Think about this number, $67,000,000,000,000 - that's $67 Trillion dollars in outstanding Credit Default Swaps. The GDP of the US, according to the BLS, at the end of Q4 2008 was $14.2 trillion. This means, that the Fed, the regulator of all US National Banks, allowed banks to get into a business that leveraged their capital by a factor that is way outside of what is considered within the acceptable guidelines of risk. Further, they did it with their eyes wide open ... when Citi's capital went below the regulatory limit of 3% in 1991, the only thing that kept them afloat was their $1 trillion interest rate swap book. That is, the Fed was too obtuse to comprehend how to unwind an interest rate swap book - CDS's, referenced to a mortgage-backed security are more complicated by a huge factor. IN SPITE OF THAT, THEY LET THE BANKS GO DEEP ENOUGH INTO THIS MARKET THAT THEY HAVE BANKRUPTED, NOT ONLY THE US, BUT ENTIRE THE WORLD BANKING SYSTEM.
Golly, don't you just love a deregulated market? Yea, but I like the way that things get done in Washington even more. I sleep extra soundly knowing that the regulatory framework of the entire US capital market is written by people hired by the firms that are the beneficiaries of lax regulation. Golly, thanks W, thanks Alan and an especial thanks to the Hammer.
THINK!
2 comments:
OK, if 67 trillion is the right number, then the US, the
banks, and maybe the entire world is basically
Bankrupt, Insolvent, Dead in the Water. Who has
that kind of money? I'm assuming that this number
assumes that the various "derivatives" are worth
zero because nobody will buy them. If they are
worth, say, 30 cents for every dollar of face value,
then it's still too much debt.
I'm hardly an expert on credit default swaps. But, no matter how one looks at it, the swap market has always been bloated ... I think that the issuers show both sides of a swap on their books on a "notional" basis. The actual obligation to pay, for instance, interest or the spread between Euro and Dollars under the terms of a swap, is quite a bit lower than the notional amount. That is, the notional amount is the principal amount and the actual swap payment requirement is either a spread difference or an interest payment, either of which are less than the notional amount and both of which get payments back from the swap counter-party.
Now, CDS seem to be quite a bit different. Here the issuer of the swap is actually required to come up with the principal amount of the swap. This, by the way, is supposed to be hedged with the purchase of a "referenced security" that acts like the security that is supposed to be insured against default. The problem is, the referenced securities seemed to have either suffered a rating downgrade or outright default along with the hedged security.
They are victims of limited minds and limited models and very big egos.
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