Recent attempts by corporate media to explain the nature of our economic meltdown have left me ready to bite the ears off mice. They’ve been superficial, profoundly misleading and, above all, apologias for the likes of Paulson, Bernanke and Geithner. So, having spent every spare moment over the past three years studying the debacle that many saw brewing, here’s the simplest explanation I’ve come up with:
Imagine being able to insure a car that you don’t own or use. Imagine it’s the car your neighbors will let their teenage son drive, when he gets his license in a few weeks — and you know the kid is a reckless brat.
Now imagine that, by using financial derivatives called swaps, you can purchase as many insurance policies on this car as you can afford to pay premiums on.
When that car is eventually trashed and scrapped, you — and any friends you clued in on the deal - might collect millions, even billions, of dollars. By contrast, your neighbors, who bought real insurance on a real vehicle, get only its Blue Book value (and, one hopes, a chastened child).
This explains the primary problem with swaps. Anybody can bet on anything, so the nominal value of the bets far exceeds the actual worth of any property involved.
Still worse, no tangible or financial asset has to be in the picture. Wagers of any amount can be made, based only on opinions. You can bet on next Wednesday’s weather, if a counterparty wants to take the other side.
Only a fraction of swap action stems from logical situations in which, say, Party A owns a certain debt-based bond and Party B feels good enough about its prospects to accept premiums against possible default. Those are the Credit Default Swaps we hear so much about, which are a small part of the picture.
Similarly, Credit Default Obligations comprise a much larger category than merely those bonds into which home mortgages have been sliced, diced, tranched and peddled to the unwary. Every type of debt is subject to the same treatment, called securitization or financialization. Commercial mortgages, student loans, home equity loans, credit card balances and auto notes spring immediately to mind, but it doesn’t stop there by any means. Among the latest wrinkles are buying up and bundling seniors’ life insurance policies and selling solar equipment with financing and service contracts attached, so that those obligations can be packaged and resold. Carbon credits, if cap-and-trade is approved in the US, instead of a sensible carbon tax, will be another new toy for the boyz.
Beyond swaps and CDOs, there are many other types of derivatives. Some serve no purpose except adding layers of expense to the delivery of commodities. Think of the possibilities as endless and you’ll be right.
This is how speculators in derivatives have created a “shadow economy” so vast it looms over the actual economy like a death-star over a bumblebee.
Continued>>>
http://dandelionsalad.wordpress.com/2009/02/18/exclusive-derivatives-for-dummies-by-the-other-katherine-harris/
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