CDS = No Problem?
March 13, 2009 Comments (0) | RELATED TICKERS: AIG
I learned something new today about "Credit Default Swaps", and I almost
swallowed my gum.
I was listening to an interview with the author of an article ("the formula
that destroyed wall street", or something like that). He said that CDS were not
that big of a problem (I thought: oh, yeah? Can you say $63T?). He then said
that when you issue (sell) a CDS, you also buy offsetting CDS', sort of like a
margin account. That was the lightening bolt: you mean to tell me that all
those tens of trillions of CDS's are backed up by assets (OK, here is where we
get into that leverage debate: for every $1 of CDS, how many basis points of
backing assets are you going to carry?). He then went on to say that AIG was
unique in that it sold a wheelbarrow full of CDS', but did NOT buy offsetting
securities, so that when LEH went belly-up, it did not have backing assets, and
needed backstop $$$ from Uncle Sam. He also said that CDS were a zero sum
game, in that what the issuer loses, the buyer gains (this was less convincing,
since in the absence of a bankruptcy, the gains and losses are like stocks,
since value can simply disappear in normal trading).
