jdl51

CDS: The Sabotaging Asset

This is the crux of the financial meltdown. The U.S. banking system could have handled a few percent of mortgage defaults, albeit with some pain. What it couldn't handle was the multiplying of that default liability potential a thousand fold. The CDS formula was developed around 1997 and by the time Clinton left office the CDS market was only a few hundred billion, hardly enough to bring down the worldwide financial system. Calling them swaps instead of insurance, which they are, was designed to by-pass the regulatory agenices. In hindsight this was a monumental mistake.

"Credit Default Swaps were invented in 1997 by a team working for JPMorgan Chase[7][8][9]. They were designed to shift the risk of default to a third-party, and were therefore less punitive in terms of regulatory capital.[10]
Credit Default Swaps became exempt from regulation with the Commodity Futures Modernization Act of 2000, which was also responsible for the Enron loophole. U.S. Sen. Phil Gramm (R-TX) introduced the Act on behalf of financial industry lobbyists. The Modernization Act was rushed through Congress as a companion bill to the omnibus spending bill, the last day before the Christmas holiday[11]. It by-passed the substantive policy committees in both the House and the Senate so that there were neither hearings nor opportunities for recorded committee votes [12]. The omnibus spending bill, which was 11,000 pages long, is the financial plan the government requires for everyday operations. President Clinton signed the bill into Public Law (106-554) on December 21, 2000."