Everybody should go read Mish’s Credit Default Swap Tsunami Approaches article, posted today.
This clarified much of the mess for me. Yes, trillions of dollars of paper equity is going to be wiped out. There is nothing anyone can do about that now and the economic fallout will be severe.
However, its not going to be the end of the world. The key is that the vast majority of the phantom equity that is destroyed is going to be in hedge funds. For those that don’t know what a hedge fund is, its basically a mutual fund for rich people thats allowed to use dirty tricks. For example, the greatest hedge fund returns in history were generated this year by shorting mortgage back securities. Basically betting that poor people were going to lose alot of their homes.
Thousands of other funds, however, are simply leveraged to the hilt betting *with* junk debt. I’m sure many have been borrowing and trading amongst themselves. These are going to blow up en masse’.
So, whats the fallout? Lots and lots of millionaires and billionaires are going to watch much of their phantom equity vanish into ether. And this is going to be largely meaningless on a macroeconomic scale. If I had 100 million dollars in a dozen hedge funds and half of them blow up, then I still have 50 million. Is this going to have any effect on my spending habits or lifestyle? Not really. And therefore the effect on the economy should be somewhat contained.
