Yes, you're right on that. But there have been 45.5 trillion dollars of these sidebets made. And they were done poorly and the government did nothing to regulate them.
I wouldn't call it a "side bet." Think of it as insurance. To insure against a loss from damaging your car, you pay a premium to protect yourself. That's not really a side bet as much as it is a protection for assuming the risk... of driving. A credit default swap protects banks who loan risky debt to investors. By putting down a certain amount of collateral, these swaps combine all these to create a giant pool that can be drawn from in the event of a default.
Well, we all know that when stuff like this gets unregulated, there are always going to be people that find creative ways to make stupid investments and assume way too much risk, but make a handsome profit doing so. That's what happened. In addition, because there was an underestimation of the rate of default (and a lot of that is probably because they underestimated how much risk these "insurers" would take on), suddenly, you don't have enough money in the pool to pay out.
Quote:
Originally Posted by KC Jones
Excellent post 
However I would add a 4.5 in there...
4.5 These securitized debts (repackaged into investments that could be sold), were then leveraged into credit derivative swaps. I seriously don't know what the **** that really means despite reading about it, but as far as I can tell it's a side bet placed on whether or not the original debts will be paid. However we allowed side bets worth far more than the initial debt. So maybe you had 50 billion in actual mortgage debt out there, but with 500 billion in side bets on whether or not it would be paid. AND these finance wizards BORROWED to make these side bets.
EDIT: Here's a nice explanation of credit derivatives that Lehman brothers put together in 2001. Oh this is just too ironic:
http://www2.wu-wien.ac.at/vgsf/curri...0Explained.pdf |