| | Last night on 60 Minutes there was a segment about credit default swaps and their role in the mortgage-induced crisis. The transcript is here. I have some comments.
Correspondent Steve Kroft and others described credit default swaps as "the heart of this mess". Only one person, Robert Pickel, gave any defense of them. Well, they are a part, but I don't assign them that big a role.
Also, the biggest sellers of the equivalent of credit default swaps have been Fannie Mae and Freddie Mac. As you might expect, the show was completely silent about them. What Fannie and Freddie do aren't called credit default swaps, but that is the essence. They sell protection, in exchange for a small slice of the mortgage interest (and maybe other related fees) against default.
Blaming credit default swaps for the mortgage mess is like blaming your insurance policy, which maybe doesn't payoff when your house burns down, as the cause of the fire.
Many buyers of mortgage-backed securities (MBS) bought credit default swaps to hedge their MBS holdings. I suspect they did this on mortgage pools that were not backed by Fannie or Freddie. If the pool was backed by Fannie or Freddie, then there was no perceived need to hedge the default risk. The buyers thought they were insulating themselves from default risk. Reality later sometimes said not so.
Credit default swaps were described as an "unregulated shadow market worth nearly $60 trillion." The $60 trillion is very misleading. That is the notional amount. The cash flows from the buyers and sellers are a very small fraction of this. Using notional amounts is like describing the homeowners insurance market by summing the maximum coverage amount on each house rather than using premiums and/or claims.
Also, there can be a lot of double-counting when notional amounts are summed. Suppose X as buyer and Y as seller enter a credit default swap with a notional amount of $100 million. Then Y enters another swap with a notional amount of $100 million as buyer with Z as seller. Y has hedged its risk and, practically speaking, is no longer a participant. Effectively, there is a notional amount of $100 million with X as buyer and Z as seller. Yet the notional amounts can be summed to $200 million.
There was much talk about this being an unregulated market. It's also a very young and fast-changing market. If regulators had stepped in some time ago, would they have done more harm than good? Very likely. On the other hand, they may have clogged the mortgage-making machine much earlier on its path to implosion. Would investors have put so much into MBS if they could not have bought credit default swaps? Would the regulators have foreseen that? Would Congress or the regulators have clamped down on Fannie and Freddie, too? Would Congress have foreseen clogging the mortgage machine and blocked any proposed legislation? Ah, unintended consequences and 20-20 hindsight.
(Edited by Merlin Jetton on 10/06, 12:50pm)
|
|
