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Originally Posted by dippin
It's far more than the 'investment banking" part. They offered corporate insurance against defaults and so on, and the only reason some banks and financial institutions have been able to stay afloat has been because of AIG's continue existence.
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As I understand it Credit Default Swaps started out as a reasonable way for lenders to insure their loans but by the end they morphed into something like casino gambling.
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Why are they ??? (Credit Default Swaps) weapons of mass destruction????
As long as they were used to cover the risk of loan defaults, then all was well. But as with many other good things, more was viewed as better.
What happened was that Credit Default Swaps were being sold to people that had not made a loan to anyone and had nothing at risk. These CDSs were based on a "reference" security. This meant that A could make a bet with B that C would default on his loan from D. These became so popular that the ???insured??? value of the CDSs exceeded the total amount actually at risk by many times. The amounts are in the trillions of dollars. There may not be enough money in the world to pay off the entire potential liability.
This practice is exactly like taking out fire insurance on your neighbor???s house. But you can only benefit if your neighbor's house burns down.
If you were an unscrupulous person and you had insured your neighbor???s house, wouldn???t you be tempted to help things along? What if you had insured a hundred houses? Would you just sit back and hope or would you attempt to improve the chances of collecting? Would you run for local government and use your position to gut the fire department or change the building codes and then insure the new homes that were built to the lower standards.
This is exactly what has happened. The government mandated lending to people who couldn???t repay the loans. These loans became the basis for the ???reference securities??? on which people made huge bets. Every CDS that was written against a reference security was in fact a bet that that security would go into default. The government actively prevented state governments from regulating these bets or the risky loans. As a result, someone has gained trillions of dollars by draining the coffers of the organizations that sold the CDSs and then of the Federal Government.
So who are these people? Who has gained the most from the massive defaults in mortgage loans? Who were the parties that purchased these CDSs but had nothing at risk? Who was the beneficiary of the Federal Government???s gutting of the figurative ???Wall Street fire department????
AIG, the 18th largest company in the world, was given $150B of public money to keep it solvent. Most of that went to pay of CDS liabilities. This is just one company of many.
It would not surprise me one bit to discover that the people involved in setting up the scenario, that allowed CDSs and subprime mortgages to both remain unregulated, are intimately connected with the people who benefited from the firestorm that has swept through the financial system of the US and the world. Unfortunately we must rely on the shallow reporting of corporate owned news organizations to get the facts into the open.
How Credit Default Swaps Became a Timebomb | Newsweek Business | Newsweek.com
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