The Real Crime in the Bailout -- Naked CDS Deals
The size of our national economy this year is roughly $15 trillion. The size of the Credit Default Swaps (CDS) market is $64 trillion. The whole world GDP is about $56 trillion. How could the CDS market be larger than the world GDP combined? That doesn't make any sense.
The minute I read that many months ago, I realized that there was something unreal going on in the CDS market. By "unreal" I mean something that is given value even though it is not attached to real assets. And the more I researched, the more I realized that was true.
CDS are basically supposed to be insurance on a group of assets. So, if you have a collection of mortgages, loans and other assets, and you would like to insure their value, you get a CDS. This makes sense since some of these underlying assets turned out to be quite risky.
What doesn't make sense is for the insurance market to be many times larger than the value of all of the underlying assets combined. Well, it turns out there is a reason for that. It's called the "naked" CDS. These deals are not attached to any underlying asset. They are not collateralized. They are not attached to anything of real value. They are simply bets. As in wagers. As in gambling.
For example, one bank will bet another bank that a group of mortgages will go under, and the other one will say they won't. Neither one owns the mortgage; they're just "insuring" it in theory. The reality is they are gambling -- pure and simple. Now, the numbers make sense. The CDS market got to be so large because people were making bets in ways that were not attached to the value of the underlying assets at all. So, they were free to bet as much as they liked.
And, of course, the more money they bet, the more money they made. And if they ever lost those bets, they knew didn't have the money to pay it anyway. So, they had all the incentive in the world to keep multiplying their bets.
So far, this is crazy enough, but here comes the really crazy part -- the American taxpayer is now paying off these bets. The people who bet that the housing bubble wouldn't burst or that the assets would retain their value, well, they lost -- but they don't have the money to pay off all of these theoretical bets since they never put any collateral down on them. So, they're turning to the government and saying they're out of money. And we're paying them. That's insane.
It's one thing to pay off mortgages that went bad. It's another to pay off insurance for a collection of bad debts. But it's another thing all together just to pay off gambling debts that otherwise have nothing to do with the economy. We, as the taxpayers, would have to be utter fools to provide the money for these inane bets. And, of course, that's exactly what we're doing now.
AIG was the epicenter for the naked CDS. If you care about this topic at all and want to understand how everything went down, you must read this excellent article by Matt Taibbi in Rolling Stone. As he explains, AIG started this madness and never had the money to back up their bets.
But what really drives me crazy is that I never hear anyone in government talk about this. I've never heard Tim Geithner or Ben Bernanke or any congressman or senator talk about what we should do with the naked CDS. They talk about all of the assets and obligations as if they are all the same. But some of the debts are based on underlying assets and some are not. Is that not an enormous distinction?
The only person who used to be in government who has raised this issue recently is Eliot Spitzer. He said what I have been wondering for a long time now - do we even have to pay these things? Since they are simply gambling wins, if the counterparties who won the bets don't get paid, nothing really happens. They didn't really actually have anything on the line, so it's not like they are going to suffer heavy losses. They are only going to suffer theoretical losses on money that never existed.
Why is Tim Geithner still paying off these debts? If he doesn't understand this phenomenon, he should be fired immediately. If he does understand it, and he thinks it is the obligation of the US taxpayer to pay off the gambling binges of the large financial institutions in the country, then I would seriously question his judgment, to say the least.
The argument they trot out every time is that we must have these financial institutions survive. I don't think that's true, but even if I did believe that, it would be important to shore up the real assets. But under no scenario is it important to pay off debts on imagined assets.
At the very least, can we please have this conversation? I would love for Tim Geithner or anyone else in the administration or Congress to explain why they think these naked CDS must be paid off. Can someone please ask them the question already, before more of our money is funneled over to the "counterparties" who won these bets?
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The notional value of CDSs may exceed any underlying assets, but that doesn't mean it's due to lots of fictional bets.
Some of it can be explained by hedging.
For example, let's say Firm A owns debt securities that it wants to "insure". It takes out a CDS by writing a contract with Firm B, a bank. Firm B doesn't want the end exposure, but instead just wants to act as an intermediary so it buys CDS on the same debt by writing a contract with Firm C, that takes on the ultimate risk. Firm B *thinks* it's hedging itself since it has a CDS on both sides.
In this example, the notional value of outstanding CDS is two times as large as the actual debt.
Where you get problems is where Firm B doesn't do a good job assessing the creditworthiness of Firm C, or perhaps wasn't in a position to assess it because they didn't know what other exposures Firm C had written.
If all of a sudden the debt goes bad, and Firm C can't repay Firm B *but* Firm B is still expected to pay back Firm A (who originally took out the insurance), then both Firm C and Firm B topples.
If Firm B has lots of these contracts with lots of other firms, then you risk getting Firms D, E, and F toppling too as a result.
So, it's a tough problem.
this is a really good post, more people should be bringing this to light!
How about this? There is an easier, cheaper, and faster way to solve the banking crisis which no one is talking about on Capitol Hill. If collateralized debt obligations (CDO’s) are the problem, just get rid of them! Desecuritize them! Just convert them back into the underlying loans. There are $1.4 trillion in CDO’s outstanding backed by Alt-A and subprime loans in the form of 3,700 individual securitizations of perhaps 3.7 million loans. Over 68% of the loans backing these bonds are current. Mark to market rules are forcing the banks to carry this paper on their balance sheets at 50%-80% discounts. The problem is that mark to market is a meaningless accounting fiction when there is no market. If you break up these securities and place the underlying loans back on the banks’ balance sheets, the good mortgages can be valued at 100% of face, and those behind in their payments or in default can be discounted to maybe 70% because they are still secured by the value of the homes. This would boost the value of the entire asset class from the current 20-50 cents up to 90 cents on the dollar. Restored balance sheets would enable banks to resume lending. www.madhedgefundtrader.com.
Cenk if msnbc were on the ball they would have you on to inform the cable watching American people of Wall Street's vacation to Vegas. Time to fess up Timmy. TYT busted you. Your indiscretions will not stay hidden there. We all know now you lost all the Naked CDOs gambling. Now this is real transparency. Obama, are you going to laugh this off too? Or do we get some of our change back? We need it to put it in the parking meter to park our "house".
Yes, Cenk, you are the next hire for MSNBC. Now that Schultz is on, there is no reason for you to be left out. They would be wise to hire you.
Only a real wicked and twisted mind could figure out how to make money off other peoples' debts. It's a sign of the times. The financial system has found a way to never take chances. I suppose they've found a way not to die and face their maker.
For anyone who wants to read a more thorough discussion of CDS issues, go to http://en.wikipedia.org/wiki/Credit_default_swap. It's pretty good at showing what's happening.
RECALL THEM AS FAULTY PRODUCTS! You Have It Exactly, Cenk!
I would assume that these naked CDS's could be recalled as faulty insurance products in the very same way that manufacturers refund money for any faulty or damaged products. Ina default or bankruptcy of the mfr, the buyer is SOOL. In an insurance product, the premiums that were paid may also have to be refunded.
The only assets that become truly "endangered" are ones that may have in turn been purchased by CDS's or "collateralized" by these horrendous insurance derivatives. In any event, there is a scam going on that represents the most heinous scheme to break the bank of the US Federal Treasury, and I'm pretty sure that's a bad thing. Geithner is transferring all the nation's wealth and future indebtedness into the hands of Goldman, CITI and BoA. For what? Privatisation of the US Federal Treasury? What a scam!
What a scam is right. The longer this charade goes on it is easy to see it's not a bipartisan issue in the democrat/republican way, but more like the entitled peolpe's(elected officials and their elite friends who have bought them with soft money) ability to steal from the average taxpayer. It's a pathetic scene, really.
Cenk, you sure hit the nail on the head! Specifically, one thing I have been yelling for months is this: if all these CDSs are getting paid off, then someone is getting rich....real, mind bogglingly rich. Rich like never before in the history of mankind.
Who ARE these recipients, and why hasn't anybody done a story on them? Maybe it's all going to Ken Lay out in Madagascar or something... LOL
Thanks for bringing it up, Cenk. You're the man.
I came across this proposal and it makes sense to me. What do you think?
There is $55 Trillion in CDSs out there. They are poisoning the financial system. The world's government could guarantee their worth, but that would inspire sheer disbelief followed by global inflation, or they can render them unenforceable.
A unified announcement from the G7 rendering them unenforceable in the G7 nations courts for a period of time, say five years, stops the ticking time bomb. No one wins and no one loses. A Derivatives Court of Claims could then be set up at the Hague to review the instruments, submitted by the parties and counterparties.
The Court of Claims could act as a Court in equity to determine the putative obligations and cross-obligations of the parties, with a decision as to what percentage of the obligations should be enforceable. This would be, in effect, a bankruptcy court for an entire shadow insurance market, if you please.
If governments cannot agree to allow a Derivatives Court of Claims to handle enforceability, then the 5-year suspension should be made permanent until the markets have developed a unified standard of capital requirements, loss reserves and limitations of the number of CDS agreements any entity could issue based on their financial strength and liquidity.
Banks could begin lending to one another again without worthless guarantees from each other or from governments who are already on the hook for systemic risk.
http://www.ireport.com/docs/DOC-112090
I have been beating this horse for months. I do not understand why they think they can pay off on these bad bets. There is just too much out there.
It would be cheaper and more effective to buy every mortgage, restructure them and end the defaults. The leverage works against the effort if you try and pay off the credit default swaps but works for you if you fix the game ie the mortgages.
I keep beating this drum. But the other beat goes on and on.
"Let Them Eat Credit."
Cenk, what we are watching is a Shadow Play that is covering for a good, old-fashioned Mexican Standoff.
The Banks say they are fine, showing profit ... doing better all the time, but, the thing is, under late 90's deregulation, the banks are allowed to hold their CDS exposure off the books. So the semi-miserable state the Banks are in is what is being portrayed, while the bank's catastrophic levels of exposure are out of sight. Basically, we are looking at two sets of books that tell different tales.
Why not just dump the Naked CDS Deals and call it a day? That's the 64 trillion dollar question. I believe there is a tremendous amount of fake wealth, supported by a pittance of actual wealth. This actual wealth is from the four corners of the world, and should the fake wealth collapse it would evaporate the real wealth with it ... the effect would be a level of ugly beyond belief with not just the little folks being devastated.
So in the small circle the Banks are looking at Wall Street, which is looking at the Fed, which is looking at the President, which is looking at the Treasury, etc ... while in the Great Circle the US is looking at England, looking at Japan, looking at the EU, looking at China ... each are waiting to see who will pull the trigger first.
We are living in interesting times.
There is no necessary reason that evaporation/cancellation of the 'fake' wealth would affect the 'real' wealth at all. Unless, of course, the holder of 'real' wealth was a losing counterparty to a CDS and had pledged that 'real' wealth as collateral against the bet. At least to the extent the CDS "market" exceeds the GDP of the entire world, the CDSs are bets grounded on 'fake' wealth and are not in any way collateralized; thus, only the fictional wealth evaporates if the CDSs are simply cancelled. It is patently clear that this whole house of cards was constructed on fantasy -- play money, like in a Monopoly game. Seems to me that unless the 'fake' wealth is wrung out of the system, the casino gamesmanship will continue, as it evidently is with Goldman Sachs, AIG, CITI, et al. The charade cannot be allowed to continue.
I guess all I can say is, it's about time someone with a forum said something about this!
My friends and I , who are in the finance world, have been talking about this issue for months.
There is not enough money in the world to pay off these bogus 'insurance' instruments.
We have been, and are being, taken to the cleaners by Bush, Paulson, Bernanke, Geithner, and Obama with their payouts to AIG, among others.
Bahhh whats the point.
No one gives a crap especially the government and all its tax/judicial related departments.
www.deepcapture.oc spells out real crimes being committed and yet , not a word.
naked short selling continues. Paper barrels of oil will reemerge to drive the price up . If the feds won't act, there must be a reason, and the reason is not because they don't know about it.
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