Wednesday, October 1, 2008
The Elephant in the Room: Credit Default Swaps
Studies show that people often fear the wrong things. We are terrified of things which probably won't hurt us, but blissfully unconcerned with things that might really kill us (see this, this and this). So we put a tremendous amount of energy into solving non-problems, and get blindsided by things that we don't know about or which we are too afraid to even think about.
The same applies to the economic crisis.
For example, the market for credit default swaps is larger than the entire world economy.
Credit default swaps - which were largely responsible for bringing down Bear Stearns, AIG (and see this), WaMu and other mammoth corporations - are now being taken out against the U.S. government.
So you'd think that politicians trying to prop up the teetering U.S. economy would want to cancel credit default swaps, or at least declare their value is somewhere near zero.
Nope . . . not even on their discussion list, even though it is the real economic crisis.
Instead, they are proposing things which most experts say will actually harm the economy.
Call congress and tell them to stop their political posturing, stop ignoring the derivatives elephant in the room, and either do something useful or nothing at all.
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Apparently these CDS have become such an important thing. I was also thinking they should bring the major CDS counter-parties together and tell them "You idiots, do you know anything about risk management? Just come up with a way of re-pricing your contracts or they will be totally nullified". But there is a catch: It's not just US involved here. So, many governments need to come together. Will they have the guts to alienate their banks is the question?
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