Credit Default Swaps 2

[kezdox]

FRAUD

[mavrick0ck]

i have a beginers questions. hedge fund 1 and insurance company 2 have a little side bet that company B is going to default, but neither of them have any connection to company B, or am i missing the connection here? also the hedge fund has taken out an insurance of 10bil but why is this? they are insuring themselves against something they have no part of since they didnt lend anything out. thanks

[jjunit207]

.. and if not by the European tax payers than by the Americas, Japanese, and/or Chinese. 2008 ALL OVER AGAIN!!!!

No one got punished in 08 for the bets they made and they did it again! Look at MF Global. Huge bets on greek debt bc they knew greece would not be allowed to default. Suprise greece got 50% haircuts, im sure all the execs shit their pants on that day, they didnt see that coming! The huge banks have the world by the balls.

Regulate the derivatives market! PLEASE!!!

[jjunit207]

the beauty of the whole CDS and derivatives market is that its too big to fail. If it does fail gameover for everyone! The derivatives market is unregulated and is currently exceeding its pre 2008 crash levels. Its almost at a quadrillion dollars, CRAZY!

The big bet now is europe. Tons of CDS on greek, italian, spanish, and portuguese debt. If europe defaults the CDS market will destroy the financial system (again). So its clear europe will be bailed out by the tax payers.

[swassontelus]

No different than the pyramid scheme we had with bottles of booze while in Engineering School. You only need 7 buddies to start and share the instant wealth at the '4th Level' of sucksalescomittment. Someone always gets screwed. You can't create something out of nothing. Peoples greed ultimately caused this chaos...and some will jump into a noose and others will simply be content and not even care as they simply didn't play the game in the first place.

[mikek241]

Good video. But unfortunately more gov't regulation on these credit default swaps will not solve the problems of insolvency, that's like treating the symptom instead of the disease. This whole system is allowed to exist only b/c of the FED's easy credit policies and artificial fixing of the interest rates. If the money supply could not be manipulated so easily but instead was backed by a commodity standard, this whole ponzi scheme would not be able to exist in the first place. RON PAUL 2012!!!!!

[Vveljac]

You forgot to add another bracket, "Government ", and extend an arrow from Moody's giving % to political campaign's so the government would advice

to trust in Moody's judgement, as in to direct pension funds and all others

into taking their services. Because after all, there must be someone above Moody's who vouches for them, and gives them credit rating.

[bio84]

perfect explanation

[PureTamil]

people need to go to jail for this collapse!

[IvanAndreevich]

3:55 yes there is a limit on how much you can insure. You don't need a law, because the market imposes that limit. If they insure too much, they go bankrupt :)

[vonnegut77]

@IvanAndreevich Except, since the insurance company is 'too big to fail', they are bailed out by the tax-payer if they overextend. :D Bonuses for all!

[thenumber13dotnet]

So @ 4:10 approx. really the Insurer should have to put aside for the amount insured because if it's not regulated as being required the Insurer could go belly up leaving the whole thing high and dry? Also how can a Hedge fund that has no interest in company B take insurance on the debt of that company ^_^? The WHOLE thing makes me say OMG lulz

[klrscout]

@thenumber13dotnet

I'm interested in the answer to the second question. How can you insure something you don't own?

[thenumber13dotnet]

@klrscout Im not sure of the laws in the USA however it is my understanding that one must have an interest before one can insure. So I could not insure against the death of my neighbour for example since I don't really have an interest in his/her life. But the stock market appears that it's ok to insure something you don't own. I believe this is what happened with Lehman Bros. Someone may be able to answer that better....<3

[abdulfattahahmad89]

OMG, you have explained everything that I've been trying to do so in years. Thank you so much.

[heyathere1000]

insurance stupid company.

[Mestilf22]

@TheTomMan95 It knows it's a bet. I-2 takes the deal on the assumption that B is good for the money. Hedge Funds are speculator's. They try to predict where markets are going. I-2 as you saw in the video, held the position that B was good for the money. If B hadn't defaulted then I-1 would have made pure profit.

[barrywilliamsmb]

Holy Moly.

Thanks for this, Sal.

[bjmorris64]

Given your explanation, wouldn't H1 actively conspire to undermine B2 in an attempt to put them out of business?

[thegoonist]

question: why was this side betting between hedge funds and insurance companies ever allowed? doesnt this just make it all seem like a glorified casino? this is people's money we're talking about here...

[juujuuuujj]

@thegoonist This is allowed because the gamblers control the house. This phenomenon is explained very well in the Wikipedia article Regulatory_capture . It lists at least 10 regulatory commissions (among them, the SEC, responsible for regulating securities) that have been captured by the industries they're supposed to watch over.

[thegoonist]

@juujuuuujj if this is so, why isnt this made known to the public? doesnt the govt have a responsibility to let the ppl knw that their money is not being "invested" but essentially gambled? a class action suit from all americans should be filed against the govt for gross negligence in this case. unless the courts are in on it too.

[juujuuuujj]

@thegoonist When both parties are financed by major industries (finance, pharma, oil, war), they see no danger losing their support to a more honest party. So when they get into government, they have no incentive to cut their own ties to the hand that feeds them. And in times of an economic bubble, everyone thinks the economy is going well, so they think it's a riskless win-win: let these industries do whatever they want, and they'll magically drive the economy forward to everyone's benefit.

[thegoonist]

@juujuuuujj that may be true. but you have not answered my question. the govt, according to the information you have provided me, is guilty of gross negligence by omission of act. this system may work during the bubble. but what abt during the recession? this system is not something we want in the long run. the govt is obligated to let people know that their money is at great risk of disappearing during the recession.

[juujuuuujj]

@thegoonist Yes, that's because the government is not a democracy (rule/power by the people), it's a plutocracy (rule/power by wealth). After we elect representatives, we have no control over what they do, but industry does. Bill Black (the chief regulator during the averted S&L crisis) explains this process better than I can - watch?v=Rz1b__MdtHY

[juujuuuujj]

@thegoonist On the twelve minute mark of this video ( watch?v=Rz1b__MdtHY ), Bill Black talks about US regulator Brooksley Born trying to regulate Credit Default Swaps. Larry Summers, Robert Rubin and Phil Grahmm (Wall Street insiders) immediately said they'd block the regulation, and also pass a law that you can't regulate it.

[p4r4d1gm]

Hi SAL. Your videos are great. You're an MBA from Harvard. I thought you might be having a CFA Charter. But all in all, great stuff. I hope you get to buy a huge mansion in Greenwich ;) lol

[spacekillers123]

Thank you Sal, you are awesome!

One day when I graduate college and get a job, I'm going to donate to you big time. No money right now lol

You are helping me so much :DD

[DanHall4RonPaul]

AMASS THE PEACEFUL VERBAL MILITIA EXCELLENT COMMENTARY YOU HAVE HERE! Ron Paul 2012. Go V for VIRAL Online The Business of We The People! Goo: DanielHall4Freedom MyName4Freedom < SAZ VM4Freedom < MDV SteveAlan4Freedom CraigNewton4Freedom BlakeLynch4Freedom RichardHays4Freedom Facebook: Daniel Patrick Hall Blog.DanielHall4Freedom.ws Our Words are Weapons. Our Ammo, the Truth! /verbalmilitiatv ~@ VM !!!

[verbalmilitia]

Google: The Track Record of The Federal Reserve

/ A US History of False Flag Attacks

[verbalmilitia]

The private and foreign owned, illegally formed, illegally taxpayer funded, illegally for profit Federal Reserve Banking Scam is anything BUT Necessary.

Google: The Track Record of The Federal Reserve A US History of False Flag Attacks

A1, S10, USC, No State shall accept any Thing but Gold and Silver Coin in the payment of debt. The Counterfeit US Dollar, The US Federal (Non Governmental) Federal Reserve Note is backed only by the Debt of your labor.

911 was an INSIDE JOB.

[verbalmilitia]

Wake The Fuck Up Citizens of the States of The United States.

We the People are the Free Press, a Verbal Militia,

taking Action online as a Group.

JUSTIN. TV/VERBALMILITIATV

Marc Douglas Vogt / Facebook

Club V, V2, VERBALMILITIA

Our Words are Weapons,

Our Ammo, the Truth.

VERBALMILITIA

marc27

[passwordrequired]

thanks, this helped my understanding greatly

[saulherman]

can you do a video on interest rate or currency swaps

[RunLiberty]

Study libertarian economics has been totally hijacked by the "court economists" aka State government bootlickers like Geithner, Bernanke, Fed Board, etc

Ron Paul 2012

[oneyedo]

@RunLiberty Tell me this how is libertarian economics going to prevent the side bet in CDS, or how is libertarian economics going to work where the there is incentive to not make this kind of side bet. Or do you believe CDS and the side bet in CDS are natural results of libertarian economics.

Explain what ideas that the court economists come up with that causes the creation of side bet in CDS, or CDS itself.

[montrealrobby]

well done

[lordkoos]

Thanks much for your explanations, makes it very easy to understand.

[nickfl1980]

"Of course the answer is that he & his crew weren't watching"

Sure they were watching but didn't care, because their buddies told them to deragulate the rules, not to worry, while receiving "campaing donations", and after the whole show, don't worry, you'll get something for your pension or whatever. Oh by the way, the Bush family bought land in Paraguay, during the summit of the Americas in 2005. Just some info.

[thechivagringo]

im 16 and saw a video for this stuff so i was like what the hell. and now i am learning about this stuff and its cool lol :D

[cdltpx]

What H1 did is what is called CDO's I think the investor that managed a fund said that he was buying the products and had to hold them for som 2 years that for him to make money only7% need defualt the default rate was around 30% depending on the area where the loans were made for the housing. Some of the bonds that were in play here were the very ones made by Michael Milken way back then. What was retarded was the government paying 100% many that were betting against the market expected

[cdltpx]

@cdltpx Those that made those unwise options on those products to go under and they would be out much of the money they were owed. In fact one of the big winners was selling all he could thinking this very thing that he better get out while he can get cause when they fold he better have 100% of what he can get than 0%of that which he cant. Say they were allowed to fail what would have happened major correction yes but 1 trillion dollars was lost in a flash or changed hands from taxpayer to corp

[cdltpx]

@cdltpx The end result is we still have major job loss the same AH are in business only a hand full of men lost their jobs worse yet less than 10 had criminal charges brought against them. This segment of the market needs to be removed sometimes the answer is no we don't need business like this. We especially don't need politicians that are owned by the corps and will do things that are nothing short of fascist.

[chandanpujapanda]

great work explaining and sharing your knowledge

[OceanWushi]

I'm not sure why CDSs are getting all this hate. There's nothing inherently wrong with CDSs, just like there's nothing inherently wrong with short selling. The problem lies with the issuer of the CDS making promises it can't pay for. The fireman analogy is different because you could just go burn your neighbor's house down. But you can't just force a company to default on its loans.

[zulfi721]

nice explanation

[anryth]

if anyone is thinking "why would these investment banks engage in such risky activities?"

the answer is, the government told them that they were "too big to fail".

in other words, the government took out all the risk that would have offset the returns. its like going to a casino and being greeted by a manager at the front door who tells you that the casino will pay back all the money you lose. this was all caused by government intervention into the market, not lack of intervention.

[RunmoreThinkless]

so are the credit default swaps part of the shadow banking system that Krugman was talking about?

[Kaysersoze5]

dear sal,

i have one question. why is the insurance company happy with a fraction of the interest received, when the insurance company is fully liable when the borrower defaults. the insurance company could also lend the money, get 100% of the interest and have the same risk profile on the transaction. am i missing something?

[KrispyKangaroo]

@Kaysersoze5 The insurance company doesn't have to lend any money in a CDS, so it can use its rating to get a lot more of them and accumulate a greater inflow of cash than they could by direct lending.

[Chnamanjx]

@Kaysersoze5 If the Insurance company lent out the money the money themselves, they have to set aside 100% of the money and xfer it to the borrower.

With the credit swap, they set aside ZERO money, and get 10% fo the interest or so.

[zee687]

@Kaysersoze5 i think the insurance company banks on the government bailing them out if there is a wreck, in the mean time it is happy to collect rent till the building collapses...from what i understood from sals video

[juujuuuujj]

@Kaysersoze5 Because 1) they don't have to use any of their own money and 2) because they can insure loans on many companies. This means that you can potentially get more revenue from 100 streams of 1% than from 1 stream of 10% (limited by how much you can lend). The reason why they ignore the risk is because they can manipulate the market and shift risk in other ways. And of course, there's the expectation of a bailout, since they have lobbyists and insiders in high places (and they're TBTF).

[pierd]

@Kaysersoze5 In this system the insurance company does not need to back up their guarantee with actual collateral thus enabling them to insure infinite amount of loans. Had the taken 100% of the interest by supplying the actual loan they are limited by the amount of assets they actually have

[pierd]

had they*

[garizable]

@Kaysersoze5 insurance companies are counting on favourable market conditions where they expect the company (which has borrowed money) to not default. so just by promising insurance they get money without havng to formally put any capital of their at risk.plus they don't insure money of just one company.they insure it for many others.so imagine free money comng to their organizatn from many sources with them havng to do almost nothing.yes there is risk involved.bt they take it nd hence recession

[moistfaucet]

@Kaysersoze5, the answer to your questions is over confidence because all company categorize too big to fail.

[BelijaNero]

@Kaysersoze5 You are missing, that the ionsurance company does not have the need to lend the money, if they insure a lending op for 2-3% they earn 2-3% for doing nothing than saying "I guarantee for this", if they lend the money to the company they would need to put a lot of cash on the table in return of 10% interest, which they cant do frequently, as they have limited money to spend. but their word is unlimited, which means they can guarantee for 300 comapnies and get 300 x 3%.

[ZakBrownrigg123]

6:00

How can you buy insurance on something if you haven't even invested in it? Isnt the whole point you lend Corporation B money, they pay you interest, and part of that interest goes into paying the Insurance entity? If your not paying Corporation B any money, and are only paying insurance, not only are you not getting a return, your LOSING MONEY.

Am I wrong or is this video wrong?

[KrispyKangaroo]

@ZakBrownrigg123 You're betting that Corporation B is probably going to default soon when you buy the swap.

[rscoville82]

Excellent explanations. Thanks.

[RNelson144]

It's strange that you can buy insurance on debt that isn't owed to you, but in the video you state that you can buy insurance on debt that isn't owed to anyone ($10 billion when the company doesn't have $10 billion in debt). How do you identify the debt being insured except by reference to the amount and the person it is owed to?You owe $1 to each to two people for a total of $2.A third party insures $100 billion worth of your debt.Is payment conditional on the default of either debt? On both?

[theporksicle]

@RNelson144

I think the way it works is you buy a CDS on a reference entity (I.e. B in the case of the hedge fund example) and since CDS' are not bought on an exchange you and whoever you are making the deal with (i.e. the insurer) write out the terms. So you could buy $10 billion of insurance on B defaulting on their loan from P2 or you could buy it on all of the loans they have, or on them becoming insolvent etc

[OfficialiPAUL]

Dude, this is so beast!

[vaughnstar]

Great job in explaining this god awful mess. I tried reading several definitions and could never understand the entire concept of CD swaps.

All in the name of greed...

[thegoonist]

i have a few questions. firstly, how could the govt/legislature EVER ALLOW THIS TO HAPPEN? i think this is how insurance companies worldwide are operating but this system (insuring money they clearly dont have) is a fucking stupid business model! is the reason why theyre allowed to persist with this inane method because of the economy? i.e. they need more people to lend to others for investment, and these people lending need more insurances before they can lend?

[thegoonist]

@thegoonist shouldnt there be more strict regulations regarding the insurance companies besides a probability of whether debt ridden companies will default?? because probability doesnt work in the real world due to business cycles! when theres a recession like now, the math goes out the window because like the video shows, there is a cascade of chain reactions due to the inability of insurance companies to repay their promised amounts!

[thegoonist]

@thegoonist the only reason i can see so far as to why this mind numbingly stupid system is allowed to persist is because of the insatiable need for investment capital and loans and the excessive need to insure these loans (demand of $> supply of $) and that many economies depend on these capital injections annually to grow their GDP?

is this the only reason? if it is i dont see how the govt or whatever worldwide body that regulates this crap system justifies itself.

[thegoonist]

@thegoonist ive asked my parents these same questions when i was a 9 yr old kid when i asked them about how car insurances work. they couldnt give me a straight answer as to the logic of these companies' business model.

as to the side bet portion of the video, how can this even happen in the first place?! shouldnt the insurance company ENSURE (i.e. paperwork verification) that the hedge fund indeed loaned the money to corp B BEFORE selling them the insurance?!

[thegoonist]

@thegoonist because if they dont ensure the loan occurred, they are just perpetuating this cycle of risky betting that would implode either way! its destructive to the economy! (if insurance company wins, hedge fund probably would be in HUGE debt and may declare bankrupt; if hedge fund wins bet, insurance company goes bankrupt and starts off a huge chain reaction due to its heavy involvement in CDS!)

[thegoonist]

one more question: how does one get out of a loan obligation as mentioned in 10:32? is it possible in the loan contract to include a clause that states that the lender can request his money from the borrower at any point in time? and if the borrower is unable to repay the money the lender is able to sue?

im not sure about this because i mean most loans are for investments and these take time to bear fruit right? (in most cases at least) and wouldnt it be unreasonable to include this clause?

[notme222]

@thegoonist Getting out of a loan generally means selling the loan to someone else, at lower value. You loan $100 to someone, then worry they won't pay you back. I say "OK I'll buy the loan, here's $85 for you and now they owe me the $100 instead."

BTW, one smooth way to fight "too big to fail" is just by adjusting something the government ALREADY does. Khan has explained reserve requirements in other videos. So gov't simply has to say "bigger banks get higher reserve req." Thus less risk.

[notme222]

@thegoonist Well ask this first: why would "I2" (the insurer, like AIG) let this happen? Gov't wants to stop bad choices. But I2 has *every* motivation, yet they _destroyed_ themselves. Not on purpose but because they weren't smart enough to understand the risk.

So why govt let it happen? Well if AIG experts work 10hr/day on it and they don't know the risk, how's Congress going to? What politicians can do is wait til after and say "well I would know better." Then bail out the dumb guys.

[thegoonist]

@notme222 @notme222 tbh there is no excuse to say that they "werent smart to understand the risk". the risk was fundamental to the whole business and i think they perfectly understood it but still persisted to play against the odds betting that this kind of a catastrophe would never occur.

any rational, inquisitive person, children included, who want to know how insurance agencies operate or make a profit would ask fundamental questions that would inevitably reveal these flaws.

[andykala1000]

Again Khanacademy.. awesome videos :) you make something confusion to something totallly understandable :D

[imbagogo]

@lilpenguinboy The point Sal is trying to illustrate is that these insurance companies and other entities who hand out swaps don't need to set aside money for the risk of default.[cos of loosely defined mandate (pre-crises)]

Thus making them in Buffet's words "financial weapons of mass destruction".

[shofie222]

Jay..Many European banks are I2!! Thats why they are so nervous.......

Sal Thanks!!!

[theporksicle]

I think the 'lessons' we're supposed to learn from this crisis are false ones, the fact is that almost every business relies on credit and gives credit, and the world's better for it.

[Jayd3z]

great lecture!

Now, Goldman is using CDS to bet on Greece's default. Of course, Goldman would be H1 and Greece would be Corp B in the video. P1 and P2 is probably the EU countries, such as Germany. I am curious to know who plays the role of the insurer, I 2 in the video, in terms of the situation in Greece?

[lilpenguinboy]

This is so poorly explained! I shudder to think of the number of people who believe that this is how it works.

Just enough text for one point. If the CDS (Insurer) issuer had to hold the billion dollars for the insurance why would they EVER offer it? They could get 8% return on the same amount of money by investing the company directly instead of the paltry 1%.

[theporksicle]

Absolutely, my thoughts exactly but there's no way to reconcile it other than perhaps the Pension fund accepting 6% and the insurer 4% because then the insurer could still have the $1 billion in the bank accruing say 6% a year and then if they need the cash out they can just withdraw it.

[doc7474]

Wonderful explanation. Thank you.

[inhoo117]

There is no mention of increased Collateral Calls when the ratings are downgraded whereby depletion of capital happens, sort of like run on banks

[mediblue9]

I wonder how many H1's bet on General Motors 10 years ago?

[mx4life321]

great job sir. i really enjoy the way you lecture.

[Hudson4351]

At around 3:55, you said that the companies issuing the CDS only have to keep enough money aside to cover the probabilistic amount of debt defaults rather than the entire amount of CDS issued. You imply that this is one of the major problems with CDS, but don't car/house/life insurance companies work the same way? They don't actually have to set aside $1 for every dollar of insurance they issue, right?

[LAmacchiaBLOG]

@Hudson4351 That is correct. Insurance rates are based on actuarial tables that predict the probability of various events happening ie. car crash, age of death, etc. CDS are different though because it is as though 1000 people could get insurance for one car. Even if the probability of this car crashing and the insurance having to be paid out is the same as all other cars, in the event that this car actually does crash (the company defaults) then the insurance company is screwed.

[justforfun11197]

It is probably debateable whether a financial instrument 'CDS' would be a weapon of mass destruction in the financial market or the credit rating companies themselves whom rated those insurance companies as good enough to insure those financial institutions like pension funds and hedge funds

[blygrace]

Excellent video!

[majaap]

hey just clarify the relationship with corporation B and Insurance 2 in that explanation

[Georgy27]

Thank you for this great video! But what happens if insurance company doesn't have enough money to the pension fund in case the company A or B is bankrupt? Thanks

[riskyshotz]

Great video. Very informative, thanks.

[pinko1975]

Derivatives are WMD!  so true!

[lwnamr]

so why can't this be resolved like this: moody's should be very strict and verify all those insurance companies or banks before every insurance/loan is being set?or if not for every transaction, then periodically check ups.. so in that way, insurers wouldn't be so overrated...why isn't the blame put on moody's?

[Brecx]

faaaantastic

[paddywalsh84]

kudos guys, your work is very important. the more I understand this, the less chance I have of becoming a victim of the financial system. keep it up! perhaps a video on the big carry trade?

[Psmerling]

the dollar is propped up by being the currency oil is priced in.

[Mastophales]

Nice job, this is what happens when there are no checks & balances. Any "credit default insurer" should be required to have the ample assets to cover every transcation. Which shows another problem, the bond rating companies and or S&P, how much are they influenced as to their ratings. Similar problem with our currency, it is backed by nothing, no longer gold. Federal Reserve System, i.e their backing is us, the Taxpayer. We already well into the trip of "Finacial trainwreck of the Millenium".

[gcat4u]

Bravo

[hbjon]

I used to think this form of fraud was very complicated. In fact, it is very obvious. Given there are no regulations and transparency. Take a close look at what needs to happen to defraud the Insurance company. Who is being wronged and who will ultimately be responsible for the financial obligations. How is it that when this thing unwinds, they can exchange their poker chips with greenbacks? And where are those greenbacks taken from?

[raybonent]

THe bank charges me $20 in monthly fees, I take money out of my 401k and I get penalized and we have this kind of betting going on!!!!!!! Give me a break. Great explanation. Thank you

[atultiwari1000]

Khan Academy , you guys are wonderful

I am already a donor to your academy , just want to support your endeavours where i am learnign and you spread knowledge also

all the best

Atul

[jvdesensi]

legend!

[VigilanteNighthawk]

By far, this is the best explanation of CDS I have seen, and it has clarified a great deal for me. Thank you.

[Smokr]

Thanks. A nice, understandable rundown on these insane transactions and how one domino falling brings down so many others.

[3waybar]

The Ceo of CDS creating firms, stand nothing to lose but his/her job and have everything to gain in stock options and bonuses, if the company gets bancrupt they just move on to the next job opportunity, there is generally no penalty or retroactive imbursement of bonuses.

[megatrazor]

CDS is good as long as it is regulated by Fed.The fall of AIG was due to their greedy obtaining more money on guaranteed a loan. This system make the lender exposed to risk compared to the borrowers.They need to check the background of the company they Insured thoroughly before give the CDS.

[stitlskin]

well, here in spain we're having a big time problem since many of these CDS have been commercialized as "true insurance" to the "lay people", I mean individuals with mortgages, small credits, ... and they are making our life IMPOSSIBLE!! How could it be possible that small banks can commercialize this stuff to individuals like us, that have a really hard time just surviving to get to the end of the month. They are RUINING US!!!!! Pls be careful with this product, it is very dangerous!!!!!!!!

[archelonprime]

I don't know what's more laughable, the very concept of credit default swaps/derivatives or the people that defend them.

[ObsessiveDetailer]

So notional values aside, what is the real sum of the CDS market worth? A lot less?

[eswarifcai]

Hey Khan,

Absolutely love your vids on swaps. There is a currency swap deal struck by the Fed recently. Any videos on that?

[drobberbaron]

But why would the insurer give insurance to people who hadn't made a loan on companies that some hedge funder thought migfht fail? Are they stupid?

[CONGKAMAEL]

I think, the insurance company just wants to make money and that's it!!! As long as they think there is very small chance that the company, which hedge funder thought might fail, goes default, then the insurance company gets lovely 1% or 2% money which generates lovely bonus... this is all like gambling... insurance company thinks the risk is low, they agree the deal, the hedge funder think the chance is big, then they also willing to make the deal.

[IndyFlick]

Seems like I2 would simply buy the bonds of B2, for cents on the dollar, and continue to make payments to P1. Even if they paid par, it would save them $8B ($10B CDS - $2B Par).

[johnny1436]

excellent

[Lovebaby109]

how does the Pension Fund unwind their CDS now that the Insurance is undercapitalized, i.e. cannot meet its obligation to insure the debt given to B corp?

[MrAnderson122112]

And that's what happened to AIG!

[DiltonDalton]

The CDS allows the equivalent of buying fire insurance on your neighbor's house. In fact it is like insuring your neighbor's house N times. This situation is not legal for several reasons. First it is insuring where there is no risk. Second it makes it tempting to set your neighbor's house on fire. CDSs need to be make illegal unless there is a real risk being insured. The government should declare the "side" bets null and void and not collectible. Nobody would be hurt and crisis avoided.

[13WhiteFang37]

Excellent reply! U just summarized the ENTIRE video. Hah. Kudos to you.

[JoshuaSethComposer]

"The CDS allows the equivalent of buying fire insurance on your neighbor's house. In fact it is like insuring your neighbor's house N times. This situation is not legal for several reasons. First it is insuring where there is no risk. Second it makes it tempting to set your neighbor's house on fire."

Agreed. But are we sure this is what was going on? The magnitude of the absurdity is so mind-boggling that it's really hard to believe. The tooth fairy has more credibility.

[DiltonDalton]

Yes it is indeed mind boggling. What is even more mind boggling is that the federal government under George the 3rd actually passed laws to prevent this practice from being regulated. An industry that was bigger than all the banks and all the mortgage companies and in fact larger than the entire economy of the USA was allowed to run wild with nobody watching. Good old George said, in jest, "Why did this have to happen on my watch?" Of course the answer is that he & his crew weren't watching.

[wordpresswidget]

@DiltonDalton oh they were watching all right, with drool falling profusely from the chops. This was a poignant example of why one does not let the fox watch the hen house.

[WorldlyTyrant]

@DiltonDalton no, it's freedom of contract...parties are free to make arrangements as long as it is not illegal; no one would complain if the "side bets" are worth say $100K...that would be nothing to these companies. The point is - govt should declare that a certain amount of collateral is needed for ANY insuring to take place, say 1000% (you need to have $10 to insure $1 debt).

[dontblamethemessenge]

I dont understand that the hedgefund can bet on the default of a company.

So it pays 50 million per quarter to the insurance company, and if the company goes broke, then the hedgefund gets billions.

I really don't understand one can do this.

[ThatIsNotDeadWhich]

Well, they can do it because "Alcoa" Rubin, "Bubbles" Greenspan, "Chiquita" Clinton, "Harken" Bush and the rest of the neoliberal gangsters that pass for politicians on that side of the Pond decided that they were allowed to do it.

*Should* they be allowed to do it? Heck, no. No way. But hey, GoldmanSachs has had three Treasury Secretaries in a row and pay a lot of money to the right people...

[bobbyv364]

You can thank Phil Gramm who on December 15, 2000, rushed through the Commodity Futures Modernization Act of 2000, which Because of the swap-related provisions of Gramm's bill, a $62 trillion market (nearly four times the size of the entire US stock market) remained utterly unregulated, meaning no one made sure the banks and hedge funds had the assets to cover the losses they guaranteed.

[Serge808]

Why would I2 insure co. B to H1 for $10b, that wouldn't be realistic.if co. Bwas only worth 2billion why would I2 take on the risk? that means they would take a massive potential loss, their credit rating shoiuld fall dramatically just based on the signing of the contract with H1

[aw3212]

They never had the intention of paying anything back. Like AIG; they will just ask for a bailout or like others go bankrupt. The executives that ruined the company has already made millions off the tranactions and bonues from good earnings (which were deceptive). BTW - have you seen a CDS or CDO contract? They are so simple considering they were multi-million sometimes multi-billion dollar contracts. The reason you don't see "insurance" written on them is because that would mean regulation.

[MyFreeCredit]

Entertaining to watch. Thanks for sharing.

[robrown1]

Google UNIFIEDMARKETS

[rockyjay55]

Our goverment made this legal by passing bill hr 4541 in 2000.This betting was made illegal after the 1929 crash!!! WHY ARENT THE PEOPLE SCREAMING FOR TERM LIMITS!! HOW MUCH ARE WE WILLING TO BE SCREWED!!!

[gunsandroses1111]

Well explained. So greed triumphed over prudence. But there is worse to come - defaulting A plus and jumbo mortgage loans (due 2009). And VIEs. And many remaining non subprime SIVs. As all this unwinds one may find it is more money than the Fed, or available world loans to it, can cover. Then entire US becomes bankrupt, as with Iceland, but no monetry authority in the world has anywhere near enough money to bail them out. Best then is to really give up? Game over ....

[emilianopickett]

We need to talk. How likely is this? If the US defalults what is the next step? When are the 2009 mortgages due, in what month?

Jeff

[shakaama]

you know what your video is more awesome than i thought. i completely understood fast money tonight. except for the part where they went into the g7 conference for injecting liquid cash directly to non-financials. whatever that means.

[shakaama]

i understood and liked the video, but you do make leaps in your vocabulary that one has to overcome and infer upon oneself.

[mrfexboy]

good video , puts it in "plain speak"

[brco2003]

1984

[mrfexboy]

1984 indeed.

[bjohnt9]

Awesome video!

[TomStHubbins]

Dude you are one clever fella!!! keep up the good work

[MyLittleFunk]

Excellent vids...a great resource!

[cbot141]

The notional value could quickly compress to a much smaller sum as settlement occurred, and it is the general case that the insurer's risk is limited to a percentage of the underlying asset's face value rather than the entire accumulated notional value of the problem. Usually, it is the cash flow vis a vis a bench mark cash flow which is at risk rather than the full default loss.

Thank you. I greatly appreciate this thread.

[cbot141]

Thus it would seem that when writing CDS insurance on an underlying RMBS or a CDO the initial CDS is left open in its notional value even when it is offset or covered by an equivalent opposing position. At the same time the writer of the new and opposing position now has an added open notional value. It would not take long for these open layers to become an astronomical total.

[cbot141]

As to the putative $50T in CDS reported to have been written, shouldn't we need to remember that this is the notional value? CDS's are an over the counter derivative. As such they are not subject to offset as are futures or exchange traded options.

[kinimalia]

reported on NPR 10/4/08 on This American Life that for the taxpayers to purchase this huge, stinking pile of garbage assets and get nothing in return is certainly possible.

However, someone in both Sen and House has added language to the bailout bill to give the Treasury Secretary the OPTION of requiring stock in the failed banks, along with the worthless assets.

Sort of like yes, we'll buy your bad debts, but we also get a share of your business.

Q: How do we force them to do this now?

[didichai]

oh my god, it's really really great, thank you very very much

[sgentry777]

Is my understanding correct that there are no GAAP/FASB disclosure requirements for these contingent CDS liabilities?

[estgemme]

great videos, great supplement to my schooling. why wasnt it made this easy in high school? thank you.

[tashagrace12]

This is an awesome segment. In fact all of them, the CDO, MBS, Bailout Series are amazing. You are doing a great public service by explaining this in layman's terms. I will recommend this to all my family and friends to understand this mess the corps have gotten into. I will also petition my congress reps to avoid bailing out these fat cats.

[sayyedsalman]

Thanks Sal for Explaining the Credit Default Swap.

[crocop60]

Wow. The most comprehensive explaination I've seen. That's scary, I almost wish I remained ignorant of learning that.

[SteadyHaze]

I haven't watched this finance series..But I gotta say, you are the man..You harbor so much knowledge...

[Impactofdeath]

You're So Great!

[kulapica]

Would you please explain Collateralized Debt Obligation (CDO) as well?

[stretchyrubberbands]

Actually he already has, in another video.

[pongman]

Why can't Corporation A do the same thing as the Hedge fund 1 and bet on insurance that they wouldn't go under and default? But, in actuality do default and take the billions of dollars they would make by defaulting or better yet maybe they are in cahoots with Hedge Fund 1 and have a vested interest in the hedge fund and make billions more than the money that they borrowed,lol. After all the Government isn't watching and there are no rules or laws to break. The taxpayer gets screwed again.

[Shadyhunter04]

100 basis points as in 1%? of that 10% they earn of interest?