Credit Default Swap: A "swap" (trade) designed to transfer the credit exposure of fixed income products between parties.
Or there's this definition:
A specific kind of counterparty agreement which allows the transfer of third party credit risk from one party to the other. One party in the swap is a lender and faces credit riskfrom a third party, and the counterparty in the credit defaultswap agrees to insure this risk in exchange of regularperiodic payments (essentially an insurance premium). If the third party defaults, the party providing insurance will have to purchase from the insured party the defaulted asset. Inturn, the insurer pays the insured the remaining interest on the debt, as well as the principal.
Good luck with a definition of a credit default swap. Trust me on this. Google "credit default swap" and go through the list, see if you can understand it.
Here's the best, simplest definition I could find: The buyer of a credit swap receives credit protection, whereas the seller of the swap guarantees the credit worthiness of the product. By doing this, the risk of default is transferred from the holder of the fixed income security to the seller of the swap.
What it boils down to is a giant ripoff, designed by JP Morgan and company:
The first CDS contract was introduced by JP Morgan in 1997 and by mid-2007, the value of the market had ballooned to an estimated $45 trillion, according to the International Swaps and Derivatives Association - over twice the size of the
And as anyone who has read anything by Matt Taibbi of Rolling Stone magazine would know, these are a) not really, officially "insurance" at all and so b) are not regulated by the Federal Government. The banking community created a $45 trillion dollar market and has kept it away from any regulation which would be fine but if this market crashes, as it nearly did in 2008, it could take down not just the US markets but the world's.
So here's what's been going on, and what a "naked credit default swap" is, as told by that same Matt Taibbi, on his blog (link below):
In insurance...you can’t buy policies on someone else’s property. But in finance, you can buy credit default protection on anything, whether you own the underlying property or not. This is called a naked credit default swap. So if Bank of America is holding a billion dollars in mortgage-backed securities, Goldman Sachs can actually buy swaps on all of those MBS, even though it doesn’t own them. Your problem with this is that you don’t understand it because you think it doesn’t make sense, and that’s because it doesn’t make sense – a naked CDS is totally indistinguishable from gambling, but it’s legal. There was an ill-fated attempt by Byron Dorgan to outlaw naked CDS in the negotiations for the Dodd-Frank bill, but that attempt failed.
So, other than the fact that Goldman Sachs is inside the White House and has been for at least decades and the fact that the banking industry virtually runs, if not owns our government, why have we not made "credit default swaps" and especially "naked credit default swaps" illegal? It's a great question. CDS's and the banking industry nearly wrecked our economy and they're still running the game.
Why are you not mad as hell?
And why aren't you raising hell with your Congressman about this?
(Well, other than the fact that we're all just trying to keep our jobs, not have our unions wrecked by the Republicans, keep up our payments on our homes and our outrageously-high health care, etc., etc.)
Final note: If you want to get a great, enjoyable, even fun, if sick read that will also tell you where America has been economically for the last decade or so and where we likely still are, go get Matt Taibbi's
book Griftopia: Bubble Machines, Vampire Squids, and the Long Con That Is Breaking America. You'll be very glad you did.
Links: http://www.rollingstone.com/politics/blogs/taibblog/mailbag-friedman-naked-swaps-and-madoff-20110228
http://www.investopedia.com/articles/optioninvestor/08/cds.asp
http://en.wikipedia.org/wiki/Credit_default_swap
http://www.rollingstone.com/politics/news/exclusive-excerpt-america-on-sale-from-matt-taibbis-griftopia-20101018
http://www.randomhouse.com/catalog/display.pperl/9780385529952.html
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7 comments:
"Good luck with a definition of a credit default swap"
...but even though you can't define them, you want to make them illegal.
It doesn't matter what is outlawed--Goldman Sachs and their ilk will find the next loophole, and the one after that--Complexity is to their advantage, lets them succeed where smaller or more honest companies can't.
We need to focus on disclosure, making sure investors really know what they are getting involved with--that the information is actually available and not locked in the bottom drawer of a filing cabinet in the ladies' toilets at the back of the second sub-basement of an obscure office block, behind a door bearing the warning "Beware of the Leopard"
Geez, you're better than this argument.
Just because the definition of the nonsense that is a "credit default swap" is slippery doesn't mean they're a good idea, by a long shot. Further, just because I show they're difficult to define doesn't mean they can't be defined.
Yes, they should be outlawed. They are one more facet of a creative, insane industry that nearly brought down our economy.
Then, in addition to making them illegal, focus on disclosure for everything--these, hedge funds, etc.--especially when they get in the billions and trillions of dollars.
Definitions in the law are quite important, but that's not even the most important point here.
While there may be benefits to certain individual regulations, once you reach a certain level of complexity (that we passed decades ago) additional business regulations are far more likely to favor large, wealthy and less-honest businesses, and make it far more difficult for individuals, small companies and startups. It doesn't particularly matter what the regulation is, Goldman Sachs will have an easier time complying with it, and how it interacts with others than Minster Bank.
It sounds like you're saying we should just not legislate any longer, first, and I admit we don't want to try to "legislate to utopia". If we get Goldman Sachs out of the White House, as we should, they wouldn't have an easier time with it--if they weren't writing the legislation themselves, they wouldn't have an easier time of it.
No, that would be anarchy, too far towards the other direction.
Yes. You are so right. I believe that this is maybe our only option, to make Naked CDS's illegal, because of the European melt down. With Europe being made of of so many different economies and with NO mandate to deal with the CDS situation, we have to consider considering this a problem of the utmost national security to the entire world.
Making naked Credit Default Swaps simple illegal is one of the most innovative ways to deal with this economic crisis. Yes, this is a legal problem because the entire Naked CDS market has very little legal footing beyond being a set of betting contracts. Do you really thinks for a minute that if an extremely large number of business in the same country all defaulted on their CDS's that the holders of these contracts would really be able to pay off their CDS contacts at face value. The answer leads us to realize that the people that are insuring others through CDS contract are far from able to ever hold reserves big enough to call themselves insurance company. Naked CDS's are not insurance contracts but only betting deals to make money and give other businesses a false sense of security. One does not have to be an actuarial to realize that this is not insurance. Statistically it is nearly impossible for only so many people do die in car accidents in any given area. during a one year. However, because of the interconnectivity of their being so many CDS's, almost every business is at serious economic risk if just a few major players default on their CDS's in a particular county this year. Didn't you guys take Statistics in College?
The amount of money that exchanged hands during the last CDS crisis in America and all over the world was absurd and simply should never have happened. Political officials and the news media still persist in blaming the crisis on the sub-prime market, when in fact the CDS market was in the foremost focus when the US government did the deal to fund the Banks. What triggered the bank funding was the ultra high cost of CDS's and not because the banks were close to defaulting on the relative small Sub-prime market. These facts have been supported by many discussions of important business people over recent years on CNBC news among other places. No one seems to take a stand against Naked CDS's. Lets make them illegal before it is too late.
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