I find the way these threads morph into conspiracy theory and eventually dip into astrological-like predictions to be extremely entertaining. There are some very creative minds (even if defectively wired) at work here.
Not quite. Let's say you are a bank holding bonds in Corporation A. To protect yourself, you purchased a credit default swap on the underlying face value. Corporation A starts to deteriorate and so do the value of the bonds you hold. Thank goodness you bought that insurance against default which has risen as the bonds have fallen. But here's the rub, the guy you bought the insurance from (AIG and countless others) cannot afford to pay you. They are insolvent. Suddenly your balance sheet looks terrible. The bonds you held are now worth 20 cents on the dollar and your insurance is worthless. Now multiply this across thousands of financial institutions around the world. Even the safest institutions are STILL exposed to systemic risk which they cannot hedge away (you can't solve a derivatives problem with more derivatives in the same way the U.S. government can't solve a debt crisis with more debt. Doh!) A very big problem. I think this is why guys like Steve Cohen have shut down their big operations for the year. A quick plunge in the DOW to 6000 is not unimaginable (S&P 500 earnings for 2009 are projected at $50, slap a 12 multiple on it and you get 600 on the index. Some bear markets tough at even lower multiples and given the extremes we've seen, it is certainly possible)
600 Trillion? Of course not. And even if global economy was worth 600T, most products/services are NOT backed by derivatives. As if there were default swaps for everything, even for prostitutes; in case the customer doesn't pay.
These statistics prompting news stories about 600 zillion in derivatives are misleading. I'm sure a few of you trade Eurodollar futures every now and then. Each CME contract is worth $1,000,000. Much of the activity is spreads and the spreads are most often pretty stable. You need to trade size for the movements to matter. So a trader with 100 Dec-March ED spreads can brag to the girls in the bar that he has two hundred million dollars worth of "exposure" but in reality his ultimate risk is no more than one of us trading naked long or short 5 or 10 ES. The true exposure in OTC exotics isn't systematic market risk but counter party risk. We're quickly seeing counter party risk re-regulated. The threat going forward isn't going to come from the use of exotic derivatives per se' but just good old fashioned asset depreciation, over extended Government borrowings and God forbid a few VERY expensive natural disasters......
Some good sense out of you, Pabst. Thanks for bringing this back to reality. As long as you stay away from politics you keep your vulnerabilities well protected. I'm not going to be surprised if the S&P heads south to 600. But please, not before May!
8.2 cents on the dollar? or 8.6 cents? I can't remember which. That doesn't bode well, given the much greater publicity of that event and the efforts the government has taken to establish a price - any price - for Lehman CDS's.
By the way, Zuckerman is on Bloomberg Saturday talking exactly about this and the NOW conventional wisdom that this could be every bit as disastrous as the article suggests. "Nobody knows where this ends." "That is a nonsensical answer by [Bernanke] and [Paulson]..." - when asked by the interviewer if the money allocated will even make a dent in this crisis. We've never been in these waters before. It's a completely unpredictable event. ...all because someone was clever enough to coin the term 'credit default SWAP' rather than 'insurance,' so as to avoid the regulation that insurance brings, such as setting aside enough capital reserves to pay off on the policy. ...By the way - how many freaking meetings are they going to have? http://www.bloomberg.com/apps/news?pid=20601087&sid=aiH3z_aP7pxY&refer=home