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The problem with CDS is when they are based on crap, ie the ability of people without money to buy houses. Clever people looked into those CDS and decided to b
by shin_lao 17y ago
The problem with CDS is when they are based on crap, ie the ability of people without money to buy houses.
Clever people looked into those CDS and decided to bet against them. They became extremely rich during the crisis.
There is nothing wrong with CDS, it's just that it was based on crap and people didn't do their homework. "It earns money, must be cool".
Want to prevent this? Well have American banks join Basel II. Stop allowing them loaning money to people who will never be able to reimburse. Make sure insurance companies like AIG can't enter the derivative products market so easily.
And please stop reading articles from people who learnt about derivative products yesterday.
- eru 17y agoIf banks want to lend their capital to people who can't repay, who am I to judge? However, we should consider not helping them, if it fails.
- shin_lao 17y agoThe problem is that you can't let a bank fail, especially a big bank, it would bring the whole system with it. Since you cannot allow it to fail, you must set in place some rules to limit the risks they take. (Yes I know about the typo CDS=>CDO, I can't edit myself).
- rortian 17y agoUmm, I think you mean CDOs. CDS are credit default swaps. These are what brought AIG down. Frankly I think you are the one being glib. A huge problem with CDOs was that many carried AAA ratings. In this past, buying a security with this rating was doing your homework. Unfortunately, Moody's and S&P were not purveyors of accurate information on these securities. This became a huge problem since AAA ratings allowed banks to hold these securities and call them capital.
- deleted 17y ago[deleted]
- shin_lao 17y agoExactly what I meant. So you just buy stuff with AAA ratings and consider this "your homework". That's the problem I'm talking about.
- byrneseyeview 17y agoA derivatives contract has two sides. You have to pick which side you're talking about when you say it's dumb -- if one side of the trade was exceedingly stupid, the other side must be extremely smart. And your argument doesn't make sense in light of how much money the Euro-banks lost. If lack of regulation was the problem, why did the most regulated entities, buying the most regulated securities, according to the strictest rules -- lose the most money? Why did regulated hedge funds beat the S&P by about 20% in 2008? If regulation keeps us safe, why is it always so dangerous?
- shin_lao 17y agoBecause European banks do a lot of business with American banks. Even banks who did stay out of the "contaminated" credit business had business with banks who didn't.
- sokoloff 17y agoIt's entirely possible for both sides to be dumb. Suppose your liquid net worth is $2mm. It would be a very bad idea for you to enter into a legally binding wager with a penniless person on a fair coin where "heads you win $1M; tails you lose $250K"
- jeromec 17y agoeru is right, banks decide to lend at their own peril. The problem was moving from a model where the mortgage stayed with the bank, to a model of sending mortgages upstream to Wall Street where greedy, er.. I mean clever managers packaged them into complicated financial instruments (CDOs), and then buying triple A ratings from agencies like Moody's.
- solutionyogi 17y agoWell, I am not sure if I should listen to you as CDS is clearly not what you are making it out to be. CDS is Credit Default Swap, which one can buy to protect themselves again credit default of another party.