A Look at Wall Street's Shadow Market

[Gavin in Va Beach]

Didn't catch the show, but the transcript of it provides some interesting reading. Sure sounds like we're screwed.

 

 

http://www.cbsnews.com/stories/2008/10/05/...in4502454.shtml

 

What most people outside of Wall Street and Washington don't know is that a lot of people who bought these risky mortgage securities also went out and bought even more arcane investments that Wall Street was peddling called "credit default swaps." And they have turned out to be a much bigger problem.

 

They are private and largely undisclosed contracts that mortgage investors entered into to protect themselves against losses if the investments went bad. And they are part of a huge unregulated market that has already helped bring down three of the largest firms on Wall Street, and still threaten the ones that are left.

 

Before your eyes glaze over, Michael Greenberger, a law professor at the University of Maryland and a former director of trading and markets for the Commodities Futures Trading Commission, says they are much simpler than they sound. "A credit default swap is a contract between two people, one of whom is giving insurance to the other that he will be paid in the event that a financial institution, or a financial instrument, fails," he explains.

 

"It is an insurance contract, but they've been very careful not to call it that because if it were insurance, it would be regulated. So they use a magic substitute word called a 'swap,' which by virtue of federal law is deregulated," Greenberger adds.

 

 

ISDA's CEO, Robert Pickel, says there is nothing wrong with credit default swaps, and that the problem was with underlying mortgage securities.

 

"Well, there's clearly something wrong with the system if all of these leveraged bets, hidden leveraged bets, caused a collapse in the financial system," Kroft remarks.

 

"It is something that we all need to look at and learn lessons from. And we all need to work together to understand that and design a structure in the future that works more effectively," Pickel says.

 

"My point is, the people that made these mistakes are the people you represent in your organization. And many of them sit on the board. I mean, if they didn't get it right, who would?" Kroft asks.

 

"These people understand the nature of these products. They understand the risks," Pickel replies.

 

"Well…they didn't or they wouldn't have bought them. They wouldn't have used them," Kroft says.

 

"These are very useful transactions. And the people do understand the nature of the risk that they're entering into…but I'm not sure that…," Pickel says.

 

"Useful?" Kroft interrupts. "How come they brought down the financial system?"

 

"Because, perhaps they didn't understand the underlying risk, and nobody really saw the effects that were going to flow through from the subprime lending situation," Pickel says.

 

Asked how much of this was incompetence on the part of Wall Street and the people who ran it, Jim Grant tells Kroft, "The truth is that on Wall Street, a lot of people just weren't very good at their jobs. It's as simple as that."

 

"These people were being paid $50 to $100 million a year. Some of them, the guys that were running the places," Kroft remarks.

 

"There is no defending," Grant replies. "A trainee making 45,000 a year would have had the common sense not to bet the firm on mortgage contraptions that no one in the firm actually understood. That is not a deep point to comprehend. Somehow, through, I will call it a criminal neglect and incompetence, the people at the top of these firms chose to look away, to take more risk, to enrich themselves and to put the shareholders and, indeed, the country, itself, ultimately, the country's economy at risk. And it is truly not only a shame, it's a crime."

[meazza]

If you look back at like all the finance threads, I think GG mentionned about 1000 times the impact of the CDS market...

[GG]

If you look back at like all the finance threads, I think GG mentionned about 1000 times the impact of the CDS market...

 

I may have, but perhaps not channeling it through Revelations is why it got lost in the ether.

[John Adams]

GG mentioned it and it's been in the financial periodicals. I'm no economist (but I stayed at a Holiday Inn express last night!) but it's clear the CDSes are also part of the problem.

 

We're all going to take more medicine before this turns around.

[Lurker]

What most people outside of Wall Street and Washington don't know is that a lot of people who bought these risky mortgage securities also went out and bought even more arcane investments that Wall Street was peddling called "credit default swaps." And they have turned out to be a much bigger problem.

 

They are private and largely undisclosed contracts that mortgage investors entered into to protect themselves against losses if the investments went bad. And they are part of a huge unregulated market that has already helped bring down three of the largest firms on Wall Street, and still threaten the ones that are left.

 

Before your eyes glaze over, Michael Greenberger, a law professor at the University of Maryland and a former director of trading and markets for the Commodities Futures Trading Commission, says they are much simpler than they sound. "A credit default swap is a contract between two people, one of whom is giving insurance to the other that he will be paid in the event that a financial institution, or a financial instrument, fails," he explains.

 

 

Gotta quibble a bit with the tone of this description of the CDS market--it makes it sound like poor unsuspecting Joe Sixpack was buying swaps sold by unscrupulous Wall Street con artists. Credit Default Swaps are contracts primarily between very sophisticated counterparties (major corporations, hedge funds) who can--as it's tuning out--be wrong about the cost of the risk they are insuring, but who are by no means innocent rubes or entities that need to be protected from themselves.

[TPS]

I may have, but perhaps not channeling it through Revelations is why it got lost in the ether.

Blame Paulson for worsening this crisis. You posted this link in one of the earlier threads:

 

counterparty risk

 

A much larger threat of potential market disruption would be the failure of a major counterparty such as a large bank or broker-dealer, which would have the effect of significantly widening spreads on both credit default swaps and cash bonds, Moody's said

 

This was back in May. When Paulson and Bernanke decided to let Lehman go, there was an exponential expansion of the crisis.

[GG]

Blame Paulson for worsening this crisis. You posted this link in one of the earlier threads:

 

counterparty risk

 

 

 

This was back in May. When Paulson and Bernanke decided to let Lehman go, there was an exponential expansion of the crisis.

 

Should've quit my job back then, too. You know, go out on top.

[TPS]

Should've quit my job back then, too. You know, go out on top.

AS I recall, you were (and still are?) in the "it's only a crisis if you panic camp,"...

[bills_fan]

Step 1 to recovery...

 

http://www.cnbc.com/id/27044623

[GG]

AS I recall, you were (and still are?) in the "it's only a crisis if you panic camp,"...

 

You can read my role as either Bluto asking if it's over when Germans bombed Pearl Harbor, or Kevin Bacon imploring all to remain calm, as all is well.