16 September 2008

Ras ( and most of the rest of us) called it

If ANY of these jokers who destroyed RasputinLives NEW 9/16/2008 5:11:55 AM

...the world's financial system try to claim:

"NOBODY could have predicted that CDS would have been such a problem"

...I direct the posters here to a post I wrote more than two-and-one-half years ago on this very subject.

Below, please find that post and note that at that time the total outstanding CDS positions were a "measly" $12 trillion fiatscos against $5 trillion of debt. Now, they are estimated at $62 trillion on $6 trillion of debt and are failing outright.

In any event, here is my original post:

rasputin NEW 1/8/2006 10:23:31 AM A HUGE issue with the CDS markets is...

...a very simple premise:

"insurable interest".

In the real world (outside of the derivatives fantasyland), one CANNOT buy insurance against an event unless they have what is known as an "insurable interest" in the asset. For instance, one cannot buy life insurance on strangers, property insurance on buildings they DON'T own or car insurance on some random teenager who has a hot new Mustang. (Although this last instance would be tempting!).

Not so with CDS.

Any joker who wants to pay the premium can buy "insurance" against, say, a GM default, whether or NOT they actually own the underlying bonds. This--in my view--crosses the line between insurable interest and dives into the casino-like gambling arena.

Now, I don't have any particular problem with gambling. However, a few nasty little issues rear their ugly heads when the gambles are on financial instruments:

1. The previously-mentioned "insurable interest", which from the insurer's standpoint presents inordinate risk that NO prudent real-world insurance company would accept.

2. The ever-present "moral hazard" that the central banks have fostered by bailing out non-bank players like LTCM, which only incents players to underwrite these risks.

So, what we have now is an exploding CDS market. And oh by the way, UNLIKE interest-rate swaps, when CDS bets go "wrong" against the insurer, the insurer is on the hook for THE ENTIRE NOTIONAL AMOUNT (Less whatever value is left of the underlying debt--probably zero)!!!

So, we have $12 trillion in bets against credit default exposure of $5 trillion, which outstrips the actual amount of bonds issued by a factor of at least two.

In addition, the CDS might also be a part of a CLO,CDO, or other alphabet soup of "diced and sliced" debt. Can you say "Cascading cross-defaults?"

(Ras): So, there you have it folks. Lowly Rasputin could see this coming a mile away, but NO Wall Street gambler OR federal or state regulator OR Congress could?

We're scroomed. I knew it even back then. I tried to warn people about it then. They wouldn't listen to me.

Now, everybody is gonna know it. And feel the pain.

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