Tuesday, September 30, 2008

Fortune: The $55 trillion question

"The financial crisis has put a spotlight on the obscure world of credit default swaps - which trade in a vast, unregulated market that most people haven't heard of and even fewer understand. Will this be the next disaster?"

"CDS are no mere artist's fancy. In just over a decade these privately traded derivatives contracts ballooned from nothing into a $54.6 trillion market. CDS are the fastest-growing major type of financial derivatives. More important, they've played a critical role in the unfolding financial crisis. First, by ostensibly providing "insurance" on risky mortgage bonds, they encouraged and enabled reckless behavior during the housing bubble. "If CDS had been taken out of play, companies would've said, 'I can't get this [risk] off my books,'" says Michael Greenberger, a University of Maryland law professor and former director of trading and markets at the Commodity Futures Trading Commission. "If they couldn't keep passing the risk down the line, those guys would've been stopped in their tracks. The ultimate assurance for issuing all this stuff was, 'It's insured.'" Second, terror at the potential for a financial Ebola virus radiating out from a failing institution and infecting dozens or hundreds of other companies - all linked to one another by CDS and other instruments - was a major reason that regulators stepped in to bail out Bear Stearns and buy out AIG (AIG, Fortune 500), whose calamitous descent itself was triggered by losses on its CDS contracts (see "Hank's Last Stand")."

1 comment:

Anonymous said...

The sale of Wachovia Corp. to Citigroup Inc. will create one of the country's largest banks, with 4,300 U.S. branches and $600 billion in deposits.

Both companies had fallen prey to the nation's home-loan crisis.

Even so, the deal was a sigh of relief because fed regulators were worried about Wachovia's financial health that they had urged the bank to find a stronger partner, which in fact that they did.