Credit Default Swaps Again

Yesterday I found what most people definitely avoid giving if they can at all manage it -- a definition of those veritable economic demons called "credit default swaps," though the writer instead called them "collateral debt swaps." So he said this:

In pursuit of ever more profits, financial institutions began betting on the success and failure of various debt instruments and by implication on firms. They bought and sold collateral debt swaps. A buyer pays a premium to a seller for a swap to guarantee an asset’s value. If an asset “insured” by a swap falls in value, the seller of the swap is supposed to make the owner of the swap whole. The purchaser of a swap is not required to own the asset in order to contract for a guarantee of its value. Therefore, as many people could purchase as many swaps as they wished on the same asset. Thus, the total value of the swaps greatly exceeds the value of the assets.

,,,The next step is for holders of the swaps to short the asset in order to drive down its value and collect the guarantee. As the issuers of swaps were not required to reserve against them, and as there is no limit to the number of swaps, the payouts can easily exceed the net worth of the issuer.


I don't know about you, but I find this explanation to be just as impenetrable as all the others I have seen, of which there could've been as many as two. And this was in a sweeping overview of the whole current economic mess, called "How the Economy was Lost" and that otherwise was generally easy enough to understand, written by a man named Paul Craig Roberts, who used to be a high U.S. Treasury official. I don't know if the trouble was due to the way it was written -- Roberts, after all, worked (I think) for R. Reagan, which was when all the trouble started -- or whether the fault lies in the total craziness of the swaps themselves.

As far as my extremely limited view of these things allows, what he is saying here is that the swaps are actually side bets that the holders of these loans that are now securities makes with someone else as to whether the loans will be repaid. Only the arrangements are not called "bets." Instead they are seen as being insurance policies. But after all, what is insurance if not a wager or a bet that the cost of paying it out will be less than the cost of paying for it?

So here, in that highly rarefied and deliberately obscured world called "High Finance," which after the events of the past several months should be called "Low Finance" instead, we have people totally unknown to the original borrowers who are taking the loans that the borrowers take on and making huge quantities of bets as to whether or not the loans will be repaid. And, according to Roberts, huge amounts of the bailout money voted by Congress and thereby taken from the taxpayers is going toward paying off these side or above bets and not the loans themselves.

That makes no sense at all!

And why are these things called "swaps?" What is being swapped, i.e. traded?

But if this is in any way what is happening and at the heart of the economic crisis, and if this is where the High Finance geniuses have taken things, then it's practically impossible to see how Prez Obama or anyone else can pull this situation out of the toilet, that is, with money.

So I must be wrong. Right?