Wednesday, January 30, 2008

Credit Default Swaps

[I sent this to Jerry Pournelle earlier, but in retrospect I should have Cc'ed the blog. Actually, this needs a little explaining. The real estate side of the economy is having problems right now. The news is full of articles about poor immigrant workers in L.A. with 11 kids who are about to lose their home to mortgage default, but the real question is, how did someone with an $11-an-hour job get a loan sufficiently large to afford an 8-bedroom house when he can barely make the interest payments? Of course he was relying on the house to rise in value so that he could sell it, without any expectation of actually being able to pay off the loan otherwise. He was a bad credit risk. So even though this looks like a human-interest story, from a business perspective it's the bank trying to avoid losing money from a mortgage default--they would much, much rather that the government step in to cover the bad debt. Jerry points out that this is terrible policy and rewards poor business decisions, so why are we even talking about it? That's where this piece from Selenian Boondocks, by someone who works in the financial industry, comes in. The post is mainly about private space ventures, but the intro is relevant to the real estate debate. There. That's the context for your sake, my presumably non-existent readers.]

Subject: Credit Default Swaps

'That was the Faustian bargain in granting companies "corp"-orate status - they have equal "status" with you in the courts, but they can exercise far more economic clout than the vast majority of individuals can ("classes" of individuals at least have a fighting chance) - they can afford far, far more lawyering than you or I. When companies have difficulty servicing their debt, that raises the odds of a default, which angers the gods of CDS, and they induce volatility in the market and require that more capital pay attention to them. By lowering rates, companies whose debt is little more than a promise can at least keep that promise for a little while longer.'


"The presentation or 'gift' of the Holy Ghost simply confers upon a man the right to receive at any time, when he is worthy of it and desires it, the power and light of truth of the Holy Ghost, although he may often be left to his own spirit and judgment." --Joseph F. Smith (manual, p. 69)

Be pretty if you are,
Be witty if you can,
But be cheerful if it kills you.

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