[Marxism] Credit Default Swaps: Next Phase of an Unravelling Crisis

Dbachmozart at aol.com Dbachmozart at aol.com
Sat Jun 7 13:59:00 MDT 2008

The Financial Tsunami has not reached its Climax  
Credit Default Swaps: Next Phase of an  Unravelling Crisis 

By F. William Engdahl
_Global Research_ 
hkOq9Rxg==) , June 5, 2008
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The Sub Prime Meltdown is but the Tip of the  Iceberg 

While attention has been focussed on the  relatively tiny US "sub-prime" home 
mortgage default crisis as the center  of the current financial and credit 
crisis impacting the Anglo-Saxon  banking world, a far larger problem is now 
coming into focus. Sub-prime or  high-risk Collateralized Mortgage Obligations, 
CMOs as they are called,  are only the tip of a colossal iceberg of dodgy 
credits which are  beginning to go sour. The next crisis is already beginning in 
the $62  TRILLION market for Credit Default Swaps. You never heard of them? It’s 
 time to take a look, then.

The next phase of the unravelling crisis in the  US-centered "revolution in 
finance" is emerging in the market for arcane  instruments known as Credit 
Default Swaps or CDS. Wall Street bankers  always have to have a short name for 
these things.  
As I pointed out in detail in my earlier exclusive  series, the Financial 
Tsunami, Parts I-V, the Credit Default Swap was  invented a few years ago by a 
young Cambridge University mathematics  graduate, Blythe Masters, hired by J.P. 
Morgan Chase Bank in New York. The  then-fresh university graduate convinced 
her bosses at Morgan Chase to  develop a revolutionary new risk product, the 
CDS as it soon became known.   
A Credit Default Swap is a credit derivative or agreement  between two 
counterparties, in which one makes periodic payments to the  other and gets promise 
of a payoff if a third party defaults. The first  party gets credit 
protection, a kind of insurance, and is called the  "buyer." The second party gives 
credit protection and is called the  "seller". The third party, the one that might 
go bankrupt or default, is  known as the "reference entity." CDS’s became 
staggeringly popular as  credit risks exploded during the last seven years in the 
United States.  Banks argued that with CDS they could spread risk around the 
Credit default swaps resemble an insurance policy, as  they can be used by 
debt owners to hedge, or insure against a default on a  debt. However, because 
there is no requirement to actually hold any asset  or suffer a loss, credit 
default swaps can also be used for speculative  purposes.  
Warren Buffett once described derivatives bought  speculatively as "financial 
weapons of mass destruction." In his Berkshire  Hathaway annual report to 
shareholders he said "Unless derivatives  contracts are collateralized or 
guaranteed, their ultimate value depends  on the creditworthiness of the 
counterparties. In the meantime, though,  before a contract is settled, the counterparties 
record profits and losses  -often huge in amount- in their current earnings 
statements without so  much as a penny changing hands. The range of derivatives 
contracts is  limited only by the imagination of man (or sometimes, so it 
seems,  madmen)." A typical CDO is for five years term. 
Like many exotic financial products which are extremely  complex and 
profitable in times of easy credit, when markets reverse, as  has been the case since 
August 2007, in addition to spreading risk, credit  derivatives, in this case, 
also amplify risk considerably. 
Now the other shoe is about to drop in the $62 trillion  CDS market due to 
rising junk bond defaults by US corporations as the  recession deepens. That 
market has long been a disaster in the making. An  estimated $1,2 trillion could 
be at risk of the nominal $62 trillion in  CDOs outstanding, making it far 
larger than the sub-prime market.   

full - 

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