It has always been my impression that the primary effect of a CDS is to generate massive fees at a publicly traded company, and thereby loot the company’s treasury.

Someone on a news program recently stated that there are 300 trillion dollars worth of credit default swaps in the system. Could that be true? If so any level scares me.

And what are “artificial” SWAPS

Brilliant article.  Such esoteric stuff written for amateurs like me without dumbing it up for us.  Thx, Jesse.  Somebody give this kid a payraise.

The Commodity Futures Trading Commission has proposed rules about an open market for credit default swaps, including a central “market” where prices would be posted and available to anyone. When it became obvious to Wall St. that the rule was going to come into force (because bankers were the only ones objecting), lobbyists scurried up to the Hill where they found Republicans on the House Agriculture Committee to insert a clause in a funding bill that prohibits the CFTC from forcing the creation of a transparent market. The bill is now moving to the floor.

The crookery continues.

And to Harold (at 2.53): The dollar figure is roughly correct.

Well there you go, Jesse. Charley just gave you a lead on a great follow up article: expose on the congressmen who inserted a clause to prohibit transparency.

CDS are a very useful product as long as the net outstanding notional amount is kept in balance with the underlying debt of the reference entity. If CDS were to be settled (in case a credit event has triggered a relevant event) with deliverey of the underlying bond or equivalent with no cash-settlement allowed, an equilibrium between outstanding CDS and actual debt would be established: While the value of a long CDS increases bond prices will fall correspondingly - as bankruptcy nears, those who actually bought “protection” will have created a synthetic short position in the bond which neeeds to be covered - if they exercise their CDS, they have to deliver a bond of the reference entity. If the CDS market is overbought that would create a short squeeze in the underlying debt - these mechanics would exercise control. Once major market particpiants agreed on cash settlment it opened the floodgates, that was the crucial point when regulators should have stepped in. The CDS market does not need new regulation, it needs to correspond with the amount of underlying debt dynamically and excessive speculation would be curbed automatically, let market forces and not regulators do the work!

If regulators failed to step in during the 2008 disaster why would we trust them now?

And what do you know about the cousin of the credit default swap– the bond debt swap? This is where governments trade variable rates on their bonds for a fixed but higher rate with a brokerage. This financial “tool” seems to be driving the deficits of many cities along with some tricky things to do with their pension fund investments.
do you suppose that at the heart of the Greek debt crisis is this credit default swap and that the banks are going to make more profit on the country defaulting than they would if they didn’t?

@Harold, @Charlie James

https://www.cia.gov/library/publications/the-world-factbook/geos/xx.html lists Gross World Product at $79 trillion (approximately).  That makes $300 trillion in credit default swaps 3.5 times GWP.  In other words, if they all crashed, the world literally could not pay off the bets.

To me, that’s scary.  And demands transparency & regulation before someone really tanks the economy.

Harold, in 2008, the number I remember consistently reported was in the neighborhood of sixty quadrillion.  So, your number doesn’t sound out of the question today.

Now, given that we’re finding that banks are largely in the business of manipulating economies for their own benefit while barely acknowledging their customers, and playing with far more money (as j points out) than exists on the planet, here’s an uncomfortable question:  What purpose do banks actually serve?

Seems to me that, if we can’t answer that question clearly and without invoking resemblance to another entity, the obvious solution is to exterminate the parasites, rather than regulate them.

To give an example of side-benefits, decades ago, when people had lost faith in the banks, the Post Office stepped up to handle deposits, check-cashing, and so forth.  Given their precarious financial situation in a world where people don’t buy stamps, such a move could save them.

(Some early American colonies also eliminated taxes in favor of interest on government-provided loans.  Ben Franklin doesn’t exactly strike me as a Commie, so I don’t imagine such a program should be a huge problem for us…)

i can’t believe derivatives market is still open for business?  do they have a license to operate a casino?

@ Richard (Yesterday at 6.00)

When I read your comment, I immediately wondered if you are a writer for The Daily Show or maybe Colbert and were trying out a bit for tonight’s show. If you’re not, then I have to winder what color the sky is on the planet where you live.

You wrote “let market forces and not regulators do the work.” Have you not picked up a newspaper recently?

- Right now, the entire basis of how banks set interest rates - LIBOR being an unregulated market - has been shown to be utterly corrupt. The scandal broke in Britain but is about to consume Bank of America, Citi and, quite likely, JPMorganChase.
- Recall hearing anything about “securitized mortgages”? That was another unregulated market that damn near sent the world into Great Depression II instead of merely The Lesser Depression. It so screwed up the credit markets that banks trying to foreclose on hapless homeowners can’t demonstrate, let alone prove to a court, who actually holds the mortgage to a house and thus has an interest in seizing it.

I could keep going but the list is too long. The financial industry has shown it has absolutely no ability to “self-regulate” (which is as much of an oxymoron as ‘jumbo shrimp,’ ‘military intelligence’ and ‘Justice Scalia’).

I imagine you will all recall a quote from an interview in the WSJ some 20 years ago, the reporter asked a senior officer in one of the big brokerages the cause of criminal behavior in the financial markets. His response was, “money attracts scum”. Scum metastasizes in dark, opaque corners and endangers its’ host. There are two obvious choices: demand transparency and rigorously enforce discipline; or allow disease to flourish and destroy its’ host.

I would bet that those arguing that we should let the market operate may well be an investment bank lobbyist, banker or someone else who directly benefits from this corrupt practice.  Transparentcy and some aggressive investigation and prosecution would help.  But we also need politicians not willing to sell their souls.  The loss of protective laws and enforcement practices are the primary reasons for this recession.  A good public caning of a corrupt banker each morning would help.

Are taxpayers going to pick up the tab when these bets go bad on government deals? So far, it looks as if the answer is yes. The SEC is trying to figure out how much is hanging out there, but we know in a few instances local boards got sucker punched on these deals, and taxpayers suffered. How can we NOT regulate a process that puts our money at risk in the dark?
http://www.statebudgetsolutions.org/blog/detail/high-finance-bookies-betting-both-sides-of-municipal-bonds

Oh, but we are mere Muppets. Too ignorant and foolish to understand ethereal finance. Too unsophisticated to trade in synthetic collateralized debt obligations and write credit default swaps with counter parties with no reserves. Too stupid to rate worthless mortgages as AAA. Too stupid to loan money to overextended socialist governments.

Oh, but we are mere Muppets. Too ignorant to appreciate the rewards of ethereal finance. Too unsophisticated to trade in synthetic collateralized debt obligations backed by vaporous assets and write credit default swaps with counter parties with no reserves. Too stupid to rate worthless mortgages with AAA. Too simpleminded to loan money to hopelessly overextended socialist governments.

Oops, sorry about that. I thought the first version failed to load.

I think that this is an old problem, one that was solved back during the Great Depression with the separation of investment banks from commercial or consumer banks. Anyone remember why the Savings and Loans crashed? They stopped doing the thing that they were created to do, local real estate lending!
The banks need to be forced back into traditional banking, not allowed to play with public investments in venture or vulture capitalism, OR the government should set up it’s own bank like North Dakota has done. We might conceive of banking like we do a public utility with a regulated profit margin.

@ Charley James today 10:20 et al
You must read my whole comment – I do not reject regulation, in the instance of CDS I try to explain that regulation again is coming late, while a little adjustment in the mechanics would create the desired effect.
And as you may have guessed, I am a banker, a liberal one though, and support meaningful regulation built on common sense and industry know how; with the current regulation orgy we get a lot of regulation, often counterproductive or just impossible to implement, just not the regulation we need.  Financial markets are complex if we make them so, the underlying movers are pretty simple and once regulators would care to recognize that, we actually would get better regulation. But do not forget, regulators now have created a lucrative industry for themselves depending on ever more and complex regulation!