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A Look At Wall Street's Shadow Market

803 views 36 replies 12 participants last post by  merpk 
#1 ·
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But it didn't stop ratings agencies, like Standard & Poor's and Moody's, from certifying the dodgy securities investment grade, and it didn't stop Wall Street from making billions of dollars selling them to banks, pension funds, and other institutional investors all over the world. But that was just the beginning of the crisis.

What most people outside of Wall Street and Washington don't know is that a lot of people who bought these risky mortgage securities also went out and bought even more arcane investments that Wall Street was peddling called "credit default swaps." And they have turned out to be a much bigger problem.
http://www.cbsnews.com/stories/2008/...=mostpop_story
So how did these people get away selling this as insurance, but not calling it insurance so they wouldn't be regulated?
 
#2 ·
WOW

Greed = blindness

These investment firms would have been better off hiring bookies to run their companies. A bookie would never have sold "insurance" for folks to get their money back if their investment went bad.

50 - 60 TRILLION dollars of these swaps are out there!!! OMG - I am going to start my doom shopping that I keep putting off.

ETA: Morgan Stanley & Goldman Sachs still selling these Financial Weapons of Mass Destruction as of 9/17/08 per this article. Unbelievable.
 
#3 ·
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Oct. 6 (Bloomberg) -- The Federal Reserve Bank of New York will meet tomorrow with banks and investors in credit-default swaps to gauge progress on an initiative to create a clearinghouse to curb risks in the market, a spokesman said.

The group in July set an end-of-year deadline to have a central system in place to absorb a failure in the $54.6 trillion market in which banks and investors privately negotiate contracts that protect against losses on fixed-income securities.

The Fed will hold a meeting with ``a small number of banks and buy-side firms'' to discuss progress being made on creating a central counterparty, said a New York Fed spokesman who declined to be identified.
http://www.bloomberg.com/apps/news?p...Zjg&refer=home
Has anyone seen this reported anywhere else?
 
#4 ·
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Credit default swaps are insurance-like contracts that promise to cover losses on certain securities in the event of a default. They typically apply to municipal bonds, corporate debt and mortgage securities and are sold by banks, hedge funds and others. The buyer of the credit default insurance pays premiums over a period of time in return for peace of mind, knowing that losses will be covered if a default happens. It's supposed to work similarly to someone taking out home insurance to protect against losses from fire and theft.

Except that it doesn't. Banks and insurance companies are regulated; the credit swaps market is not. As a result, contracts can be traded - or swapped - from investor to investor without anyone overseeing the trades to ensure the buyer has the resources to cover the losses if the security defaults. The instruments can be bought and sold from both ends - the insured and the insurer.
http://www.time.com/time/business/ar...723152,00.html
This articlle is from TIME dated Monday, Mar. 17, 2008
 
#5 ·
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In December 2007, the Bank for International Settlements reported derivative trades tallying in at $681 trillion - ten times the gross domestic product of all the countries in the world combined. Somebody is obviously bluffing about the money being brought to the game, and that realization has made for some very jittery markets.

"Derivatives" are complex bank creations that are very hard to understand, but the basic idea is that you can insure an investment you want to go up by betting it will go down. The simplest form of derivative is a short sale: you can place a bet that some asset you own will go down, so that you are covered whichever way the asset moves.

Credit default swaps are the most widely traded form of credit derivative. They are bets between two parties on whether or not a company will default on its bonds. In a typical default swap, the "protection buyer" gets a large payoff if the company defaults within a certain period of time, while the "protection seller" collects periodic payments for assuming the risk of default.
http://www.globalresearch.ca/index.p...xt=va&aid=8634

She goes on to say that nationalizing it is probably the best way to deal with this. I would love to hear others thoughts on this.
 
#6 ·
So, since mortgages are insured through credit default swaps, and a major component of this crisis is bad mortgages, and the default swaps are "bets" that the investments go down in value so that the holder of the default swap makes money on the investment that is going down in value, my question is - who are the holders of the default swaps? And, how much do they stand to make in this financial down turn?
 
#8 ·
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Originally Posted by Tata View Post
So, since mortgages are insured through credit default swaps, and a major component of this crisis is bad mortgages, and the default swaps are "bets" that the investments go down in value so that the holder of the default swap makes money on the investment that is going down in value, my question is - who are the holders of the default swaps? And, how much do they stand to make in this financial down turn?
It is probably hard to tell who all the different holders are because one of those articles talked about the credit default swaps being traded just like other securities. I'm going to speculate that China holds a number of these because Rep DeFazio was talking about China threatening us because they want their money back on the bad investments. I didn't quite understand that when I first heard it because it seems to me that if you make a bad investment, you don't get to go ask for your money back. However, if they purchased the credit default swaps, I can see how they feel entitled to getting their $$ back.
 
#11 ·
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Originally Posted by MommytoTwo View Post
Yup. The credit default swaps equal more than the GDP of the entire world as I understand it. I dont even comprehend that.
Isn't it crasy? It's like a ticking bomb.

Why are they legal? How are they useful? Why are we going to continue to allow them?

Also, the read talking about nationalizing the banks was pretty interesting and it talks about how that is really the only solution.
 
#14 ·
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Originally Posted by StacyL View Post
If you read people like Karl Denninger, Bob Chapman, Mish Shedlock, Jim Willie, etc. they are calling this the Quadrillion Dollar Derivatives Death Star. When the Death Star implodes it will basically collapse the market to zero.
Not quite.

A swap is basically the exchange of interest rates. In a "plain vanilla" swap, the interest rate of a variable loan is exchanged with the interest rate of a fixed loan. Since the underlying principle has to be the same for both parties, it in effect is cancelled out. "I will swap the fixed interest rate on my hundred million if you will swap the variable interest rate on your hundred million." The transaction involves only the interest rates, but in these scary articles the principle is often included as part of the "total" liability.

It's the same with the housing market. Although all real estate has a total notional value, this is not what is at risk in a bubble meltdown. What is really at risk is the difference between the actual market value of the real estate (a value that no one may know at the time but which is always more than zero) and the inflated values that the real estate had the last time it was in the market.

The point is, this is going to be bad, but we need to sort of keep our heads when we see people doing this end of the world stuff.
 
#16 ·
It may be a lot more calculated.
http://newcombat.net/Conversation/ji...short-selling/

You put $25 million in a credit default swap. [I.e, you bet against, e.g., MetLife, by buying Protection in a CDS.]

Then you buy all the puts you can [which frightens the public investors], then you jam the stock down through shorting [which makes your puts and your CDS a lot more valuable], then you buy $25 million more in credit default swaps [doubling down once it's clear that you've succeeded in establishing a downtrend], then you alert the media [with "helpful" phone calls to hustling so-called journalists looking for a scoop to the effect that the target is the next Lehman], and the ratings agencies panic and downgrade, and you are done./QUOTE]

It doesn't seem to be the normal market at work here.
 
#17 ·
Quote:

Originally Posted by dooldad View Post
It may be a lot more calculated.
http://newcombat.net/Conversation/ji...short-selling/

Quote:
You put $25 million in a credit default swap. [I.e, you bet against, e.g., MetLife, by buying Protection in a CDS.]

Then you buy all the puts you can [which frightens the public investors], then you jam the stock down through shorting [which makes your puts and your CDS a lot more valuable], then you buy $25 million more in credit default swaps [doubling down once it's clear that you've succeeded in establishing a downtrend], then you alert the media [with "helpful" phone calls to hustling so-called journalists looking for a scoop to the effect that the target is the next Lehman], and the ratings agencies panic and downgrade, and you are done.
It doesn't seem to be the normal market at work here.
Funny you should mention that...

Huckabee was just on Cavuto moments ago saying he has a reliable source that he won't name who claims that the whole thing is an act of financial terrorism and is an illegal intentional manipulation (i.e. collapse) of the market. He's essentially calling it an act of war.

As Huckabee is member of CFR, I would assume he was given permission to reveal this information this morning.
 
#18 ·
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One prominent financial figure, however, has long thought otherwise. And his views held the greatest sway in debates about the regulation and use of derivatives - exotic contracts that promised to protect investors from losses, thereby stimulating riskier practices that led to the financial crisis. For more than a decade, the former Federal Reserve Chairman Alan Greenspan has fiercely objected whenever derivatives have come under scrutiny in Congress or on Wall Street. "What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn't be taking it to those who are willing to and are capable of doing so," Mr. Greenspan told the Senate Banking Committee in 2003. "We think it would be a mistake" to more deeply regulate the contracts, he added.
http://www.nytimes.com/2008/10/09/bu...enspan.html?hp
 
#19 ·
Quote:

Originally Posted by StacyL View Post
Funny you should mention that...

Huckabee was just on Cavuto moments ago saying he has a reliable source that he won't name who claims that the whole thing is an act of financial terrorism and is an illegal intentional manipulation (i.e. collapse) of the market. He's essentially calling it an act of war.
As Huckabee is member of CFR, I would assume he was given permission to reveal this information this morning.

But I would suggest if this is the case it came from somewhere inside the beltway...

in the event of a crisis, the president has the right to delay a general election.

Obama is ahead of McCain in double digit figures.

1 + 1 =
 
#23 ·
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Q: Is anyone saying we could just erase all these contracts?

A: Financial commentator Ben Stein has said that's just what the federal government and the New York State government should do. (Most U.S. credit-default swaps are sold in New York.)

"After all, there was no insurable interest in most cases, which tends to void insurance contracts, which is what a CDS (credit-default swap) is," he wrote in a column on Yahoo's financial web site.

Because of the murkiness of the market for credit default swaps, it's hard to know who would take a financial hit if the swaps were erased.
http://ap.google.com/article/ALeqM5i...vH8fwD93UFR380
 
#24 ·
I was wondering about CDS today, and when/if they are going to start being regulated. I did a couple of searches and came up with nada, zip, nothing. Maybe I'm not using good search terms....

Nullifying the contracts could be a huge shock to the system and further bring the economy down. I'm not sure that would be the best course, but I'm no economist.

At minimum, they need to start requiring companies to keep reserves if they are going to keep selling credit default swaps. I would like to see the whole CDS business abandoned. It seems to me investing should be about providing a company capital, not investors lining their pockets when a company's stock loses value. The people who invest should have an interest in the companies succeeding, not getting rich whether or not that company is profiting.

I know that it is all more complicated than that, but I also think the transactions should be straight forward enough so anyone could get what is happening.
 
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