BraneMatter
15th October 2008, 00:13
Suppose Clyde, and about ten of his friends, make a football bet. Clyde bets his friends that the Cardinals will loose to the Dallas Cowboys on Sunday. Clyde is sure the Cowboys will win, and his ten friends are all just as sure that the Cardinals will win.
The amount of the bet is $100 dollars, and although Clyde only has sixty dollars to his name, he goes ahead and makes the bet with each of his ten friends, because he is sure the Cowboys will win, and he thinks he is going to make a killing on the bet.
They all sign a paper outlining the terms of the bet.
Ok, the Cowboys loose, and the ten friends tell Clyde, "You owe each of us fifty dollars!"
Clyde says, "Well, I don't have that much money. Did you really think I did? Why don't we just forget about it."
So, Clyde gets taken to court by his ten friends who are now wanting their money.
The judge can do two things.
He can tell Clyde and the ten friends,"What the hell were you all thinking! Clyde, you knew you would not be able to pay if you lost, and you other guys knew that poor Clyde didn't have that kind of money. You are all wacky and greedy to make such a stupid bet in the first place, and so I am going to void this "private contract" bet and throw this case out of court."
Or, the judge could say, "Clyde, you're in BIG trouble! You signed the bet agreement, and so you have to pay. I know you don't have the money, but I'm going to sell your property and confiscate your future earnings and profits until the debt is paid in full." :crying:
So, in the second court scenario, a "debt" in the amount of $1000 dollars has just been legally created and become enforceable. The $1000 dollars did not exist in Clyde's bank account or wallet, and so poor Clyde is screwed and will have to come up with the money somehow.
Now, imagine millions of "Clydes" all around the world, each making the same stupid type bets. Imagine the 'debt' that is created if the courts all say, "Pay-Up!"
To further complicate the scenario, imagine that the reason Clyde's friends went ahead and made the bet with Clyde, even though they knew he couldn't pay without extreme hardship or bankruptcy, was because they were all trying to cover other potential losses they might incur because they had all bet on other football games as well!
Multiply this by millions of people all making bets to insure against loss, and you can see the amount of "debt" that is created.
So you can see that what is really going on here is like a giant "bookie" operation or casino! Everybody bets on the horserace or poker game, but only a few walk away winners!
Credit default swaps are a lot like the above descriptions, except they may be longer term bets or "insurance." For accounting purposes, however, ANYONE who has signed-on to a bet is a potential looser, and must, if they are honest, list the CDS as a potential liablility on their books. And they have to have enough cash to cover their bets, or their books don't look so good! In the case of CDS's, however, they are TOTALLY OFF THE BOOKS! No one knows how many are held by a given entity, and so you have no way to judge its potential liability, or know if they have enough in their accounts to cover their butts! You might think twice about doing business with them.
Now, as if the above is not ridiculous enough, imagine that people holding these long term bets (CDS paper) start borrowing money against their bets. And suppose, in addition, greedy speculators use complex computer software to generate a whole host of even more exotic betting instruments in order to make "bets on bets."
More money is borrowed, and more instruments are sold. Everyone is now on the hook.
Next thing you know, you've got $64 TRILLION dollars of potential CDS debt being held out there, not to mention whatever other exotic instruments that no one understands!!!
Do we even have a clue what all the bets are being made on? Of course not, nor do we know the total "debt" floating around that may come due. Mortgage backed securities are said to account for a lot of it, but there is only around $100 billion in actual default, and even the total mortgages do not amount to $64 trillion.
Now it came about that the banks, traders, and speculators held so much of this potential "debt" that they finally realized that if even a portion of it came due, they would all be in big trouble. They did not have enough on deposit to cover all the potential losses. In fact, the amount of debt exceeded the amount of money available in the supply. The debt thus became "toxic."
They needed to raise capital to make the books balance, and FAST! No time to lend out money, so credit freezes up.
Now along comes the "court," or, in this case, the Treasury, the FED, and the FDIC. So, in order to pay Clyde's debt, balance Clyde's books, plus give him some "operating capital," they order that a huge deposit be made into Clyde's bank account from the all taxpayers' money held by the government!
Now poor Clyde will be able to keep his property, any profits, and his paychecks, and will now have more money to bet on more football games!!! :thumbup:
And Clyde, being an enterprising sort of fellow, takes a million or so bucks of the taxpayers' money put in his account, and goes on a first-class junket to Vegas, hoping to hit it big!!!
Ain't capitalism great???
The amount of the bet is $100 dollars, and although Clyde only has sixty dollars to his name, he goes ahead and makes the bet with each of his ten friends, because he is sure the Cowboys will win, and he thinks he is going to make a killing on the bet.
They all sign a paper outlining the terms of the bet.
Ok, the Cowboys loose, and the ten friends tell Clyde, "You owe each of us fifty dollars!"
Clyde says, "Well, I don't have that much money. Did you really think I did? Why don't we just forget about it."
So, Clyde gets taken to court by his ten friends who are now wanting their money.
The judge can do two things.
He can tell Clyde and the ten friends,"What the hell were you all thinking! Clyde, you knew you would not be able to pay if you lost, and you other guys knew that poor Clyde didn't have that kind of money. You are all wacky and greedy to make such a stupid bet in the first place, and so I am going to void this "private contract" bet and throw this case out of court."
Or, the judge could say, "Clyde, you're in BIG trouble! You signed the bet agreement, and so you have to pay. I know you don't have the money, but I'm going to sell your property and confiscate your future earnings and profits until the debt is paid in full." :crying:
So, in the second court scenario, a "debt" in the amount of $1000 dollars has just been legally created and become enforceable. The $1000 dollars did not exist in Clyde's bank account or wallet, and so poor Clyde is screwed and will have to come up with the money somehow.
Now, imagine millions of "Clydes" all around the world, each making the same stupid type bets. Imagine the 'debt' that is created if the courts all say, "Pay-Up!"
To further complicate the scenario, imagine that the reason Clyde's friends went ahead and made the bet with Clyde, even though they knew he couldn't pay without extreme hardship or bankruptcy, was because they were all trying to cover other potential losses they might incur because they had all bet on other football games as well!
Multiply this by millions of people all making bets to insure against loss, and you can see the amount of "debt" that is created.
So you can see that what is really going on here is like a giant "bookie" operation or casino! Everybody bets on the horserace or poker game, but only a few walk away winners!
Credit default swaps are a lot like the above descriptions, except they may be longer term bets or "insurance." For accounting purposes, however, ANYONE who has signed-on to a bet is a potential looser, and must, if they are honest, list the CDS as a potential liablility on their books. And they have to have enough cash to cover their bets, or their books don't look so good! In the case of CDS's, however, they are TOTALLY OFF THE BOOKS! No one knows how many are held by a given entity, and so you have no way to judge its potential liability, or know if they have enough in their accounts to cover their butts! You might think twice about doing business with them.
Now, as if the above is not ridiculous enough, imagine that people holding these long term bets (CDS paper) start borrowing money against their bets. And suppose, in addition, greedy speculators use complex computer software to generate a whole host of even more exotic betting instruments in order to make "bets on bets."
More money is borrowed, and more instruments are sold. Everyone is now on the hook.
Next thing you know, you've got $64 TRILLION dollars of potential CDS debt being held out there, not to mention whatever other exotic instruments that no one understands!!!
Do we even have a clue what all the bets are being made on? Of course not, nor do we know the total "debt" floating around that may come due. Mortgage backed securities are said to account for a lot of it, but there is only around $100 billion in actual default, and even the total mortgages do not amount to $64 trillion.
Now it came about that the banks, traders, and speculators held so much of this potential "debt" that they finally realized that if even a portion of it came due, they would all be in big trouble. They did not have enough on deposit to cover all the potential losses. In fact, the amount of debt exceeded the amount of money available in the supply. The debt thus became "toxic."
They needed to raise capital to make the books balance, and FAST! No time to lend out money, so credit freezes up.
Now along comes the "court," or, in this case, the Treasury, the FED, and the FDIC. So, in order to pay Clyde's debt, balance Clyde's books, plus give him some "operating capital," they order that a huge deposit be made into Clyde's bank account from the all taxpayers' money held by the government!
Now poor Clyde will be able to keep his property, any profits, and his paychecks, and will now have more money to bet on more football games!!! :thumbup:
And Clyde, being an enterprising sort of fellow, takes a million or so bucks of the taxpayers' money put in his account, and goes on a first-class junket to Vegas, hoping to hit it big!!!
Ain't capitalism great???