Credit-Default Swaps

One World Eggheads
And
Credit-Default Swaps

It has been a surprise to me how the banking and capital generation system works in the real world. To say I am ignorant about the finer points of the current financial system that is in such disarray today would be a colossal understatement, however, with a little research and in simple terms that normal people can understand, I believe this is how it works. You deposit one ($1.00) dollar in your local bank, get your receipt, and feel good about putting a little away for a rainy day. Your bank is now authorized to provide a loan to a credit worthy person in the amount of ten ($10.00) dollars for every one ($1.00) the bank has on deposit of the real money real people deposited. Where did this $10.00 of “artificial” money come from to lend to a credit worthy person desiring a loan? A very good question Holmes. The $10.00 is borrowed from the Central Bank at the “discount rate” to provide the money for the loan. The Central Bank is part of the U.S. Federal Reserve System and the money it supplies is printed-up money based on some esoteric reasoning usually influenced by political reality. The Federal Reserve System was created for a number of good reasons but the main reason was its ability to provide for an “elastic currency”. The Federal Reserve officially defines “elastic currency” as: “currency that can, by the actions of the central monetary authority, expand or contract in amount warranted by economic conditions” or in everyday terms, it can print-up money or take money out of the system. Now if the loan originated by your bank happened to be a large amount backed by a physical asset as collateral, such as your home mortgage, the bank will sell the loan to another financial entity, like Fannie May or Freddie Mac for a fee and the fee received now provides more “real money” the bank can then leverage into even more loans. Fannie May and Freddie Mac (or other financial entities) takes your loan and bundles it with other loans it bought (some made to not so good credit risks and distributed within the bundle to hid them) and then sells the investment bundle to investors at a profit, of course, for its stockholders. It should be noted that Fannie May and Freddie Mac had the implicit backing of the Federal Government to “insure” that the investment package being sold was safe so the investment bundles being sold are very marketable. Other financial entities also buys bundled investment packages but they lacked the implicit government guarantee of safety so companies, like AIG, issued “Credit-default Swaps” policies for a big profit-making fee to insure the bundled investment instruments and the “Credit-default Swaps” insurance policy made the investment packages marketable to all investors. “Credit-default Swaps” is just one of many so called “derivatives” offered to investors (like your local government, IRA accounts, insurance companies, ad infinitum) by various financial institutions that are, in reality, instruments that further leverage money on top of leveraged money in order that everyone in the food-chain can continue to make a handsome profit without ever providing something tangible in return that would provide real value in exchange for the money earned. You may be surprised to learn that some financial entities have leveraged already leveraged money up to 30 or 40 times (not just the 10 times your bank did) to sell investment “derivatives” for big profits to “Hedge Funds” and other really smart people who then leverage the money that the “derivative instruments” represent to buy real companies that make things and provide jobs to real people. A case in point, Carlyle Capital, a division of the Carlyle Group, loaned out leveraged money at a ratio of from 20 and 30 to 1 and has, of course, failed. If all of this sounds vaguely familiar, it should. There are a large number of criminals in the slammer serving time for concocting such schemes as these and these schemes, when done on an individual basis, is call a Ponzi or Pyramid scheme. A Ponzi scheme is a fraudulent investment operation that involves promising or paying abnormally high returns (“profits”) to investors out of the money paid in by subsequence investors, rather than from real net revenues generated by real business (it was named after Charles Ponzi). Well if it looks like a duck, quacks like a duck, waddles like a duck, what the hell, it really must be a duck. If all of this hasn’t started to make your stomach churn, I know something that will turn you into a fetal ball. Christopher Cox, Chairman of the United States Securities and Exchange Commission, wrote in a 19 October 2008 New York Times article that there are $55 Trillion Dollars in outstanding “Credit-default Swaps” out there right now. Oh by the way, $55 Trillion Dollars is more money than all of the GNPs (Gross National Product) of all of the nations on earth combined. I’ll just pause here a moment to let that fully sink in. So what does this have to do with One World Eggheads? Thomas L. Friedman writes in the same New York Times issue that the current leveraged mess is indeed a Global mess and only a fully connected Global economy and regulations can properly “fix” the mess. The One World Eggheads are dancing in the streets.