Credit Default Swaps: The Poison in the System

Weekend Edition
May 22-24, 2009

Credit Default Swaps
The Poison in the System
By MIKE WHITNEY

In a little more than a decade, Credit Default Swaps (CDS) trading ballooned into a lucrative multi-billion dollar industry which has changed the fundamental character of the financial system and increased systemic risk by many orders of magnitude. CDS, which were originally created to reduce potential losses from defaulting bonds, has turned into a cash cow for the big banks, generating mega-profits. In the case of insurance giant AIG, losses from CDS transactions has already cost the American people $150 billion, and yet, there still has been no serious effort in Congress to ban them once and for all. Even worse, CDS is the root-cause of systemic risk which connects hundreds of financial institutions together in a lethal daisy-chain.

CDS contracts are not cleared on a centralized exchange nor are they government regulated. That means that no one really knows whether issuers of CDS can pay off potential claims or not. It's a Ponzi-insurance racket of the first order. AIG is a good example of a company that gamed the system and then walked away with millions for its efforts. They sold more CDS than they could cover and then -- the debts started piling up around their eyeballs -- they trundled off to the Fed for a multi-billion dollar bailout. Fed chief Bernanke later said that he was furious over the AIG fiasco, but it didn't stop him from shoveling the losses onto the public ledger and making the taxpayer the guarantor for all AIG's bad bets. Keep in mind, that AIG was selling paper that had zero capital backing, an activity is tantamount to counterfeiting. Still, no one has been indicted or prosecuted in the affair. Defrauding clients and then sticking it to Joe sixpack has become de rigueur on Wall Street.

CDS have spider-webbed their way into every corner of the financial system, lashing together banks and other financial institutions in a way that if one defaults the others go down too. This is what's really meant by "too big to fail"; a euphemism which refers to the tangle of counterparty deals which has been allowed to spread -- regardless of the risk -- so that a handful of banksters can rake in obscene profits. CDS has become the bank cartel's golden goose; a no-risk revenue-generating locomotive that accelerates the transfer of public wealth to high-stakes speculators. If it wasn't for the turbo-charged profits from derivatives transactions, many of the banks would have already gone belly up.

Treasury Secretary Geithner recently sounded the alarm for more regulation, but it's just another public relations stunt. Geithner is an industry rep whose sole qualification for the job as Treasury Secretary is his unwavering loyalty to the banking establishment. He has no intention of increasing oversight or tightening supervision. All the blather about change is just his way of mollifying the public while he tries to sabotage congressional efforts to re-regulate the derivatives market. In the next few weeks, Geithner will probably roll out a whole new product-line of reforms accompanied with the usual claptrap about free markets, innovation and "protecting the public's interest". It's all fakery. Fortunately, sad sack Geithner is the world's worst pitchman, which means that every word he utters will be parsed by scores of bloggers trying to figure out what he really means. That will make it especially hard to for him to pull the wool over the public's eyes again.

"Too big to fail" is a snappy PR slogan, but it's largely a myth. No financial institution is too big for the government to take into conservatorship; to put the bad assets up for auction, replace the management and restructure the debt. It's been done before and it can be done again without damaging the broader system. The real problem is separating healthy financial institutions from insolvent ones now that the whole system is stitched together in a complex net of counterparty deals. Credit default swaps form the bulk of those counterparty transactions, which makes them the main source of systemic risk. To fix the problem, current contracts must be either unwound or allowed to lapse, while new contracts must be traded on a central clearinghouse where regulators can decide whether sellers are adequately capitalized or not. The Fed's solution -- underwriting the entire financial system to prevent another Lehman Bros. Fiasco -- doesn't address the fundamental problem; it just puts more pressure on the dollar which is already beginning to buckle. The question now is whether Congress will pull its head out of the sand long enough to do the people's work and pass the laws that will re-regulate the system. There is a remedy, but it requires action, and fast. Without course-correction, the prospect of a derivatives meltdown gets bigger by the day.

Please read the complete article at:

http://www.counterpunch.org/whitney05222009.html

:hi:

Instead of throwing our seed corn away and flushing our last dollar down the Bankster-Black-Hole... we should have used the money to put Americans back to work ...rebuilding our rail system and electrical grid.

Clean drinking water, national health care and wind-farm energy would also have created jobs.

I don't know, I can't see behind the scenes and our press certainly doesn't tell us what is really happening.... so I can only guess.

Maybe Obama and Geithner have bought us some time... but the wolf will be at the door any time now and the inevitable will happen.

The bovine excrement is going to hit the rotating wind device very soon in California. Rumor has it that the State is going to cut off all welfare and public payments. I look for large numbers of people leaving the State.. tent campers and people sleeping in their cars... headed east.

:thumbsup:

It will be the beginning of the great depression.

They are trying to save a failed system.

He is part of the problem.

And Obama is showing us daily that that is who he is working for.

And Congress doesn't have its head in the sand. Rather, they answer to the same Masters of the Universe that Obama answers to.

The middle inocmed person is being destroyed. And no one cares at any level except that of us bloggers and a few people like Moyers as far as the media.

:kick:

our GDP is fifteen trillion

that's fifty times the size of the world's largest economy

wtf?

A CDS is an insurance product. Back at the turn of the century you had Insurance companies involved in a similar Ponzi scheme. Same thing happened they all went bankrupt and the policy holders all were left with nothing for the premiums they had paid.

The states created a system of regulations that required the insurance industries to carry assets called reserves for the risk they were taking. It limited the amount of risk any one insurance company could take on.

The Clinton and Bush administrations chose to not classify these products as insurance products out of fear that they would be marketed somewhere else and wall street wouldn't get the money from them. Guys like Summers, Greenspan, and Geithner assured those administrations this would never happen.

They were wrong. Never underestimate human greed.

Far too much of what is called "money" in our financial system owes its very existence to such derivatives where they're bundled, tranched, and traded almost as a currency-equivalent. Pulling the plug will be enormously painful ... but the alternative is a total melt-down.