National Underwriter Editor in Chief Sam Friedman’s blog entry concerning last Sunday’s 60 minute piece about speculation in Credit Default Swaps and their role in the recent implosions on Wall Street is excellent. I highly encourage our readers to pay Sam a visit and read the entire entry. I don’t necessarily agree with his conclusions that state regulators would have had any impact curbing the abuses but I thought the overall entry was excellent. Here is a snippet:
As CBS noted, once players packaged and passed along millions of shaky subprime mortgage loans in the form of collateralized debt obligations, buyers seeking to hedge their bets bought credit default swaps to transfer the risk of failure to others–such as AIG’s ill-fated Financial Products Division. This was essentially an insurance deal on AIG’s part, but no state regulator was permitted to oversee or restrict such transactions, and Uncle Sam didn’t interfere, either.
That meant there were no reserving standards, so AIG was allowed to become heavily exposed without having any real funds on hand if they ever had to pay off on these big-time bets.
The problem was exacerbated by the fact that speculators who didn’t even own CDOs started buying credit default swaps.
“As the market began to seize up and as the market for the underlying obligations began to perform poorly, everybody wanted to get paid–had a right to get paid on those credit default swaps…,” explained Mr. Dinallo. “There was no money behind the commitments. And people came up short. And so that’s to a large extent what happened to Bear Sterns, Lehman Brothers, and the holding company of AIG.”
The fact that so many people bought credit default swaps from AIG and others without having any underlying security to “insure” was what really undermined the entire financial market, according to Mr. Dinallo. “It’s legalized gambling. It was illegal gambling. And we made it legal gambling…with absolutely no regulatory controls. Zero, as far as I can tell.”
Even without regulation, shouldn’t AIG and other CDS issuers have known that they needed to account for some capital reserves to cover their CDS exposure?
Nobody included the risk that a bank may crash due to bad risk management in regards to CDS issuing in their risk-calculation for issuing new CDS’s- and I supposed they were proven right, because the taxpayers will get to foot the bill, just as they assumed. All is well in the land of financial miscalculations.
Isn’t that the point Greenspan was making about his having no idea the industry wouldn’t police its own investments. In other words, you shouldn’t have to regulate what should be common sense.
Seems to me that the way these deals are packaged and repackaged that it’s likely people bought back what they sold – so that when all the layers are pealed away, there are even more with nothing behind them than we know at present.
To bring this back to a Katrina analogy, risky mortgage cdos were flood insurance policies behind a levee system. Credit default swaps were the floodwalls and levees that collapsed because they were not built on solid ground. Alan Greenspan was MRGO.
I think the main issue is – who put money in this system of “no self control”. Customers? Just a very very small part. Most of it was handed out by the central banks at sub-market interest rates. So why does the fed lend money to banks that have no self control, and in fact encourage them to lend it out irresponsibly? If one wasn’t politically correct, one could almost imagine the FED trying to commit economic suicide and send the US back to utter poverty. The only thing is I cannot find any possible reason for why it would want to do it … Save capitalism
hpx83, I just had time to look over what you’ve posted on your site but intend to come back and read carefully. Very interesting information. Thanks.
There is more information coming – I only have to find time to write it. If I had the skills necessary I would make a rudimentary equation of the variables needed to crash a financin sector the way it was done now. Need to read up on my linear algebra first, so it may be a while though 🙂