CDS: “The Global Poker Tour”

Here’s a good link for folks still struggling to understand Credit Default Swaps and how they brought the world financial system to its knees (hat tip: Patrick).  It tells the story of CDS in allegory.  A snippet:

…What a disaster this was. What a mess! What had begun so innocently and had been so small at first became the engine that ended up bringing the entire world’s economic system tumbling down. And all of the leaders of the world got together and decided that they still wanted the [Global Poker Tour] to exist, because it made them really really rich, but that they could never ever let anyone break rule #2 again! And so there would be no more Tommy Lehmans. Anytime a player was broke and needed cash for some reason, the governments of the world would give them the money and the people of the world would pay back the government through taxes. And that way the Global Poker Tour could survive and live on forever! Because the survival of the GPT, after all, is best for everyone.

In point of fact, the “Global Poker Tour” could stand in for the fractional reserve banking system in general, not just CDS.  And to be fair, it isn’t just the wealth of the world’s politicians that make it necessary to save the banking system from total collapse.  It’s the wealth of anyone who has their savings on deposit at any financial institution, which is ostensibly everyone with positive net worth.

Check out the whole story at the link above.

As it happens, this morning I attended a New York State Assembly hearing on whether CDS should be regulated like insurance (where OA blogger Arthur Kimball gave testimony).  It was disconcerting to hear Robert Pickel, head of the International Swaps and Derivatives Association, defend the CDS market.  How he, and the guys on the Wall St. Journal editorial page, can claim that the CDS market is doing just fine is positively dangerous.  Their obfuscations have contributed to the explosion of bank leverage ratios, threatening the banks’ very existence and putting the global economy at risk of complete meltdown.

To prove their argument that the CDS market is healthy they point to the Lehman CDS settlement in late October.  Since it didn’t collapse the system, everything’s copacetic.

But these are smart guys, and they know perfectly well that the only reason the CDS market continues to function is that the federal government has thrown literally trillions of dollars at the banks (and AIG) to keep them from imploding.  All markets in which the banks operate, from simple lending to complex CDS, now function courtesy of taxpayers.

On one hand, Pickel claimed that the CDS market has admirably withstood many credit events this year.  (Many?  You mean one.  Lehman.  And that nearly collapsed the world financial system.)  On the other hand he noted AIG’s holding company clearly didn’t have enough cash on hand to protect itself from mark-to-market collateral calls for all the CDS it had written.  What does that mean in English?  Well, basically he acknowledges that the players in the market are undercapitalized to the point of insolvency yet still says the market itself is functioning just fine.

But of course he would say that, he gets paid by the banks.

Posted in Wall Street, accounting, bailout, banking, bankruptcy, credit crunch, credit default swaps, politics, taxpayer issues |