Credit Default Swaps: Bringing Wall Street Down
The big news on Wall Street this morning is the multiple whammy involving these events:
- Lehman Brothers (LEH) and bankruptcy.
- Bank of America (BAC) to buy Merrill Lynch (MER).
- What will happen to Washington Mutual (WM).
Credit default swaps
One of the main offenders right now is what is known as the credit default swap (CDS). BloggingStocks explains the “freedom” CDSs have provided to investors, mortgage lenders and any number of market players:
Gramm’s 262-page amendment, dubbed “The Commodity Futures Modernization Act,” according to Texas Observer, freed financial institutions from oversight of their CDS transactions. “Prior to its passage, they say, banks underwrote mortgages and were responsible for the risks involved. Now, through the use of [CDSs]-which in theory insure the banks against bad debts-those risks are passed along to insurance companies and other investors,” wrote Texas Observer.
The idea, of course, was to encourage more and more risky investment. And, of course, pump up Wall Street profits and allow for more speculation. What the widespread use of CDS arrangements did, though, was pave the way for mortgage lenders to approve borrowers irresponsibly (since they could just pass the risk off to someone else) and open up the U.S. economy to a rather large economic debacle. Indeed, the CDS market is a $62 trillion market — much larger than the “paltry” losses due to subprime.
Investment banks are dropping like flies. All of the risky assets they hold, from CDOs to CDSs to rapidly depreciating real estate are coming back to haunt them. And these big banks are getting ready to continue to fail. The government has made it clear that Bear Stearns, Fannie and Freddie have pretty much maxed out what it is willing to add to its already maxed out balance sheets.
It remains to be seen whether loan pool from Wall Street investment banks will really staunch the bloodflow.
Disclaimer: I am not an investment professional. Nothing in this piece or on this Web site should be construed as investment advice. Before making investment decisions, do your own research and/or consult with an investment professional. All investment comes with the risk of loss. You are responsible for your own investment decisions and any loss that may result from your decisions.
Tags: stock market, stock market news, investing blog, credit default swaps,
economy, investments, investment banks
September 15th, 2008 at 10:44 am
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September 18th, 2008 at 9:05 am
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[…] brilliant blog post about CDS’s as the culprit behind the current financial mess. But these CDS’s (Credit Default Swaps) are just the car. The real culprit is SPECULATION. Here’s how it has played […]