Void Payout to Non-Debt Holders of CDSs

In the AIG casino, banks and other parties played the CDS game against the house. Unlike blackjack where mostly one person wins, here in the CDS game all parties won against the house (AIG). The table person took a $165 million bonus but AIG paid out so far $90 billion to banks, or perhaps the entire $160 billion of taxpayers' money.

Goldman Sachs (GS) knew its own mortgage bonds were worthless, and then bought CDS for more than its worth. To hold a CDS, the bank doesn't need to have the loan instrument with it. Now, GS has already been exposed that it made bets worth $9 billion and took taxpayers' money.

Currently, in the world, the open CDS contracts are worth many times more than the outstanding debt notes. It means people simply bet mortgage bonds would fail and bought as many CDS as they could for the same underlying mortgage bond.

To cut its losses, why can’t AIG just return the premium it got from the people who own the CDS, but not the loan? An investor should get a payout for CDS only when he holds the underlying security. Can Congress help control the bleeding by enacting a law? It is better than taxing 165 million. It will save a lot more for tax payers.

We can get out of the CDS pit only through a law that voids payout to non-debt holders of CDS. It is simply a bet. Just return their money.

Comments

[ArkansasAngie:]

Financial companies have no business selling naked CDS' to speculators.

I'm for dissolving all naked CDS' today. They never happen.

And ... I guarantee you that if $1 of tax payer money goes toward paying off a naked CDS held by some day trader on a beach in the Caymens, some of us are going to be unhappy. AIG bonuses are small potatoes comparatively.

You don't suppose that Osama's been buying naked CDS' ... do you? Maybe Homeland Security needs to investigate this, too.

Mar 22 10:00 AM

[Dan Daly:]

Goldman Sachs called their bookie (AIG) made a bet. AIG covered the bet and lost. Res ipsa loquitur. Instead of being an insurance company they became bookies and we are going to pay for it . The AIG traders should be going to jail.

Mar 22 10:26 AM

[random walking:]

At the minimum, your idea deserves inclusion in the debate. We have these quasi-receiverships, quasi-bankruptcies, quasi-conservatorships, and imposed ownership restructurings that have not foreseen all implications, and that are motivated by political pressures as well as pragmatic needs. It is clear that by going the quasi route, the normal regulatory forces that were implied by rule of law were being circumvented.

Clearly there is reason to consider that prior contracts are not all cast in stone, and to start giving the highest weight to this point. Obviously, our conceptual framework in regards to solving this mess is evolving, and your comment can only help in this evolution.

The political expediency in using quasi restructuring steps is problematic in that existing rule of law may not apply. If the pre-crash rule of law was not sufficient for intervening with failed mega corporations, then instead of inventing new quasi systems of restructuring, regulators and politicians should have done the necessary homework to revise the systems of restructuring allowed by the rule of law. Then all contracts would have been on the table, not just those at the whim of the regulators (politicians) operating outside the rule of law.

Mar 22 02:03 PM

[jimmy46:]

You are suggesting that only parties with an INSURABLE INTEREST can buy CDS's,

I agree totally.

Everyone else is gambling.

Mar 22 02:13 PM

[Poor Dude:]

I whole heartedly agree. All naked CDS's should be voided immediately.

Mar 22 02:15 PM

[Al-USA:]

Excellent articla and a clear illustration of the decaying political establishment in Washington.

Mar 22 02:52 PM

[Tom Armistead:]

Agree wholeheartedly, all naked CDS (those that are not backed by an insurable interest) should be voided as gambling contracts.

What the article did not cover is the extent of the moral hazard created by the ability to buy naked CDS. It's like buying fire insurance on your neighbor's house, or life insurance on his life. The only reason to do it is to make money by causing a loss.

What speculators did was buy up CDS on various companiies and then spread rumors about coming insolvency, meanwhile selling shares short, and profiting from the incrased value on the CDS. Ackman was the first really successful operator, witness what he did to MBIA.

Further, CDS are insurance and all seller of CDS protection should be regulated as insurance companies with a requirement of adequate capital. AIG's CDS operation evaded the insurance regulators by placing itself under OTS supervision. If AIG's Financial Products operation had been supervised as an insurance company, their contracts would not have included the requirment to post collateral and there would have been no problems.

Mar 22 03:45 PM

[InnocentsAb...:]

Nice article and comment stream.

I'd just like to advocate for a little different approach -- that derivative transactions be clearly identified as leveraged contracts, and then regulated the way that margin purchases of stock are, with a minimum downpayment.

I'm kind of thinking that they should be treated as traded securities, like other derivatives (futures contracts, options, etc).

This would stabilize markets and also provide some protection for companies and municipalities engaging in the derivative markets with a limited awareness of the hazards (the naive investor).

Mar 22 04:17 PM

[William Cowie:]

I agree with the article and the comment from InnocentsAbroad: the key to stability in the market is the elimination of naked derivatives. This includes instruments like USO and other "perpetual" commodity bets that just roll over month to month, with no intent to take delivery. This is exactly what caused the surreal spike in oil prices a year or so ago.

Here's why naked derivatives should be banned: the process is one of printing money. That is why bank loans and stock trading margins are regulated and monitored.

Mar 22 05:08 PM

[Allan Frain:]

Unfortunately, GS, the primary holder of these naked CDSs has filled the top level of government with their hand puppets, so they have not let that happen. They have converted AIG into a siphon that runs from the Treasury to their balance sheet.


On Mar 22 02:15 PM Poor Dude wrote:

> I whole heartedly agree. All naked CDS's should be voided immediately.

Mar 23 10:48 AM

[ain't no fo...:]

Finally! Finally! Finally people are starting to understand that there was never any insurable interest held by many buyers of these death insurance policies against corporations in the first place!

And why were they called "swaps" instead of "insurance" in the first place? Because the geniuses in the cockaroach dens who dreamed up these hideous abominations knew that if they were called "insurance" they would have to open up their books to 50 state insurance commissioners, and just like their namesakes, those cockaroaches sure didn't want regulators shining a light on their handiwork.

But hey, those regulators would've done something anti-capitalist like try to restrict the exercise of free, unfettered markets if they tried to inject a little common sense and time honored insurance principles into the game, and we can't have all that socialist meddling now, can we? Free market capitalism will regulate itself!




On Mar 22 02:13 PM jimmy46 wrote:

> You are suggesting that only parties with an INSURABLE INTEREST can
> buy CDS's,
>
> I agree totally.
>
> Everyone else is gambling.

Mar 23 12:10 PM

[NanO49:]

That's WAY too simple! After all, I cannot insure someone's life in whom I have no interest -- why should these guys be any different?

Mar 23 12:52 PM

[henarl:]

I absolutely agree. In every other type of "insurance" the policy holder must have an "insurable interest". CDS bets in excess of insurable interest should be canceled as illegal policies. Why should a third party (the taxpayer) be forced to cover these bets?

Mar 23 03:25 PM

[terrybrr:]

I like the point that wpdragon makes. I always wondered why they were called swaps. The term doesn't make any sense. It is clear that this term was coined so that they could avoid regulation.
Swaps are simply gambling debts. Gambling debts are not enforceable by law. Take it to the Supreme Court. Let them decide.

Mar 24 04:31 AM