Diary

The Financial Instrument That Ate The Earth

thefadd.

Posted to Diary on Tue Sep 30, 2008 at 03:25:39 PM EST. RSS.

$700 Billion? Why bother. There are $54.6 trillion in outstanding credit default swaps--you know those made up securities that repackaged debts which will no longer be paid as unemployment rises and incomes fall. The world's GDP is $54.3 trillion. By comparison, the sum total of the US National Debt, the US GDP and all the stocks on the NY Stock Exchange is only $50.5 trillion.

< How subprime lending works

Sing for Change Obama >

Tags: (all tags)

This story: 7 comments (0 from subqueue)
Post a Comment
1

Re: The Financial Instrument That Ate The Earth

joshv.

Tue Sep 30, 2008 at 04:29:53 PM EST

none

That is a big number, but let's take your article's advice:

"Take that gargantuan number with a grain of salt. It refers to the face value of all outstanding contracts. But many players in the market hold offsetting positions. So if, in theory, every entity that owns CDS had to settle its contracts tomorrow and "netted" all its positions against each other, a much smaller amount of money would change hands."

Now can someone 'splain me this - what does it mean to hold "ofsetting positions".  Does that mean you've both bought and sold CDSs?  If so, why would anybody do this?  Is it like an insurer buying re-insurance?

3

^ 1

Re: The Financial Instrument That Ate The Earth

Steve Urkel.

Tue Sep 30, 2008 at 05:51:00 PM EST

5.00 (astute)

I have meager knowledge and understanding of CDS, but the offsetting thing is like hedging your bets. The problem is because the bets involve multiple parties, if one of the players goes bust then the offsets are gone and you will be stuck with potentially large losses.

See this explanation.

4

^ 3

Simple Example

Shy Elf.

Tue Sep 30, 2008 at 08:40:24 PM EST

5.00 (informative)

  1.  Party A buys a bond issued by Party B
  2.  Party A insures said bond at 3%/year cost by buying a CDS from Party C
  3.  Party A sells said bond.
  4.  Party A offers to sell said CDS.  Party C offers 3%/year.  Party D offers 3.5%/year.
  5.  Party A sells said CDS to Party D.
  6.  Party C goes bankrupt.
  7.  Party B goes bankrupt.
  8.  Party A is fucked.

5

^ 4

Re: Simple Example

delete me.

Tue Sep 30, 2008 at 09:47:20 PM EST

none

+simple

- derumi (del-me)
"Bobby Fischer? Man, that guy is crazy!" - Mike Tyson

6

^ 4

Re: Simple Example

JimmyHavok.

Wed Oct 01, 2008 at 04:06:13 AM EST

none

In  other words, the system works fine until you have both party B and party C going bankrupt, and in that case you get a  cascade of bankruptcies that showers through the system...and in some cases, the fall of party B may be enough to bring down party C, depending on how many of party B's transactions they insured.

The smaller the number of possible parties there are to these transactions, the greater the danger of a cascade.

2

^ 1

Re: The Financial Instrument That Ate The Earth

thefadd.

Tue Sep 30, 2008 at 05:17:16 PM EST

none

The easiest answer is that it could be competing managers within the same company. But you are right--one thing I've noticed that these companies do a lot of is investing in $100 in seeing X succeed, then investing $50 in seeing X fail. Is it simply that it expands the balance sheet a la Enron? I too would appreciate an informed answer.

I was at a poker game with an international finance guy last week and he was touting this derivatives and credit default swaps as the next big market bust so that is what piqued my interest in them. Of course he was also predicting a linking of the dollar to a commodity standard within 2-3 years.

It is easy to buy small plaster models of what you think life is like.

7

^ 2

Re: The Financial Instrument That Ate The Earth

gerrymander.

Wed Oct 01, 2008 at 10:44:40 AM EST

none

one thing I've noticed that these companies do a lot of is investing in $100 in seeing X succeed, then investing $50 in seeing X fail. Is it simply that it expands the balance sheet a la Enron?

What you're talking about is known as a "straddle." It's like placing a chip on the "insurance" box when playing blackjack*. If you only buy a big position you'll get the most benefit when the value goes up, but you also get hit with the full loss if it goes down. Place a smaller bet on the other side, however, and you make some money to offset the loss if the market drops. In either case, you can try to get out of the side you don't want when you know which way the trend is going.

* The blackjack "insurance" box is a sucker bet because it only pays off when the dealer shows an ace. The strategy works better in actual financial markets.

This story: 7 comments (0 from subqueue)
Post a Comment

search »
Login »
Make a new account
Related Links »
thefadd's Diary
QuickLinks »
If 39% isn't diverse enough, what is?
From the previous QL's link: Sidwell has between 1,000 and 1,100 students and says 39% of them self-identify as students of color.
- delete me
<—————+————Ο>
The OBAMA has spoke
Diversity for thee, but not for me!
- Steve Urkel
<—Ο———+—————>
Obama Picks Treasury Sec'y
Obama finally announces the selection of NY Federal Reserve President Timothy Geithner as the new Treasury Secretary, and the Dow jumps up 7%. Tell me again how markets don't react to political appearances.
- gerrymander
<———Ο—+—————>
Best pareidolia ever
Submitted for your approval: a family portrait is rudely interrupted by a giant Jesus head.
- Steve Urkel
<—————+——Ο——>
Hindsight's a Bitch
Dow Jones is down 40% this year. Remember the movement to privatize Social Security?
- DEMachina
<—————+———Ο—>
Why are the automakers in this mess?
Humourous comment here. Let's bail them out!
- pO157
<—————+—Ο———>
Have you heard?
Obama may have a Polish connection.
- Steve Urkel
<—————+——Ο——>
Al-Qaida wrong again
Al-Qaida number two (insert your own joke here) calls Obama a House Negro. That is so wrong...everyone knows he was a 'Senate Negro'
- Lou
<—————+————Ο>
Submit a QuickLink:
If you'd like to submit your own QuickLink, you'll need to log in (or register) first.

Users own their contributions, all else is © 2006, 2007 Trees and Things, Incorporated.

Powered by Scoop.

Terms of Service

Privacy