[Paisleychick-lj] Reflections of reality

[Beatrice M's blog]

[![][1]][2]   
[Golden Tinted Windows][3]   
Originally uploaded by [blmurch][4]. 

So I was just [reading about another market layer][5] that might drop out - "credit default swaps". The article wonders if this "arcane term" will become as common a household word as "subprime mortgages". Credit default swaps are fairly unregulated and seem to be in trouble. One of the things is that they're sold or "swapped" around - just like the mortgages have been sold by the banks that the people bought their mortgages. Usually it was the second mortgage that was/is sold, but the first can be sold off as well. What's to stop people - banks & insurers - from buying something they sold off before without realizing what they're buying? Artificial market anyone??? Now, I of course realize that I'm not an economist, I only took Econ 101 at UPenn back in the early 90s. But, this just doesn't seem right nor does it bode well.

> "Because these contracts are sold and resold among financial institutions, an original buyer may not know that a new, potentially weaker entity has taken over the obligation to pay a claim.  
  
In late 2005, at the urging of the Federal Reserve Bank of New York, market participants agreed to advise their trading partners in a swap when they assigned contracts to others. But it is unclear how closely participants adhere to this practice.  
  
It would be as if homeowners, facing losses after a hurricane, could not identify the insurance companies to pay on their claims. Or, if they could, they discovered that their insurer had transferred the policy to another company that could not cover the claim.  
  
Credit default swaps were invented by major banks in the mid-1990s as a way to offset risk in their lending or bond portfolios. At the outset, each contract was different, volume in the market was small and participants knew whom they were dealing with.  
**...**  
To be sure, the $45 trillion in credit default swaps is not an exact reflection of what would be lost or won if all the underlying securities defaulted. That figure is impossible to pinpoint since the amounts that are recovered in default situations vary.  
  
But one of the challenges facing participants in the credit default swap market is that the market value amount of the contracts outstanding far exceeds the $5.7 trillion of the corporate bonds whose defaults the swaps were created to protect against.  
  
To the uninitiated trying to understand this complex market, its size might initially seem a comfort, as if there were far more insurance covering the bonds than could ever be needed. But because each contract must be settled between buyer and seller if a default occurs, this imbalance can present a problem."

As an aside - have you seen [this video by the Dean of Columbia School of Business Glenn Hubbard and some of his students][6]? Hilarious. :D Gawd, I love geeks of all stripes.  


   [1]: http://farm3.static.flickr.com/2255/2068150766_d827403c80_m.jpg
   [2]: http://www.flickr.com/photos/blmurch/2068150766/ (photo sharing)
   [3]: http://www.flickr.com/photos/blmurch/2068150766/
   [4]: http://www.flickr.com/people/blmurch/
   [5]: http://www.iht.com/articles/2008/02/17/business/swaps.php
   [6]: http://www.youtube.com/watch?v=3u2qRXb4xCU

URL: http://paisleychick.livejournal.com/333826.html