The Plot Thickens -- Details You Need To Know About The Bailout

The Bailout Plan for our economy must completely and transparently address the ramifications of the overall exposure to credit default swaps in the global marketplace. The global market for credit default swaps is estimated at more than $60 trillion -- twice the size of the U.S. stock market and far in excess of the $7.1 trillion mortgage market. It is estimated that AIG sold over $440 billion in credit default swap protection for fixed income securities. A massive exposure to credit default swap failures could set off a global economic nuclear fusion the likes of which could destroy the entire financial system.

Credit default swaps are essentially insurance policies which guarantee the performance on fixed income securities, like mortgage pools. Because they are private contracts that don't trade on any exchange, the Fed may not have been able to adequately monitor the risk inherent in these complex products. The question is whether sellers of credit default swaps, insurers like AIG, have the financial wherewithal to pay up in the event of mass defaults of the underlying securities. After all, insurance is only as good as your insurance company's ability to pay out on a claim.

Taking distressed mortgage backed securities off the books of banks will not be enough to stabilize the financial system as the total exposure to credit default swaps is still largely unknown. For example, the American people will not see the effect of being stuck with the huge price tag of taking on AIG's exposure to credit default swaps until someone starts marking them to the market, i.e. seeing what they are worth. There is no valid way to immediately quantify the global exposure to credit default swaps as their market value is tied to the performance of the underlying security. Since loans aren't performing so well these days, the answer is still bleeding out in the market.

Our government, which now owns most of AIG stock, may be considered a company "insider" -- technically restricted in how it trades in the stock. That may also mean that since "we" are working on saving all of the other failing banks and the economy, there may be a conflict of interest with regard to how we handle "our" exposure to the credit default swap positions held by AIG.

This feels like the Great Depression all over again. The biggest reason for that is the enactment of the Gramm-Leach-Bliley Act in 1999, which effectively repealed the Glass-Steagall Act of 1933. Glass-Steagall was enacted after the losses suffered in the Great Depression specifically to prevent the exposure of banks to the volatility of the stock market. One of the main reasons we are in this mess is that Graham-Leach-Bliley allowed commercial and investment banks to consolidate, exposing depositor funds once again to the follies of Wall Street.

Congress must implement Glass-Steagall like measures on an emergency basis to protect depositor funds from further exposure. When Gramm-Leach-Bliley was enacted, many predicted economic doom. We now feel the painful reminder that allowing banks to be exposed to the securities market threatens the integrity of depositor's funds.

Our leaders need to have a full and frank discussion with the American people about how the bailout will address the long term effects of exposure to the credit default swap market. Since Congress and our bank regulators are working feverishly to put together a bailout package that will have some effect beyond the band-aid we've had thus far, let us hope they are looking beyond the immediate crisis and implementing changes that have a lasting impact on this and every other economic cycle going forward.

Comments

[Morpheus008]

Did Treasury have attorneys look at the AIG strategy and its CDS implications... they are now representing all counterparties at the table at the same time while being an equity owner of one party at the table. This is absolutely crazy and sounds very much like an investment banker lifeboat solution derived to basically cover their losses and figure out the legal implications later. It wont be long until the first guys to take a hit ( which must happen) seek to protect their shareholders and equity ... in the courts. Stay tuned

[FrictionSoul]

The bigger they are, the harder they fall. This is going to make the Great Depression look like what it really was: the Mild Depression.

On the flip side, if the Dems put their foot down, they can effectively erase homeowner debts(Main St), not the Wall Street debt which would cause this economy to rebound extremely quick.

As it stands, Paulson Cash for Trash benefits only the fat cats on Wall St.

[Cogs]

Donald Trump told Larry King we need less regulation and that he's onboard with with McCain/Palin. Listen to the con man.

[Leedox]

It is 12:14 am and I am reading Huffpost in the hopes of finding a glimmer of hope so that i don't have to sell all my shares tomorrow. Unfortunately, no glimmer. I don't see any of this turmoil ending any time soon and if McCain elected I foresee certain disaster. I have continued to be amazed at the lunacy that has characterized the last 8 years and to think that the american people are considering doing it all again. I am amazed that a country that is/was? so wealthy could be so poor. If I was American I would be absolutely furious that there is no universal healthcare. Especially since the $700 billion bailout has been proposed. I am sorry America, I enjoyed growing up next to you and now that I live in Australia I can stand far enough away from you to see how very, very messy and painful this is going to be for most of you. Unfortunately even as far away as Oz we are feeling the pain and this is why tomorrow I am getting out to the tune of almost $140,000. in order to stop the American disaster from spreading to my family. Good luck!
*Sorry I am being a bit melodramatic but it's now 12:30 am and I really am actually quite sad for everyone because I just don't see a way out of this ticking timebomb that Bush has set for you.

[Pendragon2008]

"Our leaders need to have a full and frank discussion with the American people about how the bailout will address the long term effects of exposure to the credit default swap market."

No, I think the American people need to have a discussion with our "leaders" over how they have pillaged our country for the last 8 years in the name of a war we should not have ever been part of, over how they have killed our troops to line their pockets and the pockets of banks, and not satisfied with that, are trying to do the same again on a last-minute massive scale with this bailout.

We can have that discussion with them on their way to JAIL.

Impeach Bush and Cheney, and get these CROOKS out of the White House and into JAIL where they BELONG. Then do the same to their international banking buddies, because they are accomplices to this financial crime which is being dressed up as a crisis in order to put one over on America.
They are trying to steal the American Dream out from under the noses of the people who value it most.

[Chavez08]

It's funny how I keep hearing "economists" desperately look for ways to protect the Capitalism, as a system, from being scrutinized.

Why are Americans so f***ing stupid that they refuse to think critically or examine history? This economic system - unrefined Capitalism - is pushed on us every few decades and the outcome has been exactly the same since the 1800s: 2% super wealthy and 98% in poverty, disease.

The only reason the "Great Depression" made it into the history books is because many of the wealthy establishment lost everything playing high-stakes "market poker". What your McGraw Hill textbooks and the corporate media documentaries consistently leave out is that most of the country was saturated in poverty, disease, organized crime for 40 years in the lead-up to the '29 market crash.

Capitalism has only one set of outcomes, it's now being thrown in your face every minute of every day and your children, grandchildren and their children will all be permanent slaves to the bankers and their dynasties now getting the bailout. Forget about owning a home, retiring because all YOUR money is being stolen and consolidated into the hands of the few due to a well orchestrated transition to fascism that started with Bush grand-daddy and sold with the help of Leo Strauss and Milton Friedman.

If you are not already in the upper 2% and you still support Capitalism, you are a complete idiot.

[eileenphoto]

Capitalism will eat itself.
This feels like a last slap in the face from an angry, failed administration giving Sen Obama a poisioned chalice.
The devil is in the detail, hiding.

[technocrat]

1. Credit default swaps net. It's zero sum. Who owes whom what at the end of the day? Any institution that has huge net unhedged exposure is probably dead from other causes anyway.

2. The SEC is not going to prosecute Treasury for Section 16 violations on CDS. CDS are not securities, they are derivatives, for one thing. The underlying point, though, is valid--left hand, right hand. People who are allowed to focus too narrowly on legal entity accounting (get the most out of AIG!) will miss the big picture (land the aircraft, get everyone evacuated, contain the fire, __then__ unload the baggage).

[DazedandConfused]

AIG was bailed out because it was a huge seller of CDS -- and it would unravel the CDS mess.

My understanding is that CDS's allowed banks somewhat lower capital requirements (since their debt exposure was supposedly assumed by another party). But if CDS's unravel, would that mean that banks have even lower capital ratios and be even more leveraged? And would banks need to come up with more capital immediately?

Another concern is that there are multiple CDS's on the same debt obligation.

I can't quite get my head around all this...

[cylindar]

You are right and I will add that it does not look very good for our future. There does not appear to ba any fix for the current situation except for a market correction. The Feds are not telling the truth about what they know and it is going to cost us more than anyone ever had thought. Say goodbye to "The Late Great America".

[peloquin]

Screw it, let all the big companies fail. EPIC FAIL. Then bailout the little guy on his mortgage instead.

[Erdgeist]

There is no natural economic law--no invisible had of God regulating the financial markets (which don't grow food or make anything except bubbles). Financial markets are, essentially, gambling with no rules. With the Gramm-Leach-Bliley Act in 1999 came a return to yesteryear, to big time gambling that brought the Depression. It proves that Republicans never learn. So why should we trust them now? I think it is time for Democrats play hardball--let's see who blinks. Democrats need to impose massive taxes on the rich to pay for this mess--and most of all do away with Bush's tax break for the rich which will cost us trillions if we don't.

[LHoney]

What do you mean they never learn? Who do you think is benefitting from this? I hate it when anyone speaks as if the republican party is looking out for ANYONE except the top 2% wealthiest. they are elected by racist (although religious LOL) ignorami and also by Diebold voting machines. This is not a case of "they never learn" - it is a case of "we never learn." Now watch the pathetically weak democrats hand over everything we own, including our country to the top 2%. Have a nice day......

[WASanford]

It seems to me that the Treasury Department has just discovered there are about 600 Billion dollars worth of pay option ARMs that are due to reset this fall and well into next year. Of course that means there will be many more foreclosures. It costs a bank somewhere in the forty thousand dollar range to foreclose a mortgage. Add to that the loss of the mortgage itself and you have a tidal wave of debt that no one will be able to deal with. I"m sorry, but I just can"t see us trying to save the idiots who backed these mortgages.

This morning on "This Week" Henry Paulson said that we should not compare this with health care or education. I don"t know who made up that rule, but you"ll have to excuse me while I break it.

We"ve been told that we can"t have universal health care because "It"s too expensive."
We"ve been told that we can"t improve public education for our children because "It"s too expensive."
We"ve been told we can"t free ourselves from imported oil because "It"s too expensive."
We can"t address global warming in spite of the fact it"s a truly dangerous problem threatening our survival because "It"s too expensive."

Then how in God's name then can this not be "Too expensive?"

[PublicAdvocate]

This mess and corruption was predicted by Ralph Nader 8 years ago in 2000. Maybe we should be listening to the sage now given his superb record of public service to our nation and foresight for the future.
Ralph warned about and predicted dire consequences to our nation and taxpayers from the bailout and meltdown of Wall Street due to deregulation and unchecked corporate thievery.
http://www.beachwoodreporter.com/politics/nader_predicted_wall_street_me.php
Both Obama and McCain have taken millions from Wall Street interests. Does money buy access and privelege and immunity? I think we all know the answer to that one. Ralph Nader takes no corporate or PAC money.
Even some well known former "Reagan era" Conservatives are balking at the size and moral hazards of the bailout and warning about the dire consequences to our nation:
http://EconomyInCrisis.org

[LHoney]

I'm sorry, I LOVE Ralph, but a vote for Nader is a sure win for McBush and Alaska Barbie....

[2kids4me]

Please explain to the average taxpayer how CEOs for major financial corporations will pay a penalty for any of the bailout or take over of negative performing assets with $700b of taxpayer money now being proposed. Is it pillage taxpayers without any civil or criminal penalties?

Moreover, what is the total bailout today from the US Federal Reserve & Treasury in comparison to the total number of people below the poverty line or persons without health insurance.

So while the CEOs of major investment banks, mortgage houses and brokerage firms have made huge salaries over the past 5 years, are we now watching as our tax dollars go (freely or without clear conditions) to bailout what was a free market capitalist economy?

Are we really opening up the Treasury because we realize our economic fundamentals were flawed and rampant with greed where now risk is reaping taxpayer rewards? Is the following analogy accurate?: CEO's and their receipt of $20m and $30m pay packages and stock options is the same as the inner city drug lord (mortgage companies) or gun dealer (rating agencies) who got their minions (bankers and analysts) to do their dirty work and walk away. So do they get their large compensation packages, pensions, retirement and estates with no questions by the judicial branch of our government?

Are the scales of a democracy in action only for the rich?

[montemalone]

Funny thing is, every god fearing, bushbackin rube in America will support the massive transfer of money to the crooks that couldn't find any more ways to get it.

[Thermodynamics]

Ticking Time Bomb
The Bush gnomes from the Dark Side have set up a ticking time bomb, they say. If we don't give them a blank check the economy will collapse like the WTC. You won't even be able to use a credit card.

We need an immediate counter-move that will stop the ticking and give us time to get in there with conditions and targeted changes.

What kind of counter-move? Is there a way Treasury can make payments on the bad loans or in some other way provide a guarantee for the more complex agreements?

[gclue]

What happens to all those CDS when the Fed buys the underlying Mortgage backed instruments? Does this constitute a credit event?