Betting on Black

Economics 101

The time has come, the Walrus said, to talk of many things.  Of shoes and ships and sealing wax, of cabbages and kings.

I want to focus here on Credit Default Swaps.  Since the abbreviation (CDS) is close to the abbreviation for Collateralized Debt Obligations (CDO), which includes as a subset Mortgage Backed Securities (MBS) there is a tendency to confuse them all together.

A Credit Default Swap is an insurance policy on a debtor paying their debt.

For a fee someone with deep pockets agrees to make good the debt if the debtor doesn’t pay.

Now as long as the debtor pays this is easy money, but what we are finding is that when they actually do default, the people who sold these insurance policies don’t actually have such deep pockets after all.

And since they’re “Too Big To Fail” financial institutions who owe other “Too Big To Fail” financial institutions the money is coming out of Taxpayer pockets instead.

As I might have mentioned before (but am too lazy to look up at the moment) it is Insurance Fraud not to keep sufficient reserves to pay off your policies.

What makes this even worse is that you don’t actually have to own the debt to buy the policy.  It’s like letting random people take out life insurance on you and not counting on them coming up with some brilliant Strangers on a Train scheme to bump you off.

It is fundamentally no different from going into a Casino and betting it all on Black.

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    • on 11/17/2010 at 16:47
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    • on 11/18/2010 at 05:00

    The first being that it is not like walking into a Casino and placing it all on black. If you could put ten million on black and you won you would only collect twenty million. Since you only need to put up a very small percentage this is more like the casino owner saying “We are running a special because we made a small payoff to congress so they would get our backs. If you put it on 32 red and that number comes up I’ll triple the payoff for you.”

    Only that dosen’t quite work because 32 red can only come out by chance. If I remember correctly the odds are 36 to 1. In the case of this government insured meltdown, hitting the big number was a far more educated guess. Take Goldman for am example. They got some egghead to create fuzzy math that made sense to nobody but it didn’t matter because they were paying the credit rating agencies to pretend it made sense and paying the regulators to not pay attention. So they sold a bunch of bullshit to investors and called it “bonds.” At the same time they took out “insurance” on these bonds that they did not own knowing that they could collect a fee from their own customers while screwing them and would also get paid off for something defaulting where they themselves created the risk but took no risk.

    And here is the best part, it was all perfectly legal. Perhaps a little embarrassment on C-SPAN and some assholeThat’s how it works when you have a government based on campaign finance. That is also why banks were allowed to hold swaps without backing. It was not insurance fraud because the bankers paid the elected officials to make a special case for CDS’s and CDO’s. Sort of made my head spin but that’s life in the world of the rich.

    I used to write about this bullshit but what will ever change when we have scumbags for leadership. I gave up when I found out that taxpayers paid out ten times the market value of Lehman Brothers. They go bankrupt and get a ten to one payoff? Whatever happened to pennies on the dollar?        

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