Tuesday, September 23, 2008

Credit Default Swaps

Ben Stein discusses credit default swaps:

Here s one big part of the answer. First, the alert reader will notice that Ben Stein said many times that the amount of money at risk in the subprime meltdown was just not enough to sink an economy of this size. And I was right...to a point. The amount of subprime that defaulted was at most - after recovery in liquidation - about $250 billion. A huge sum but not enough to torpedo the US economy.

The crisis occurred (to greatly oversimplify) because the financial system allowed entities to place bets on whether or not those mortgages would ever be paid. You didn't have to own a mortgage to make the bets. These bets, called Credit Default Swaps, are complex. But in a nutshell, they allow someone to profit immensely - staggeringly - if large numbers of subprime mortgages are not paid off and go into default.

The profit can be wildly out of proportion to the real amount of defaults, because speculators can push down the price of instruments tied to the subprime mortgages far beyond what the real rates of loss have been. As I said, the profits here can be beyond imagining. (In fact, they can be so large that one might well wonder if the whole subprime fiasco was not set up just to allow speculators to profit wildly on its collapse...)

I haven't the foggiest idea whether he's accurately described the situation.

I keep meaning to write a blurb about Naomi Klein's book The Shock Doctrine. I gave up on it because I thought it was too sensationalistic but I think we're watching exactly what she describes: the manufacturing of a "crisis" that requires emergency action, during which the population is led to believe that power must be handed to a few to address the crisis. When we do this, those few rob us blind and insist it was in all our best interest while the few profit mightily.

Has anyone seen a good description of exactly what would happen (immediately as well as in the coming months or year) if we did nothing?

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