A CDS is just like an option contract on stocks, except options are regulated by the OCC so there is no counterparty risk. The solution to that is to set up an agency similar to the OCC or the CFTC (for Futures). The margin required is also the same as options and futures. When you sell calls and puts and the stock moves in the money... you have to post collateral. This isn't any different, it's just another derivative. The problem is that you can't tell how many contracts a bank has written because it's not public. If there was an agency like the OCC or CFTC this information would be required and the exposure would be regulated (since it's obvious they can't regulate themselves).
Exactly, its not CDS's per se that are at fault, its the fact that they are traded OTC. So a zero sum contract suddenly shows a profit in both books, why because its OTC and we can basically mark it where we like. Put the stuff on a public exchange and watch!
CDS are a huge part of the problem. When the Global Financial Community is on the wrong side of a 65 Trillion dollar bet, they're completely fucked = total breakdown unless the Government steps in and prints money. Which is exactly whats going on. In some instances, CDS exposure can be netted or hedged sufficiently to prevent a global collapse. We can only assume this was the case in Lehman's Chapter 7 filing that saw an emergency netting session on Sunday prior to market open. In other pending bankruptcies, the exposure may be too systemic, counter-parties too varied or unwilling to net at a loss to themselves, and consequently, a bailout must happen or the first domino in a sequence of 1,000's will fall. I've said this a lot of times around here but not many people really get it because they don't understand what a Credit Default Swap is or the leveraged nature of the product. Wallstreet basically put a gun to the Treasuries head by writing Trillions in Options. We take the premium. And if we get caught on the wrong side, YOU bail us out or the entire economic and political landscape Will Burn. Basically, its financial terrorism.
I actually have no problem at all with greed, greed and more GREED! That's how I make my living. But you know what? If I fuck up, I get eaten. End of story. What pisses me off is that all of these firms preached free market methodology for SO many years, eschewing taxes and any government involvement in their affairs until they realized that THEY were the ones that were next on the menu. All of a sudden we need regulation and oversight and taxpayer dollars to bail us out. They created this wild animal. Then they scream like stuck pigs when it spins around and tears their fingers off. I wouldn't piss on Barney Frank if he was on fire, but I agree with him in confiscating the compensation from these thugs. If you're going to dance, you have to pay the band.
Help me understand, these are contracts. For every winner an equal loser. But they are marked to market, so for every traspearant transaction or modeling event you mark your contract to that transaciton or event. Does not take a lot of outliers and you are marking way down and dising up big collatoral on your eventual winners and losers, actual and otherwise. Easily manipulated game of bilion dollar poker in my book.
These CDSs are private contracts between business entities - analogous to if I agreed to sell you my office building and you agreed to purchase it for a specific price, with the contract being binding. How could the government come in and void what probably are millions, if not tens of millions, of CDSs' contracts?
This is from the original article. I think I am gaining a handle on some of this, but I still don't get what happens if we *don't* bail everyone out. So what if it takes years to sort out a bankruptcy? What does this mean? What happens during those years? Why is this option "untenable"? I hear "worldwide financial meltdown" tossed around but I don't know what that really means, and no one has connected the dots as to how we get from here to complete meltdown. And I hear Paulson say we need to do this so consumers can start getting car loans again. WTF? Is he saying our financial system will collapse if people stop taking out loans they can't afford to pay back? If so, why not let this house of cards collapse?