San Diego Housing Bubble News and Analysis

That's why they are called swaps, not insurance. So they can get around the law requiring insurable interest. Note that there is legit bond insurance (e.g. PMI) that can be purchased.

I've often pointed out that swaps are like allowing life insurance policies to be taken out on other people without their knowledge. Not only is there the potential for insurance companies to bankrupt themselves overnight if they over-sell an entity; there is also the incentive to kill the person you took the policy out on.

I'm almost certain that the huge explosion of swaps was due to Nassim Taleb (the black swan guy). He made billions betting on so-called 'once-in-a-lifetime' financial events. I'm sure there are hundreds of thousands of hedge funds following in his footsteps.

Regarding participation; I think that the swaps market is only open to hedge funds and other private equity groups. You need millions of dollars to make the billion dollar plays these folks have. Some ETF vendors do use swaps to implement their long/short/leveraged ETF products, so that is one way the little guy can participate.

Anyways, swaps should be illegal and probably will be after the market in them collapses. The odds aren't so great when you realize that there is absolutely no way many of these swaps can ever be paid off. Its like a lottery where the organizers embezzled the money from the ticket sales because they thought there was no chance anyone would win. Unfortunately for them (and the ticket holders), it turned out every ticket was a winner.

The good news is that *majority* of these bogus swaps are held by hedge funds, so it won't affect the average Joe when they default (unless we have to bail them out as well). It's in our best interest that they go away, as hedge funds will then be forced to invest in markets; vs. spending all their capital betting they collapse.

La Jolla Renter,

As kewp says, our govt (god bless 'em) prohibits normal people from using credit default swaps. I wanted to use them to make some very substantial bets last summer, but found out I couldn't. (And I am an Accredited Investor, per the SEC, but that's not enough.)

I could have done very nicely, but our govt protected me from that fate.

I'll take the unpopular other side of the debate. Just because CDS's were abused doesn't mean they should be banned. Annuities, options, short sales, Straddles, barbells, Swaptions, mutal funds...etc. can all be abused.

CDS's have very legitimate uses both as speculative products, and as hedging devices for people with exposure to corporate debt. They also provide a valuable market signal that, over time, will prove much more accurate than any ratings agency (they provide a leading indicator of where rating agencies will move).

Classic baby and bathwater argument. Have there been abuses on a gargantuan level? Absolutely. Should there be more regulation in this space? Probably? Should we outlaw a valuable product precisely at the time where the market has now unveiled their true dangers (lets not forget that there always must be two sides to a transaction like a CDS)? No, we shouldn't.

Financial innovation has risks, these risks are becoming much more well understood. Regulations that will have huge long term negative consequences are being proposed precisely at the moment when they are least necessary.

Stan

You may like this PBS radios program that covers CDS:

http://www.thislife.org/Radio_Episode.as...

Actually, I just changed my mind regarding CDS's.

As long as there is no bailout and the counter-parties that underwrote swaps they can't afford to pay off are allowed to default on them, I'm fine with the situation. Let the hedgies eat their bogus contracts; hope they like them!

Just no more bailing out bankrupt businesses.

Amen, kewp.

Speaking of financial innovation, we really need a product that pays off if CDS's default!

A credit default swap default swap maybe?