Monday, February 1, 2010
Is CDS Worth the Risk it Allegedly Contains? NO!
Monday Market Movement, Missing Momentum?
"Every civilization," Swiss historian Jacob Burkhardt once wrote, "carries within itself the seeds of its own destruction."
Dr. Hanmer Hill and Josh Bill tell us: "We believe the financial crisis of 2008 exposes a seed that can destroy Western-style free-market capitalism. The name of that seed is the credit default swap, or CDS… A surgeon could not take out a life policy on a patient he or she was about to operate on. You could not take out a fire policy on a home you did not own, and you could not take out more than one policy on a home you did own… It was, and still is, possible to buy an unlimited number of CDSs against any financial instrument, whether one owns that instrument or not. Imagine someone taking out 20 fire policies on his neighbor’s home. Common sense tells you the odds just went up that that house is going to burn, and you have just created a perverse appetite for the homes most likely to burn."
The total amount of subprime mortgages written soon rose to $2 trillion. The total value of the CDSs written against CDOs rose to $65 trillion. That’s right: $65 trillion of insurance against $2 trillion worth of high-risk mortgages. Those who profited the most sought out the worst of the worst mortgages to bet against. One big winner was hedge fund manager John Paulson. In 2006, Paulson convinced Goldman Sachs and Deutsche Bank to create extremely high-risk CDOs and sell them to others, so both he and they could bet against them. Paulson picked the mortgages. He made $15billion. His friend George Soros (who later said "I’m having a very good crisis") made $5 billion. Deutsche Bank made $25 billion doing this. Goldman Sachs made much, much more.
In 2006, Goldman Sachs and Deutsche Bank underwrote 352 fraudulent mortgages in Sikeston, Mo. In 2009, Goldman Sachs paid Massachusetts $60 million to close an investigation into its role in creating "mortgages designed to fail at the inception."
As I mentioned this weekend in my Davos review, I find it VERY disturbing that we are seeing an extreme uptick in both lending to risky countries and CDS betting that those same countries will fail. This is kind of like playing that carnival game where you squirt water into the clown’s mouth until you pop the balloon while adding bets that the balloon will pop.
Unlike the clown game, your bet doesn’t…