Marketplace

Thank you so much! Finally an explanation that I can see and understand.

Just one quick question: At first the example was that Sam did buy the 5M in GM bonds. I’m ok so far. But then was your later point that he could also have bought just the insurance on the 5M of GM bonds without actually having bought the bonds? Kind of like insuring a car you hadn’t bought? How do you crash a car you don’t have? Is this the crux of the problem? That Jim was happy to insure a non-existent car in order to collect the premiums, but that Sam never actually owned the car, which then crashed? AAARGH, no wonder I couldn’t understand this at first.

Thanks for the explanation, very informative. One thing that I am not clear on. Since all of these credit default swaps were private OTC deal, how did the rating agencies know if companies were exposed to too much risk in order to make the determination to downgrade their credit rating? In other words, if Jim sells ‘insurance’ to Sam and all the other parties under private OTC deals - how does Moody’s or Standard & Poor’s know about all the contracts to make the decision to downgrade Jim’s credit rating thereby causing him to have a margin call?

One question. How can we, or anyone, know how many times the same C D S was “insured” by how many different companies? Would this not be very similar to check kitting, as each of these could be sold and re-insured without any of the insurance companies ever knowing. This could flood the market with only a few “bundles” of actual mortages ever existing. I feel like a good solution to this problem would be to have all the bankers figure out how much they owe to whom; strike off any over lapping indebtedness and pay their own bills.

I like that you differentiate between insurance and bets. Insurance covers losses where bets yield winnings. These bets have exposed companies to huge liabilities. The fear I have is that should any of these bets win the banks who took these bets can’t pay causing the bets made on those banks to win…

If people who placed the bets can’t win, because the people who took them can’t pay. Then the bets have no value. As far as I can tell the bets need to be called off. To say you can’t seems to say that the banks are so weak that can’t survive without winning these bets. If that is the case their is no hope for them.

Hi Maria Yes, you heard that right. Sam could quite easily either buy or sell insurance on any kind of security, whether he owns it or not. Exactly like having insurance on a car he doesn’t even own. Or making a bet that a car he doesn’t own will crash. paddy

Hi Mandie Over the three quarters prior to AIGs downgrades, the company revealed that it had massive exposure to CDS contracts written on mortgage backed securities - to the tune of $18 billion in losses (according to Insurance Journal). So the ratings agencies knew there was more to come, and they cut the company’s ratings accordingly. paddy

Thank you so much, Paddy Hirsch, for appealing to us - the commoners.

Hello guys, I love how you guys explain these derivatives. We want more of this visual explanations:)

Paddy,

Excellent job again! Please keep them coming!

Clark

CDSes sound like gambling, but of a form that doesn’t have to be reported. If a public company reported ‘good’ earnings but also had to report the level of CDSes that enabled those earnings, the market would have a much better sense of the company’s real finances.

Also, surely there’s going to be a lot of fraud uncovered? High finance seems ripe with it…

Thank you Paddy Hirsch for yet another great video! You have explained CDS in such a very easy to understand way. I do hope there will be more videos to come in the future. Great work!

Randolph - “The good part is that no matter whether our clients make money, or lose money, Duke & Duke get the commissions.

Mortimer - “Well, what do you think, Valentine?”

Valentine - “Sounds to me like you guys are a couple of bookies.”

Randolph - “I told you he’d understand.”

• Trading Places

Thanks Paddy! That presentation was brilliant!! Do you think you could do one on how Fannie Mae and Freddie Mac played such big roles in putting together the champagne bottles?

great job

Ding! Ding! Ding! We have a winner!

Yes, Maria you are correct. You can buy “insurance” for a property you do not own. The insurance is really a bet— you want the other guy to fail (or crash) so you can collect. If enough people do this the market is not simply betting against itself, but wants to fail. The result should not be a surprise.

P.S. As an unregulated (and frankly deliberately obfuscated) market it is possible to wind up being self-insured and not know. (Paying premiums on a policy for which you are liable for payout.) Poetic justice.

Thanks was great, thank you Mr. Hirsch!

In its current unregulated form, CDS seems to be the most convenient betting mechanism, and CDS trading desk would be the largest unregulated casino in the world.

There is an estimated 64-trillion-dollar worth of CDS contracts written. And US’s national net worth is only about 53 trillion dollars. If gamblers who initiated all those CDS contracts win, which company will be standing to cover the contract losses?? Hm…

The CDO and CDS videos are very informative.

From those we got an explanation of what securities are in trouble and how CDS problems made the problem spread

Now how about explaining the short-term lending market and how credit is “frozen” and what the different actions of buying troubled assets, fixing up the mortguages, taking equity positions in banks or backing up inter-bank loans would mean.

Thanks for this great and disturbingvideo! If this is true then we are facing an abyss. This explains why the banks won’t lend becuase they know these crazy contracts are infecting all these institutions. Who are these “counter parties”? Is there any way of settling these contracts for a small percentage or voiding them? Otherwise the global economy is going to go broke as assets are declining.

Paddy, I find it a little disturbing to see “the largest insurance company” in the U.S. blatantly ignore what you and the CBSNews program “60 Minutes” on October 5 quickly and easily called, INSURANCE. I can only imagine that AIG jumped at the chance and then jumped for joy to partake in an unregulated indemnification agreement and then, as you say, did it over and over and over hundreds, maybe thousands of times. You mentioned the financial rating agencies, S & P and Moody’s eventually became aware what was happening which influenced their rating decisions. Again, I find it disturbing that the insurance rating agency, A.M. Best, did nothing more than say something like, “Well, if the federal government is okay with calling them “credit default swaps” (CDS) instead of insurance policies, then we, the insurance rating agency, do not need to see how it is impacting or can impact an insurance company’s accounting ledger or balance sheet. (AIG continues to hold a very good A.M. Best rating.) Sadly, it will not be the last time someone or some entity uses a euphemism for their personal benefit and at the expense of others. I thought rating agencies could and would clearly define the obfuscated terms (i.e. CDS) for the invester or insured. For insurance and financial companies, where is the penalty for these and other wanton acts? Or, with the size of these companies, will we all have to incur some kind of penalty along with them everytime?

Very enjoyable presentation. People need to understand these things.

I just graduated from the University of Illinois MBA program last June and we discussed credit default swaps and the concern that a major bankruptcy could cause untold amounts exposure to these insuring firms. Since this risk was so plain to those in the finance world how is it that firms like AIG were so willing to take this risk (thus putting our entire economy at risk) and that regulators did not act (if my finance professors understood the potential damage why didn’t the regulators’)?

Also, isn’t it true that much of this was going on through hedge funds and that they were also shorting the stocks. Everyone who held these swaps had an interest in seeing the company fail. It would be like everyone in your neighborhood taking out a million dollar life insurance policy on you. You wouldn’t feel very secure.

It seems like a crime to me that these hedge funds will enrich themselves and risk our entire economy. Wouldn’t it be better to let the writer of the swaps (AIG for instance) fail rather than allow them to pay out billions to non-affected entities? Perhaps it would be better to have the government guaranty to cover only AIG policy holders who have a real stake, rather than allow them to use federal dollars to enrich those who gambled on the failure of US companies.

that was absolutely fantastic. thank you