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we_are_toast
12-11-08, 11:56 AM
It seems to me that the Credit default swap problem in much bigger than the mortgage foreclosure problem. How will the CDS' get cleared? One proposal is to simply declare them null and void. It sounds good to me until I hear a good argument as to why this can't be done.

The following are some random excerpts from random web sites that try to make an argument for declaring CDS' null and void. Take it for what it's worth.


During the Great Depression, many debt contracts were indexed to gold. So when the dollar convertibility into gold was suspended, the value of that debt soared, threatening the survival of many institutions. The Roosevelt Administration declared the clause invalid, de facto forcing debt forgiveness. Furthermore, the Supreme Court maintained this decision.
...
Those $65 trillion reasons for the credit market freeze will never go away without a huge crash that then will have worth consequences than the 1929 stock market crash. The only way to eliminate these reasons is internationally concerted action to declare the legal obligations of all CDS' null and void.
At the same time:


all financial exchanges and markets of the world close for a week
CDS are declared null and void and new CDS creation is forbidden until new regulation is in place
the publicly dealt financial entities have seven days to figure out and publicly restate the value of their liabilities and assets excluding all CDS
a onetime windfall tax will be created that socializes overt advantages some entities will have from this
the proceed of that tax shall be used to prop up the capital of the big losers in a program comparable to the Reconstruction Finance Corporation of 1932.

To spend taxpayer money to buy up some MBS that lost value will do little to avert the coming CDS crash....
http://www.afterdowningstreet.org/node/36179

...However, since these are unusual times when conventional rules don’t apply, I would like to see the Federal Reserve in combination with the proper regulatory body step in and disqualify all existing Credit Default Swaps in the OTC market. The OTC market is a rabid beast out of control that needs to be put down before the contagion spreads irreversibly...

...The problem was that like any bubble reaching its elliptical peak, the CDS market became absolutely inundated with speculators that were flipping these insurance contracts in a very opaque, highly illiquid and non-transparent unregulated market....

...Since the CDS market remains an unregulated OTC market, in my opinion, there should be no reason that it can’t be shut down completely. Just disband the entire racket and have the dirty, smoke filled gambling den closed for business permanently....

...Perhaps, as part of the transition to a regulated swap market on an open exchange, you could stipulate and insist that all open or existing contracts are null and void, that counter-parties remain obligated to redeem the “insurance premium” paid and received only. By mandating some type of enforcement to this unregulated market, you could remove the potential liability from unrecoverable claims that hang like a noose around the neck of the entire economy....
http://seekingalpha.com/article/99027-the-60-trillion-nightmare-of-credit-default-swaps
Cancelling those bets (i.e., declaring them null, void, and legally unenforceable) would let swap sellers off the hook. It would in some sense leave the swap buyers high and dry in spite of the premiums they've payed. But, in fact, each period's premium is for insurance for that period. The buyer has already gotten his/her coverage (fair value) for the period covered by that premium. That month's premium is money that has been spent and for which value has already been received. So, I don't feel that there is any (moral) obligation to the buyers to refund past premiums for credit-default swaps. Of course:
--- Premiums for the current period should be refunded on a pro-rated basis from the cancellation date forward.
--- Valid outstanding claims against CDS sellers filed prior to the cancellaton date should be enforced, and adjudicated in the courts if necessary.
http://oxdown.firedoglake.com/diary/654

These comments were found all over the political spectrum.

So why can't, or shouldn't we do this in order to avoid financial Armageddon?

Chomsky
12-11-08, 12:09 PM
It's got to be more complicated than that, right? The entire synthetic CDO market rides on CDSs. Vaporize the CDSs and you destroy the noteholders of synthetic CDOs. No?

D-Mack
12-11-08, 01:34 PM
Engdahl wrote about it in June



Banks want secrecy

Banks have a vested interest in keeping the swaps market opaque, because as dealers, the banks have a high volume of transactions, giving them an edge over other buyers and sellers. Since customers don't necessarily know where the market is, you can charge them much wider profit margins.

Banks try to balance the protection they've sold with credit-default swaps they purchase from others, either on the same companies or indexes. They can also create synthetic CDOs, which are packages of credit-default swaps the banks sell to investors to get themselves protection.

The idea for the banks is to make a profit on each trade and avoid taking on the swap's risk. As one CDO dealer puts it, “Dealers are just like bookies. Bookies don't want to bet on games. Bookies just want to balance their books. That's why they're called bookies.”

Now as the economy contracts and bankruptcies spread across the United States and beyond, there's a high probability that many who bought swap protection will wind up in court trying to get their payouts. If things are collapsing left and right, people will use any trick they can.

Last year, the Chicago Mercantile Exchange set up a federally regulated, exchange-based market to trade CDSs. So far, it hasn't worked. It's been boycotted by banks, which prefer to continue their trading privately.

http://www.financialsense.com/editorials/engdahl/2008/0606.html


Also derivatives in general are disliked by this guy from China

About stock market derivatives and their role as source of evil:

If you look at every one of these [derivative] products, they make sense. But in aggregate, they are bullshit. They are crap. They serve to cheat people.
http://www.theatlantic.com/doc/200812/fallows-chinese-banker