Now that the economic tsunami seems to be abated --at least for the time being- it's time for the cleanup. And, like anyone who has had to assess the damage of a tornado, earthquake, hurricane--name your natural disaster-- it's also time to try to figure out what the Hell just happened.
It's called Credit Default Swaps...sometimes referred to as CDS but when you search that on Google you just get stuff for the other CDs - think music, think banks. CDS has not reached national lexicon status just yet --but they will because the 10 year old Credit Default Swap is what made the global economy come tumbling down.
As someone whose eyes begin rolling to the back of my head whenever economists start jabbering about financial instruments it has been particularly challenging to get my head around Credit Default Swaps. But... I have and may I say that if I can get a basic understanding of Credit Default Swaps..just about anyone can too.
From my post on Credit Default Swaps at BlogHer.
From HowStuffWorks :
Imagine that you could purchase your friend Jimmy's health insurance
policy from the company that issued it. Everything's going smoothly;
you're raking in the dough as Jimmy makes his monthly payments. But
things take a sudden turn for the worse after Jimmy's legs are crushed
in a car wreck. Jimmy can't afford the healthcare costs, but luckily
he's insured -- by you.
You find nothing but cobwebs in your savings account
and realize that you can't pay for Jimmy's health care. Jimmy's still
insured (he's faithfully made his premium payments), so who pays the
hospital bills? The insurance company sold the policy to you, and you
owned it when Jimmy's accident happened. You were caught with the hot
potato.
Jimmy's hospital realizes his insurer won't cover his costs and
releases him, but he still requires care. So Jimmy sues you to pay up,
but you just blew all of your money completing your collection of Pat
Boone albums, which suddenly doesn't seem like such a good investment.
Even worse, a trove of Boone's albums was discovered in the estates of
some recently deceased collectors, and the market value of your
collection plummets. You sell the collection for half of what you paid
for it and put it toward Jimmy's health care costs, but it's a drop in
the bucket. Ultimately, you're forced to declare bankruptcy.
Whenever there is a disaster, there is a natural inclination to try to find someone to blame. Usually, there isn't one person or one set of events. So when I went investigating to learn who, if anyone, we could blame for this mess, I really didn't think that Google would grace me with a name -- but it did. Her name is Blythe Masters--she came up with the idea when she was just 34 years old.
NC Painter found an article written by Ms. Masters in 1997 where she explains her concept -- this is where my eyes roll --but maybe you'll have better luck. There are two parts that I understand.
Ms Masters projected at the beginning of the article that,
Five years hence, commentators will look back to the birth of the credit
derivatives market as a watershed development for bank credit risk
management practice. Credit derivatives will fundamentally change the
way banks price, manage, transact, originate, distribute and account
for credit risk.
She got that wrong. It was more like ten years and yes commentators are looking at the birth of the credit derivatives market as a watershed --but not for the reasons Ms. Masters envisioned.
And my favorite part of the very short article was the last line
By enhancing liquidity, credit derivatives achieve the financial equivalent of a free lunch, whereby both buyers and sellers of risk benefit from the associated efficiency gains."
If only she had read science fiction writer Robert Heinlein, who introduced all of us to the idea in 1966 in his novel,The Moon Is A Harsh Mistress, that when it comes to the economy, there is no such thing as a free lunch.
Recent Comments