust, inflation will devalue the retirement payments. Things will settle out. The economy will restart. New companies will be started to replace the ones who go under. The sun will come out again. But not for a long time.
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3 REPLIES 3
_nova
Super Contributor
CDS is the reason why banks are not lending money, why there's a credit freeze, not subprime mortgages. It's amazing how few people realise this nuh? Today the Lehman CDS are being auctioned and on 23 Oct it is WaMu. Today will tell us how much impact a bunch of irresponsible snot-nosed 26 year olds in Ferrari's are going to have on our future. If anything goes wrong with the CDS settlements then corporate America is going to go bankrot and the rest of us will live with the consequences of another Great Depression
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niemand
Contributor
Hmm, interesting. How will we know how the Lehman CDS auction went? I assume we can only react on Monday.
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_nova
Super Contributor
I'm not sure what the figures are but they're big. If the debt holders don't honour the default obligations then the Fed will have to step in. That might keep things calm for now. But what the bankers know is that there is currently something like $16tn in CDS outstanding and that's what's got them in a chronic state of gippoguts. What's 5% foreclosure rate?, what's 700bn?, pfff it's peanuts compared to this monster. They're not lending money to anyone because they don't know if they'll get it back. And when the CDS aren't honoured you're going to see companies go over the falls globally
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