Professor Elam

Robert Novak has a short article on CDS. He refers to the 60 Minutes article on Crfedit Default Swaps.

So here it CBS on CDS.

And here is the ISDA Internation Swaps and Derivatives Association.

So what is all this about?  Please read the four page CBS story, yes it will be on your next exam if you are in one of my classes.  Basically a CDS is an insurance agreement that Party XYZ will not default on a loan. The problem is that this is not actually insurance. If it were it would be regulated.  Apparently no one issuing these things actually had a position in the underlying mortgages, a necessary compnent of real insurance. Rather like bettors at the race track, everyone was betting, no one owned a horse!  At the racetrack, there are posted odds and the track matches the bets off against one another. In the CDS world there is no such matching, these are open ended promises.

Now that I think about it, the same thing happened in the then unregulated world of commodity options back in the 1970s. A couple of upstarts named Goldstein Samuelson and Puts and Calls Inc offerfed commodity options, they of course did not bother to own any commodity contracts to be able to actually deliver what they promised. Just promises. The whole thing blew up as  a ponzi scheme when folks wanted the contracts to pay off. As best I can tell the same thing is happening now, the number of CDS is much greater than the number of loans. So when the loans default, it is impossible to pay off all the bets that they would default. And like Goldstein there is not regualtion.  Goldstein went to jail Will Richard Fuld Jr of Lehman Brothers who made hundreds of millions doing this go to jail or a fancy home ?