The dollar amount of credit default swaps is greater than the world’s economic output. They started out being a way to buy insurance against debt default. But even this was sleazy. Only insurance companies can legally sell insurance. So, CDS were used as an end run around that. It got worse. CDS started to be used for outright speculation and to wager on most anything. As to why wasn’t the government paying attention, well, it’s that same old sad song.
There is at least one key difference between casino gambling and CDS trading: Gambling has strict government regulation. The federal government has long shied away from any oversight of CDS. The CFTC floated the idea of taking an oversight role in the late ’90s, only to find itself opposed by Federal Reserve chairman Alan Greenspan and others.
Ah yes, the magic of the marketplace turned out to not care a whit about regulation (or ethics) and instead, aided and abetted by a deliberately asleep at the wheel government, went on a greedfest. because, after all, housing kept zooming up in price, so those trillions of “insurance” would never have to be paid back, right? Wrong. When housing tanked, then many who sold them found themselves owing huge sums.
There’s another big difference between trading CDS and casino gambling. When you put $10 on black 22, you’re pretty sure the casino will pay off if you win. The CDS market offers no such assurance.
That’s right. Many large financial institutions that cratered because of greed and recklessness can’t pay what they owe. And that impacts many other companies. But it doesn’t stop there.
In many cases, you don’t even know who has the other side of your bet. Parties to the contract can, and do, transfer their side of the contract to third parties. Investment firms assert that transfers are well documented (a claim that, like most in the world of CDS, is impossible to verify)
The robber barons of the late 1800’s may have been ruthless. But at least they created something of value; railroads, steel mills, the oil industry, etc. Tech entrepreneurs like Bill Gates and Steve Jobs have also created things of lasting value. But this now-toxic glop of CDOs and CDSs bought and sold by Wall Street has created nothing of value. Little was created except piles of money for them and pain for everyone else.
CDS should be banned. Just kill them. They are toxic to the entire financial system. Those who traded them have shown conclusively they are, like children playing with matches, not adult enough to handle without them with burning something down. Let insurance be sold only by regulated insurance companies, period. We need to put a stake in the heart of the shadow banking system before it destroys again.