Sunday, January 25, 2009

Credit default swaps: Just another good con

Gretchen Morgenson of the NY Times had a nice article on credit default swaps this weekend with a rather novel approach:

While the amount of credit insurance outstanding is around $30 trillion, Robert Arvanitis, chief executive of Risk Finance Advisors in Westport, Conn., says he believes fully half that amount isn’t problematic because it consists of winning and losing stakes that offset each other.

But that still leaves $15 trillion worth of contracts that may be in need of triage.

What if a company that wrote insurance can’t produce the required payout when a default occurs? The buyer should take the hit, Mr. Arvanitis said.

“If you live in a house and you don’t buy reputable insurance and a fire burns it down, it’s your fault,” he said.

Now of course we know the buyer isn't taking these hits. It's you, the taxpayer, that will.

As we have seen, every good con needs to take in money to succeed. Without new money coming in, the ponzi scheme collapses. That was the simple approach.

The credit default con was just a bit different. The new approach, was to give money away in the con. These investment banks approached AIG and gave them money to insure their contracts. AIG took the money from everyone. And so did the monoline insurance companies because they needed the money also. It was the same con. It was like insurance without actuarial tables, and with contracts on many lives!

Now that the deals have blown up, as long you you bought your swaps from the same firm Goldman did, you were backstopped by the taxpayer.

In the real world, only one person can have insurance on a home. If the home gets blown away in a hurricane, there is just on payment. But on Wall Street, you have ten guys who all have insurance on the same home, yet all ten guys get paid.

At least, today this scam is finally getting some press. But what good is the credit default swap market if there is transparency? Or if there is transparency in derivatives?

Now Tim Geithner, in his testimony before Congress said he was preparing his entire life for this role. Just like Bernanke studied the depression his entire life.

Here's Geithner idea of preparing his whole life for this job. Our banking system has imploded yet our future Treasury Secretary was studying credit derivatives just this past year:

Yet the banking crisis could not have come at a better time for Mr Geithner. Tipped in Washington as the next US Treasury Secretary in the event of a win by Barack Obama, he has been shown at his best in a crisis in recent months. He has spent the past year getting his head round credit derivatives, with fortuitous timing.

Remember when the Fed was lending money to Lehman? What did Geithner say about Lehman when he was speaking at the San Fransisco Fed in June? He said this:

"A classic problem in financial crises is to distinguish between problems of illiquidity and insolvency." And then Geithner said that the Fed lends only to "solvent institutions." Then wasn't he declaring Lehman solvent? After all, his minions were looking at Lehman's books since April!

Now we want Geithner, the friend of the banks to be the new Secretary of the Treasury? No wonder we find these expletive laced videos on decrying Thain and Geithner as no nothing metrosexuals. But he probably sums up what the blue collar guy feels on what he sees. (Very graphic language)

But it now looks like Geithner has seen the light:

“I believe that our regulatory system failed to adapt to the emergence of new risks,” Mr. Geithner said in a written response to questions that was made public on Friday by Senator Carl Levin, Democrat of Michigan. “The current financial crisis has exposed a number of serious deficiencies in our federal regulatory system.”

The regulatory changes are a major piece of a broader package being prepared by the new administration to address the market crisis. Another piece to be issued soon will provide the strategy for how the government will go about repairing the declining banking industry. Congress recently approved the second $350 billion in spending from the Troubled Assets Relief Program.

I guess we'll take the lesser of two evils!

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