Credit Default Swaps: Yes, You Have to Think About Them

Yes, ev'rybody's talkin' 'bout bagism, dragism, thisism, thatism, ism ism ism. And, of course, credit default swaps.

Arnold Kling over at Econlog has an interesting little exposition on why you should care, and connects them with some genuine fears about the possible effects of runaway short-selling (for more on which, see this piece from me from last month).

The key, from Kling:

A credit default swap is like insurance against default. If you want to buy a municipal bond or a corporate bond but not take default risk, you try to buy a credit default swap. You pay a fee, and in exchange for that fee the seller of the swap will make you whole if the city or corporation defaults.

The seller of swaps collects nice fees, and most of the time the borrowers don't default. But if borrowers do default, then the seller is like an insurance company in a town that was hit by a hurricane.

Sounds grim. How can the seller of such a swap hope to survive?

Suppose I have sold a credit default swap on Sallie Mae. That means that if Sallie Mae defaults on its bonds, I will have to pay some of the bondholders a big chunk of money. One way I can hedge that risk is to sell short Sallie Mae securities..... However, the more short-selling takes place, the closer they get to default. It is a vicious cycle. Ordinarily, I do not believe that short-selling affects the price, but when there is massive short-selling that is driven by dynamic hedging, I can see where the short selling would drive down prices.

So, does this mean that even the formerly soft on short selling Kling thinks there is a sensible place for short-sell bans or restrictions? It's a little more complicated than that, as are most things in the world of contemporary high-flyin' high finance. Short selling, after all, is a big way** the sellers of the swaps can hope to ride out the storm. Thus:

....if the government tries to curb short-selling, all that does is cripple the credit default swap market. It becomes costly to sell default swaps, so now creditors cannot get them at affordable prices. The only way they can reduce exposure is to sell their munis and their corporates and flee to Treasuries. I'm not saying that the curbs on short selling make things worse, but such regulations certainly don't solve the problem--at best, they shift it.

If my theory is correct, then the credit default swap protection is somewhat of a delusion....It is too late to undo the delusion. In the aggregate, markets under-estimated the risk of the bonds they were buying. The risk premium needs to adjust upward. That upward adjustment is not a credit squeeze--it's a return to reality.

See Kling talking general bailout horrors in this reason.tv clip.

**Amended from "only way" thanks to the totally justified comment from Gilmore.

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  • ||

    The short selling ban has screwed up the convertible bond market (making it harder for public companies to raise money). It wouldn't be surprising if it screwed up other markets as well.

  • GILMORE||

    From A
    One way I can hedge that risk is to sell short Sallie Mae securities.....


    To B
    Short selling, after all, is the only way the sellers of the swaps can hope to ride out the storm

    = ~Not true

    It's *one* way. Another way is to invest large static sums long term in a diversified pool of high & low yield bonds across a wide range of low-swap protected munis and corporate bonds. Or solid assets you can sell, like gold or commodities. And many many other ways. You'd want by nature to have a wide array of securities to offset swap risks - not simply single-security shorts as a 1-1 match. Your subject that you quote would have explained this to you in conversation, but to cherry pick a few sentences and go, "Ergo!..." is reductive and unhelpful when trying to explain financial strategies to people who dont know a CDO from a CDS from the TED spread or the LIBOR or what STRIPS or PIPES or REITS or what pair trades or short straddles are.

    In the last 2 weeks i've noticed that the H&R crowd, which i've always appreciated and been impressed with, are generally pretty informed about economic *theory*, but next to nothing about either day to day economic analysis or the relationship of the financial world to the rest of the world (e.g. the false Wall St vs Main Street dichotomy)

    Seriously. There was a thread a few posts ago where 99% of the "free marketers" were all braying "DIE WALL ST DIE!!" and joe was smugly just saying "well, I told you so!". Everyone is turning into caricatures of the "average joe" who dont know nuthing, but still knows some motherfucker is to blame, and i bet its them fat cats with their fancy calculators and all those funny sounding finance things which is all probably a 'Ponzi scheme' (mainly because if i dont get it, then it must be BS, since i'm such a 'getting it' kind of guy'

    its been kind of disappointing.

  • ||

    Fuck it! Let the apocolypse come. My peeps will do just fine.

    {rant}

    My paternal grandfather and his brother, although hardly educated men (8th grade), had great "native intelligence", work-ethic, and thrift.

    During the depression, while everyone else was bugging out, they used their savings to buy up land at fire-sale prices in tax sales. They then worked hard, made do with used and homemade equipment, and prospered*. Eventually they jointly owned some 20 square miles of good farm/pasture land, made sound investments, and at their deaths, their estates were each around the $4M mark. The money went into family trusts.

    *Of course, gas/oil royalties from a dozen or so wells didn't hurt the bottom line :-}

    My maternal grandparents have a similar, though not as successful, story.

    My parents, being depression kids, also know the value of thrift and work. Dad put himself through college, and worked for various railroads for 40 years. Mom went back and got a special-ed degree when I was a teen. They lived on dried beans, rice, garden veggies, and raised poultry for the first ten years of their marriage. We lived in a 8'x48' trailer till I was 12, drove used cars. They then built a beautiful, though certainly not palatial, 5 BR home paid for with CASH. I don't think they were EVER in debt for a penny.

    They continued to save and invest, and lived within their means. They have a tidy net worth of their own now ($1M+), and combined with the income stream from the family trusts (which they are now in line for) are quite secure financially. Of course, being depression kids, they only draw from the trust if they absolutely have to, otherwise they revest.

    I have a professional career, but NEVER forgot where I came from, or the lessons I learned from the grandparents and parents. I used to work summers for Gramps as a teen, 12 hour days for room/board and a whopping $500 because "it builds character". Worked with Dad weekends at various endeavors from age 10. (payed for family vacations and put money in my pocket to buy my first wheels)

    My wife and I both put ourselves through college, no handouts from mom and pop (see a pattern here?).

    Wife is a critical-care RN. I was a Paramedic and instructor of same for 25 years, taught myself computer programming just because it looked like fun. When an ugly auto accident put a serious "hitch in my git-along", I parlayed my knowledge of health care and insurance into an insurance brokerage for several years. I took that experience combined with my love of mathematics and 0's-1's, and went into risk management/analysis.

    Well, that and on-line poker ;-}. I have a nice hedge fund that started before on-line gambling became evil. It keeps growing, sitting off-shore; but I may have to eventually expatriate in order to get at it legally.

    I am quite happy to be self-employed as my love for certain herbs and organic compounds makes standard employment a bit complicated.

    We rented for about 7 years and saved our chips. Although I would have saved long enough to buy with cash, a golden opportunity came up, and I ran with it. We took over roughly 1/2 of the back-end of a mortgage on a nice house from a "motivated" seller for a token $2K. (Presto! instant equity!) Paid off the balance 5 years early. Added 1,000 sq ft to it a couple of years ago with CASH.

    (I politely turned down a horde of lenders with some pretty interesting re-fi offers with a smile instead of a kick in the nuts :-} )

    Bills are all paid, cars are all owned outright, etc. When I hit the "Golden Years", I won't have to work unless I still want to. In my dotage, after my parents have gone on to their happy hunting grounds, my siblings and I will have access to the income stream from the trust if we need it.

    Here's the main thrust of this rant:

    1. I have absolutely no sympathy for individuals, companies, corporations, OR governments who are so enamored of the American Dream that they refuse to live within their means.

    And before some redistributionist (you know who you are, Joe) makes the argument that "yeah, but you had advantages", I call bullshit. While my family has money, it's THEIR money, which they fucking earned. If they want to leave part of it to me in their will, great. If they want to spend it all on hookers and blow, (wow, thank me for a horrific visual!) that's their business. I'll be just fine. No one gave me shit other than the proper mind-set, and I am eternally grateful for that.

    I recall a news story several years ago about a man who worked as a janitor all his life, and left close to $1M to a charity. There's NO excuse for leaving planet Earth with a negative balance sheet unless you are physically/mentally incapable of making at least a decent wage.

    2. I sincerely believe that there are a lot of people like me in this country, a lot more than most of us think, regardless of their well-intentioned but misguided politics. If they had a family crest, it would probably look a lot like the "don't tread on me" flag from the LAST revolution.

    They're not racist/sexist/homophobic, they're not heartless and unsympathetic to people less fortunate, they're just tired of crooked fucks (read politicians) who's only talent is selling bullshit to the easily confused, and then deflecting responsibility. Who's only ability is to convince backward people that their problems are caused by other people who are more advanced, and can convince same that they have a "right" to color TV, health-care, a "living wage", and housing.

    They understand that if they want something in life, they might actually have to get off their asses and work for it. And they're tired of the criminal class (Guv'ment) stealing what they worked for, and squandering it on stupid shit, or giving it to others who don't deserve it.

    3. If the whole damn system collapses, we'll still be fine. Don't forget that 20 square miles in the rural heartland. Good farmland/pasturage with a reasonable amount of timber, plenty of year-round clean running water. We all know how to build/maintain structures and equipment. We can grow/raise/shoot all the food we need. We have our source of power (the wells, man, the wells!!) Don't even need to refine the oil. Natural gas wells produce a fluid by-product which is an excellent substitute for gasoline.

    It's remote enough that it will be a long time before our friendly representatives from NEW AMERIKA even notice our existance. And if they finally do notice us, we have lot's of guns 'n ammo, and can direct said ammunition quite efficiently. Perhaps efficiently enough that they will regard us as "not worth the trouble".

    To many (but not all) of you on this blog: If the soup lines get too long or violent, feel free to look me up. We can start our own Galt's Gulch. :-} Even "city-slickers" can do just fine without infrastructure if they just have the desire to learn.

    If you are willing to be self-sufficient, and pay your own way in whatever currency is in vogue, I'll be happy to sell/rent you whatever you need to get started. Otherwise.....STAY OFF MY LAWN!

    {/rant}

  • Don the libertarian Democrat||

    "If my theory is correct, then the credit default swap protection is somewhat of a delusion."

    If you add this to the article about credit ratings agencies, you do have to wonder about the wisdom of a lot of people who thought they were financial experts.

  • Derrick||

    Fuck it! Let the apocolypse come. My peeps will do just fine.

    {rant}

    [ ... ]


    Good Lord, that was one hell of a rant, man. FWIW, I'm with you on all that.

  • ||

    Sorry, it's been brewing for a long time *grin*

  • ||

    Seriously. There was a thread a few posts ago where 99% of the "free marketers" were all braying "DIE WALL ST DIE!!" and joe was smugly just saying "well, I told you so!". Everyone is turning into caricatures of the "average joe" who dont know nuthing, but still knows some motherfucker is to blame, and i bet its them fat cats with their fancy calculators and all those funny sounding finance things which is all probably a 'Ponzi scheme' (mainly because if i dont get it, then it must be BS, since i'm such a 'getting it' kind of guy'

    Wow. I didn't pick up on any of that, and by any reasonable measure, I AM one of the fat cats with the fancy calculators. In fact, I've seen some pretty reasonable questions by people who aren't industry experts.

  • ||

    I didn't pick up on any of that, and by any reasonable measure, I AM one of the fat cats with the fancy calculators. In fact, I've seen some pretty reasonable questions by people who aren't industry experts.

    I definitely picked up on some of that. As one of the fat cats with the fancy calculators (albeit a relatively skinny fat cat), I admit I don't fully understand everything that's going on in the economy right now, and I don't think anybody else does either.

    I'm not fully convinced that the "bailout"/"rescue"/whatever is a good idea, but I do know it's not as simple as letting stupid lenders off the hook for their stupidity. There will be serious costs associated with "doing nothing" here, and they won't just affect Wall St.

    Having said that, of course, the MSM still has not addressed that this whole debacle started with the last two Administrations--both parties--pushing Fannie and Freddie to make more loans to questionable borrowers. Everything else followed naturally from that decision.

  • SIV||

    Christ I can't believe I actually know what this shit is and a fair amount of how it works.
    I started reading Roubini, Ritholtz and Mish from almost 2 years ago when I was trying to understand why the CPI wasn't reflecting actual inflation.I kept thinking if I learned enough I might make a little money, which is how much I have been making as I'm all in liquid cash and government bonds.Plenty of people saw this coming for a long time.
    (funny when I use my REASON handle on financial blogs they think it is "Structured Investment Vehicle").

  • ||

    I can't imagine how Nick Gillespie let the Beatles allusion sneak in there.

  • ||

    Wow, seriously, after going back and reading my own shit, mea culpa. I think I was channeling Howard Beale for about 15 minutes there.

    Now, I know why my wife keeps threatening to have me evaluated for Tourette's lately.

  • ||

    Higher prices- good

    Lower prices- bad


    Can I be Sec'y of the Treasury next?

  • SIV||

    KfP,

    The rant was pretty damn good.Did you compose in the comment box on the fly or C&P it?

  • Dagny T.||

    Kant feel Pietzsche,

    That was one of the better rants I've read. Thanks for providing a bright spot in an otherwise dismal day for freedom and capitalism. Well played, sir.

    Keep us posted on your Galt's Gulch proceedings. You will, of course, have every right to rename it Kant's Korner or similar. :-)

  • Paul||

    I'm a little confused with this post. Maybe Reason staffers don't read every story and blogpost in Reason.* Fair enough.

    This video talked about this very thing: Credit Default Swaps and how the short-selling ban was at best, ineffective because there were "so many other ways around it".

    *not a criticism, just an observation.

    Personally, I see most of this as a complex, reverse chess game. All of these instruments, movements, swaps, sales all have to trace back to something-- some kind of asset, real capital etc. The smartes players are the ones who can 'see' more moves back than the 'dumber' players (to simplify).

    No matter how complex the chess game is, the players (smart financiers) have to be able to trace the moves back to value: asset, capital etc. It seems fairly clear that many of the financial insiders lost track of the asset or real capital, until a few (truly) smart insiders couldn't trace it back, or found what they traced it back to wanting. Hence the beginning of the 'short sell panic'.

  • Derrick||

    In the last 2 weeks i've noticed that the H&R crowd, which i've always appreciated and been impressed with, are generally pretty informed about economic *theory*, but next to nothing about either day to day economic analysis

    Guilty.

    There was a thread a few posts ago where 99% of the "free marketers" were all braying "DIE WALL ST DIE!!"

    Not guilty.

  • Bob||

    "free marketers" were all braying "DIE WALL ST DIE!!"

    That? Oh, that was just "The Wall St. The" in Mises' native tongue.

  • jk||

    P Brooks:

    Higher prices- good

    Lower prices- bad

    Can I be Sec'y of the Treasury next?


    Yes. I have invested in box-loads of 128 Mbyte USB memory sticks for $75 per unit, a bargain at the time. Now I can't even sell them on Ebay for the cost it takes to ship them to my customers. For my investment to mature, prices must go up. The government should either buy them back from me at my cost or prohibit the dumping of 1 GByte memory sticks at retail outlets for $10.

  • JMR||

    I keep saying it, but "click on the 'JMR'," it's an article worth reading, even if it's scary.

    These relatively-new financial instruments are the heroin of finance. Their "market" (read: casino.) is now bigger than many REAL markets, and this kind of leverage allows the unethical in big government to indulge many temptations. One of those is manipulating precious metals prices in order to try to manipulate inflation numbers & benefit insiders. It's also a VERY dishonest way to put off the effects of irresponsible spending on future politicians.

    Clinton did it, and Bush is trying to do it, but some people are slowly catching on...Which is why it's suddenly super easy to find the paper form of precious metals, but ever harder to find the precious metal form of precious metals. It's almost as if there's a slow-motion physical default going on, or people wouldn't be able to write articles like this.

  • Sergeant Tuttle||

    Next up, "The No Investor Left Behind Act."

  • Jerry||

    Isn't the problem that credit default swaps make no sense at all? It's the LTCM risk model Ponzi scheme all over again.

  • ||

    JMR: I read the web 'o debt piece several days ago, and your new piece just now. This kind of scam is basically what the Fed has been pulling for decades.

    Printing certificates of ownership of ANY commodity is fine, for the same reason that I can write you a check for $100K instead of having to round up a suitcase full of cash.

    But....someone actually has to have that commodity in stock somewhere in the world. If not, as Jerry said, it's just a gigantic Ponzi scheme.

    Let the champagne flow...until enough people call bullshit, then the house of cards falls down.

    You know, when Ayn Rand said that Americans were the first in the history of the world to use the phrase "to make money", I'm pretty sure this isn't what she had in mind. :-}

  • ||

    I made a joke post a few days ago about the system collapsing, and the President announcing that USD were no longer valid, and that a NEW currency known as Fecals would trade 1:5 for old invalid USD.

    I hereby announce that I will be printing Fecals en masse. Anyone who wishes a couple billion may contact me.

  • robc||

    Damn you Bob, I reserve the right to post super awesome Simpson's references for myself. Good job.

    There will be serious costs associated with "doing nothing" here, and they won't just affect Wall St.

    Ive yet to have anyone explain to me (in a way that makes sense to me) why "serious costs" is a bad thing.

  • robc||

    Jerry,

    Credit default swaps make perfect sense if the risk is priced properly.

  • ||

    Isn't the problem that credit default swaps make no sense at all? It's the LTCM risk model Ponzi scheme all over again.

    The LTCM risk model is a not a Ponzi scheme. The LTCM risk model was similar in spirit to the martingale betting strategy-- the basic idea of "OK, I want to win $100. So I'll bet that, and if I lose, I'll just double my bet until I win once, then I'll start over again with $100. Since I'll eventually win a bet, I can't lose."

    It's theoretically sound, so long as you have access to an infinite line of credit that no one will ever call in. In other words, not in practice. The problem is that while you will eventually always win, you also will eventually always have a long enough streak of bad luck to force you to get so highly leveraged (or temporarily down) that your credit will run out or someone will call in your debt, and the whole thing will collapse. Essentially you try to make profits as safe as possible by concentrating them into a event of probability epsilon.

    the MSM still has not addressed that this whole debacle started with the last two Administrations--both parties--pushing Fannie and Freddie to make more loans to questionable borrowers. Everything else followed naturally from that decision.

    Ehh, you can find lots of original causes. If you want to get technical, I'd go with Ed Glaeser and note that everything else followed naturally from land-use and building restrictions that make bubbles inevitable and stronger. Anything that creates such a lag between price signals and construction makes bubbles inevitable, and the greater the regulation, the greater the bubble. That's why we've seen land bubbles in most European countries as well, but not in many US states (NC, TX, etc.) that lack such restrictions.

    That said, the land-use restrictions explain why the housing bubble was inevitable, but there are other parts to explain. Certainly private industry did a bad job of determining the probability of rare events, such as a simultaneous housing price decline in many markets. Most previous housing bubbles were regional (such as in TX and LA when oil when it went up, and then bust when it went down); since regulations prevented S&Ls from operating in many states, this helped them go bust. Many believed that since previous bubbles had been regional, that greater diversification would help banks ride out the storm. However, there were quite a few banks that "diversified" only into those coastal states that saw the worst of the bubble, so they really weren't protected at all. Having operations in CA, AZ, FL, and VA didn't make for a hedge in this case. But note that some regional banks, like BB&T or Wells Fargo, seem to have pretty well escaped by operating mostly in less bubbly areas.

    The existences of Fannie and Freddie explains why the government (and thus you and me) were going to be on the hook no matter what. I'm not sure I could go so far as to say that the bubble would not have happened without the government pressure towards increasing homeownership no matter what (and encouraging no doc, no down payment loans), but the government certainly made it worse. At the very least, it demonstrates that no push for greater regulation could have happened, since the vast majority of politicians were pushing for regulations that made the bubble worse, not better. (The Administration and some other Republicans including Sen. McCain deserve some credit for suggesting reforms that would have helped slightly with Fannie and Freddie, even while in general being, like all other politicians, part of the general cheerleading for homeownership. It at least makes them better than the ones who opposed that and were thus close to 100% wrong.)

  • Nigel Watt||

    KIP, *clap* *clap* *clap*

  • Jerry||

    robc, how would you price the risk of you getting unemployed? Say you give me $10k, and I'll give you $100k if you lose your job. What do you think will happen?

  • Paul||

    John Thacker,

    Bravo to your very straightforward explanation. You do a great job of unweaving the 'ponzi scheme' meme.

  • ||

    Hey!

    The recent headlines about the Barney Frank/Frank Moses conflict of interest story, given the country's supposed tight credit situation, got me thinking.

    Great ideas for a mortgage company ad campaign:

    "Suck a Dick, Get a Loan"

    "Easy terms! Just come on down and bend over"

  • ||

    The LTCM risk model is a not a Ponzi scheme. The LTCM risk model was similar in spirit to the martingale betting strategy-- the basic idea of "OK, I want to win $100. So I'll bet that, and if I lose, I'll just double my bet until I win once, then I'll start over again with $100. Since I'll eventually win a bet, I can't lose."

    It's theoretically sound, so long as you have access to an infinite line of credit that no one will ever call in. In other words, not in practice.



    The highlighted sentence proves that it is a Ponzi scheme. If a bridge will stand in theory but not in practice, some engineers are going to be in trouble. It's time for some financial engineers to pay the piper.

  • ||

    "I am quite happy to be self-employed as my love for certain herbs and organic compounds makes standard employment a bit complicated."

    I wonder how many people are in the same situation, I know I am.

  • Paul||

    The highlighted sentence proves that it is a Ponzi scheme.

    I respectfully disagree. There's one fundamental difference between a ponzi scheme and the double-down theory of market betting.

    In a Ponzi scheme someone at the bottom always loses. Ponzi's usually require an increasing number of 'investors' (we'll just say capital) inputs at the bottom, which passes up to the top. As soon as the bottom quits putting in capital, the whole thing comes crashing down.

    In this type of financial situation detailed above, I can be a lone investor, putting in cash (albeit cash I don't have or have borrowed) and if the market does what I want it to (go up) I win, the lender wins etc. It only fails if the losing streak takes too long for the lender to be comfortable with-- as detailed above-- and calls in the debt.

    Ponzi schemes almost always involve fraud-- a phantom investment made out of whole cloth that you have to sell to people at the bottom. There is no investment, and any monetary gains have nothing to do with the value of the investment, but dollars moving from the bottom of the pyramid to the top.

  • Sonic Charmer||

    Back to the subject of CDS, I'm having a hard time seeing Kling's point that the existence of short-selling to hedge CDS drives down prices. This seems to look at only one side of the equation.

    Someone who has sold CDS protection is, in effect, long the bond. If they short the actual (cash) bond in order to hedge, now they're essentially flat the bond itself (exposed to counterparty risk, and/or whatever basis exists between cash and CDS, of course).

    In combo these two things should not "drive down the price of the bond" at all, because economically speaking he has bought 1 and sold 1. Kling seems to have missed that selling protection on a bond is going long. Look at it from the protection buyer's POV: he's now short the bond. If the bond defaults he gets paid; if the bond pays off and never defaults, he is stuck paying a coupon for the term of the CDS and gets nothing in return. So in order to hedge his position, he has an incentive to buy the bond. (Let's not get into squeezes resulting from the need for physical delivery...)

    The point is that for CDS, as with bonds, there is a buyer and a seller. The seller may decide he needs to short a cash bond in order to hedge, but the converse is just as true for the buyer.

    Whatever else their merits or demerits, the existence of CDS by itself should not have some sort of asymmetric effect that pushes bond prices down.

  • ||

    Paul,

    I suppose with honest brokers and transparent investments I'd agree with you. In this case, many highly rated 'pieces of paper' were actually based on low-grade investments; there is your fraud. It is also a Ponzi scheme because there actually are people at the bottom losing--taxpayers.

  • That\'s not what \"default\" m||

    "However, the more short-selling takes place, the closer they get to default." The stock price can be "short-sold" all the way to zero (assuming the market allowed it), and it still won't mean the company will be in default, or that it will increase their chances in the least of going into default. Default is when their cash flow doesn't allow them to make their loan payments. Stock price does not cause cash flow.

  • ||

    I think Kling's proposed strategy of sellng default swaps with the intention of covering losses by selling short is crazy. While, of course, selling short in a firm is about to default makes sense, depending on this to cover losses on credit swaps would mean that the intention is to shift the loss to the person who purchases the borrowed stock. It requires that there be some ignorant investor who doesn't realize the firm is about to default.

    No, the sensible strategy is to sell default swaps on a wide variety of securities, so that the money you make on the securities that don't default are covered by what is lost. And yes, hold reserves of something very low risk to cover the possibility of many defauts at once.

    In other words, act like an insurance company.

  • ||

    Kant:

    Excellent rant, dude. My folks have kind of a similar up-from-bootstraps history, though I lack their fiscal discipline and instincts.

    Still, I have to say that bail-outs serious reduce the NPV of thrift and hard work, as the fruits of thrift and hard work will be expropriated, one way or the other, to pay for the bail out.

  • andy||

    if i'm allowed to take out an insurance policy on someone else, the next thing i'm going to do is buy that person a motorcycle with no brakes.

    i.e. there is an incentive to *create* a default, by market tampering or stock price distortion through shorting (naked or no) and just general rumor circulation. of course, once aig was unable to continue to pay out on their credit default swaps, this incentive went away. still, doesn't mean we can't speculate that this sort of fraud happened.

  • ||

    The highlighted sentence proves that it is a Ponzi scheme.

    No, it proves that it sounds nice but is impossible in practice, but just because it and a Ponzi scheme both sound nice but are impossible in practice does not mean that the martingale betting strategy is a Ponzi scheme. They're very different mechanics.

    A Ponzi scheme is a fraud that always inevitable destroys the people at the bottom, and it's very predictable how it happens. It always relies on an ever increasing number of suckers-- however, the person at the top wins. The martingale betting strategy involves one person, a lot of money, and has incredible randomness that involves losing eventually when you have a "too long" streak of bad luck. No one "wins" if everyone plays the martingale betting strategy, because everyone will go "too far" into debt at some point, due to the wild swings. (Again, unless someone, say a sovereign government, has an infinite line of credit.)

  • ||

    Do you have a Private mortgage insurance (PMI) policy? If you do have one your PMI insurer passes their risk to others by bundling 100 policies together and selling them as a credit default swaps (CDS). They do this in order to protect themselves by large payment to mortgage providers such as insurers in the event your home is repossessed. In the mortgage industry this has been the case for decades. If you bought a PMI to protect your lender then you are building the CDS market. To avoid this put at least 20% down on your home or pay what it takes now to get rid of the PMI policy. http://nomedals.blogspot.com

  • andrew abraham||

    We have been speaking on the chats on Myinvestorsplace.com ...and trying to learn about credit swaps..and derivatives... as well as short selling... What I have learned is that the monster in the closet are the derivatives... even Warren Buffett called them a weapon of mass destruction...the question is ...what does the layman do??? Tell me and the members of Myinvestorsplace.com what to do??? We want to know...thanks

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