Outlaw "naked" Credit Default Swaps

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AZDan's picture
AZDan
Status: Member (Offline)
Joined: Nov 26 2008
Posts: 11
Outlaw "naked" Credit Default Swaps

I read http://www.rollingstone.com/politics/story/26793903/the_big_takeover/1 over the weekend and again read something that I haven't seen discussed.

Quote:

Secondly, Cassano was selling so-called "naked" CDS deals. In a "naked" CDS, neither party actually holds the underlying loan. In other words, Bank B not only sells CDS protection to Bank A for its mortgage on the Pope — it turns around and sells protection to Bank C for the very same mortgage. This could go on ad nauseam: You could have Banks D through Z also betting on Bank A's mortgage. Unlike traditional insurance, Cassano was offering investors an opportunity to bet that someone else's house would burn down, or take out a term life policy on the guy with AIDS down the street.  (emphasis mine)

I had read this same analogy in an article in the Villiage Voice earlier.  Now why can't the SEC, Congress or the President or SOMEONE make these naked CDS deals illegal?  Screw the investors who want to get paid on these scams.  How much $ would these investors lose as opposed to how much taxpayer $ the rest of us lose?

pleaseremoveme's picture
pleaseremoveme
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Joined: Jan 24 2009
Posts: 115
Re: Outlaw "naked" Credit Default Swaps

That would be really unfair! 

I mean, come on: the sellers of the swaps, like Cassano, should not have been so stupid. It's not like they didn't know what they where doing, or that they couldn't see they where selling naked CDS deals. But these fools saw no risk, and only more money coming in. When a smarter banker decides to punish that reckless behaviour by exploiting it, well: good for him! Here we finally see bankers doing what they are supposed to do, and you want to punish them for it!

Although it is really unfair what has been been done to `the  taxpayer', the blame falls mainly on reckless bulls like Cassano, not on the more responsible but selfish bears, who jumped on this chance to make money for nothing. If I had been given the chance to buy one of these deals, and had known just what risks Cassano was taking, I would have taken it. The money earn would go to whatever good cause I choose, and currently, I'm hardly a worse judge of what a good cause is, than the governments or the central banks.

AZDan's picture
AZDan
Status: Member (Offline)
Joined: Nov 26 2008
Posts: 11
Re: Outlaw "naked" Credit Default Swaps

Well, considering the outcome, I don't think it's unfair.  True, AIG was stupid to write naked CDSs but under normal (non-bailout) market circumstances the holder of the naked CDS wouldn't have gotten paid anyway with AIG in bankruptcy.  Now, I'm sure the premium for this CDS was considerably less than the payout.  I read somewhere where the holder could control 10 million for $50,000/year.  The way I see it, we have 3 alternatives:

1.  AIG goes bankrupt and the holder of the CDS is out the premium ($50,000).

2.  SEC (or whoever) declares the instrument illegal and the holder of the CDS is out the premium ($50,000).  (edit: or even have AIG or the Treasury (taxpayers) return the premium as a compromise)

3.  U.S. Treasury (taxpayers) bails out AIG and the payout ($10,000,000) is transferred from the taxpayers to the holder of the CDS.

I know which outcome I'd prefer.

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