Credit Default Swaps
Okay, let’s talk about money…again. A couple weeks ago, I had several posts discussing our financial crisis and how we could refocus our efforts to bring prosperity to every one. The one thing that I knew little or nothing about is something called Credit Default Swaps. This is a $45 trillion market (that is “trillion” with a capital “T.”)
Now everyone knows basically how insurance works. I take out an auto insurance policy. I pay an insurance company and they assess the risk of my driving a car and getting into an automobile crash. If the risk is low, I don’t pay all that much. If the risk is high, I pay a lot more or I become uninsurable. Suppose, on the other hand, you want to take an auto insurance policy out on me. You don’t know me. You have no financial ties to me other than to consider me a “safe bet” and, as such, you would really like to be responsible for insuring my driving. You would need to be able to find a third-party, like AIG ,to give you such an insurance policy…or a Credit Default Swap.
This is basically what happened on Wall Street. In 2000, a lame-duck Congress passed legislation which legalized these Credit Default Swaps. What’s that old saying? “Those who don’t know history are destined to repeat it” (Edmund Burke). In 1907, many states and Congress itself moved to outlaw the practice. (This is why I totally reject the idea that someone like Joe the Plumber or Sarah Palin should be in charge of anything. We need smart people who understand where we are in history. It’s nearly impossible to know where we’re going if we don’t know where we’ve been. Palin and Joe have no clue. Why did Congress outlaw this practice? A run on banks in 1907 nearly caused the collapse of Wall Street. People had what were known as betting parlors and they were betting on stocks without owning stocks (watch the 60 minutes video below):
We had multiple opportunities to intervene in this legalized gambling, yet we have or had this ridiculous notion that the markets will correct themselves. This is just one piece of the puzzle. It is a $45 trillion unregulated piece of the puzzle. Do we really need Credit Default Swaps?
Check out some great articles on this:
