I believe the PTB is primarily concerned with credit-default swaps (CDSs).
A credit default swap is like insurance on underlying debt. An issuer (might be an insurance company like AIG or Ambac, etc., or a financial firm or some other issuer) of a swap is basically saying, “if your borrower defaults, we will cover $XX of your loss.”
The issuer might have issued many swaps. In order to protect themselves in the event of a payout/triggering event, they will often use a reinsurer and/or buy swaps from another issuer. This can go on and on down the line.
At some point, **somebody** is on the hook in the event of a default. Problem is, that final bag-holder might not actually have the money to cover the agreement, and all the players down the line get screwed. Multiply this by billions++++ (derivatives market is in the tens of trillions, IIRC), and you see why everyone is freaking out.
BTW, they use math models to predict probabilities (that’s basically what insurance companies do). If the actual events differ greatly from their models (as it is now), the sh!t will hit the fan.
You’d be surprised how deep everyone is in these derivatives — pension funds, bond funds, mutual funds, banks, corporations, insurance companies, financial firms, municipalities, etc. The list is endless and these derivatives are entrenched in our financial world.
That is why everyone is freaking out right now. It’s not so much the FBs who default on an individual basis, but the amount of paper that was traded based on a model that greatly underestimated what the FBs would do (unlike the common sense bubble bloggers who had this all pretty much figured out from the get-go. Where are our
4$$multi-million$$$ golden parachutes???).
To make this even longer…(sorry)…it is these swaps which enabled the leverage to grow like it did because they had found a “new and glorious way” to “manage risk”. The players honestly believed they were immune from losses, so they extended the leverage…until it could go no further. We are witnessing the snap-back of the largest and most dangerous credit bubble in the world, IMHO.
