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There's a Swap for That

|Includes: Apple Inc. (AAPL), AIG, LEH
What’s great about Wall Street is that - if you want to sell insurance without having the cash to back it up - there’s a swap for that.

If you want to avoid paying taxes when you sell a pile of stock, there’s a swap for that.

And if you want to disguise how much money you’ve borrowed, there’s even a swap for that.

Yep, there’s a swap for just about anything.  Only on Wall Street.

Just like Apple’s App Store, Wall Street has an over-the-counter derivative (let’s call it a swap) for just about anything you want to do.  Some of those things – like hedging – are legitimately useful.  But lots of swaps are just used to get around rules that big traders find inconvenient.  That’s not fair to the rest of us who have to play by the rules, and it’s not good for the financial system.

For example - -

AIG was issuing credit default swaps on bonds.  They collected billions of dollars in payments up front in return for promises to pay the credit default swap holders if the bonds defaulted.  Credit default swaps weren’t subject to insurance rules, so AIG didn’t have to keep enough cash available to make good on its promises.  What a great business!  Especially when the government has to step in and pay all of your policy holders.[1]

If you want to get paid for a huge pile of stock that you own, but you want to delay paying taxes on it for years, you can enter into an equity swap.  Don’t worry about the mechanics of how it works.  Just know that you can do it.  Actually, not really you, unless you have lots of money to hire banks and lawyers to structure the deal.  You probably have to pay capital gains tax on the stock sale just like the rest of us.

As for disguising borrowing, let's look at Lehman Brothers, Greece, and lots of other countries, companies and municipalities that we haven’t heard about yet.  Who’s going to be next to say that they have a lot less money than people thought they had?  The suspense is killing me!

Congress should put a stop to this and pass derivatives regulations that require swaps that perform the same economic function as regulated transactions to be treated like those regulated transactions.

I hope they do that soon because, as a stand-up comedian, it pains me to write about this topic.  It’s just not that funny.

[1] Some of you lawyer-types may be saying that AIG didn’t have “policy holders.”  Rather, they had “counterparties.”  Whatever.

Disclosure: No positions