Friday, March 26, 2010

CDS Explained, Simply

I heard Michael Lewis (author of The Big Short) earlier this week being interviewed on the Diane Rehm Show, about the global financial shenanigans, and he explained Credit Default Swaps (CDS) simply, like this:
- your next door neighbor's house use to be worth about $750,000 a few years ago
- the neighborhood has been growing and maturing, and now, it is worth $1,000,000
- seeing this increase in perceived value, you go out, and you buy an insurance policy on your neighbor's house, to insure it for a $1,000,000. It's not your house, it's your neighbor's house.
- now, you take this million dollar policy, and you re-package it, and re-combine it with policies on other neighbor's houses, and you parse it up, and sell it again and again and again, to "spread out your risk".
- after all those re-arrangement shenanigans, that million dollar insurance policy, is NOW worth A BILLION dollars. Remember, your neighbor's house is still only worth a million dollars.

So, with that massive over-value, of a million dollar house, there is SIGNIFICANT incentive to Burn The House Down.

Hearing that, made me SO ANGRY, as the light bulb went off over my head. An hour of yoga later, I felt much better.

Diane asked Lewis "the right says this is all Barney Frank's and Chris Dodd's fault, due to their pushing of the Fair Lending Act". To which Lewis replied 'The Fair lending Act was such a small part of the overall inflation in worthless mortgages. Yes, some mortgages were given out to people who should not have gotten them, but it was the re-packaging of that debt that multiplied the impact 1000s or 10s of thousands of times. It is the largest Wall street investment firms who have the vast majority of the blame who are responsible - those that are 'too big to fail'. Frank & Dodd have 1 to 2% of the blame at most'. Grrrrrrrrrrrrrrrrrrr.

No comments:

Post a Comment

Note: Only a member of this blog may post a comment.