Credit Default Swap Quotes

How do you explain to an innocent citizen of the free world the importance of a credit default swap on a double-A tranche of a subprime-backed collateralized debt obligation?

They had stumbled either upon a serious flaw in modern financial markets or into a great gambling run. Characteristically, they were not sure which it was. As Charlie pointed out, “It’s really hard to know when you’re lucky and when you’re smart.

A credit default swap was confusing mainly because it wasn’t really a swap at all. It was an insurance policy, typically on a corporate bond, with semiannual premium payments and a fixed term. For instance, you might pay $200,000 a year to buy a ten-year credit default swap on $100 million in General Electric bonds. The most you could lose was $2 million: $200,000 a year for ten years. The most you could make was $100 million, if General Electric defaulted on its debt any time in the next ten years and bondholders recovered nothing. It was a zero-sum bet: If you made $100 million, the guy who had sold you the credit default swap lost $100 million. It was also an asymmetric bet, like laying down money on a number in roulette. The most you could lose were the chips you put on the table; but if your number came up you made thirty, forty, even fifty times your money.

Wing Chau didn’t know he’d been handpicked by Greg Lippmann to persuade Steve Eisman that the people on the other end of his credit default swaps were either crooks or morons, but he played the role anyway.

How do you explain to an innocent citizen of the free world the importance of a credit default swap on a double-A tranche of a subprime-backed collateralized debt obligation? He tried, but his English in-laws just looked at him strangely. They understood that someone else had just lost a great deal of money and Ben had just made a great deal of money, but never got much past that. "I can't really talk to them about it," he says. "They're English.

On its surface, the booming market in side bets on subprime mortgage bonds seemed to be the financial equivalent of fantasy football: a benign, if silly, facsimile of investing. Alas, there was a difference between fantasy football and fantasy finance: When a fantasy football player drafts Peyton Manning to be on his team, he doesn’t create a second Peyton Manning. When Mike Burry bought a credit default swap based on a Long Beach Savings subprime–backed bond, he enabled Goldman Sachs to create another bond identical to the original in every respect but one: There were no actual home loans or home buyers. Only the gains and losses from the side bet on the bonds were real.

When the Goldman Sachs saleswoman called Mike Burry and told him that her firm would be happy to sell him credit default swaps in $100 million chunks, Burry guessed, rightly, that Goldman wasn’t ultimately on the other side of his bets. Goldman would never be so stupid as to make huge naked bets that millions of insolvent Americans would repay their home loans. He didn’t know who, or why, or how much, but he knew that some giant corporate entity with a triple-A rating was out there selling credit default swaps on subprime mortgage bonds. Only a triple-A-rated corporation could assume such risk, no money down, and no questions asked. Burry was right about this, too, but it would be three years before he knew it. The party on the other side of his bet against subprime mortgage bonds was the triple-A-rated insurance company AIG—American International Group, Inc.

The less transparent the market and the more complicated the securities, the more money the trading desks at big Wall Street firms can make from the argument. The constant argument over the value of the shares of some major publicly traded company has very little value, as both buyer and seller can see the fair price of the stock on the ticker, and the broker’s commission has been driven down by competition. The argument over the value of credit default swaps on subprime mortgage bonds—a complex security whose value was derived from that of another complex security—could be a gold mine.

For example, trading in S&P 500-linked futures totaled more than $60 trillion(!) in 2011, five times the S&P 500 Index total market capitalization of $12.5 trillion. We also have credit default swaps, which are essentially bets on whether a corporation can meet the interest payments on its bonds. These credit default swaps alone had a notional value of $33 trillion. Add to this total a slew of other derivatives, whose notional value as 2012 began totaled a cool $708 trillion. By contrast, for what it’s worth, the aggregate capitalization of the world’s stock and bond markets is about $150 trillion, less than one-fourth as much. Is this a great financial system . . . or what!

Both had trouble generating conviction of their own but no trouble at all reacting to what they viewed as the false conviction of others.

Investment banking is my true calling, so I’m comfortable making sacrifices. I’ve basically given my life to it these past few years. It’s sort of like joining the Army, except instead of going off and losing a leg in some faraway desert to make some defense contractor or oil guy rich, I get to sell things like collateralized debt obligations and credit default swaps to idiots and make myself rich.

There are a lot of really crappy bonds in these CDOs,’” said Charlie. They didn’t realize yet that the bonds inside their CDOs were actually credit default swaps on the bonds, and so their CDOs weren’t ordinary CDOs but synthetic CDOs, or that the bonds on which the swaps were based had been handpicked by Mike Burry and Steve Eisman and others betting against the market. In many ways, they were still innocents.

they pale by comparison to the trading volumes of hedge funds, to say nothing of the levels of trading in exotic securities such as interest rate swaps, collateralized debt obligations, derivatives such as futures on commodities, stock indexes, stocks, and even bets on whether a given company will go into bankruptcy (credit default swaps). The aggregate nominal value of these instruments, as I noted in Chapter 1, now exceeds $700 trillion.

In early July, Morgan Stanley received its first wake-up call. It came from Greg Lippmann and his bosses at Deutsche Bank, who, in a conference call, told Howie Hubler and his bosses that the $4 billion in credit default swaps Hubler had sold Deutsche Bank’s CDO desk six months earlier had moved in Deutsche Bank’s favor. Could Morgan Stanley please wire $1.2 billion to Deutsche Bank by the end of the day? Or, as Lippmann actually put it—according to someone who heard the exchange—Dude, you owe us one point two billion.

Not a single high-level CEO has even been charged in connection with the financial collapse, much less been convicted and sent to prison, and most of them went on to receive huge year-end bonuses. Joseph Cassano of AIG Financial Products—known as “Mr. Credit-Default Swap”—led a unit that required a $99 billion bailout while simultaneously distributing $1.5 billion in year-end bonuses to his employees—including $34 million to himself. Robert Rubin of Citibank received a $10 million bonus in 2008 while serving on the board of directors of a company that required $63 billion in federal funds to keep from failing. Lower down the pay scale, more than 5,000 Wall Street traders received bonuses of $1 million or more despite working for nine of the financial firms that received the most bailout money from the US goverment.

There was more than one way to think about Mike Burry’s purchase of a billion dollars in credit default swaps. The first was as a simple, even innocent, insurance contract. Burry made his semiannual premium payments and, in return, received protection against the default of a billion dollars’ worth of bonds. He’d either be paid zero, if the triple-B-rated bonds he’d insured proved good, or a billion dollars, if those triple-B-rated bonds went bad. But of course Mike Burry didn’t own any triple-B-rated subprime mortgage bonds, or anything like them. He had no property to “insure” it was as if he had bought fire insurance on some slum with a history of burning down. To him, as to Steve Eisman, a credit default swap wasn’t insurance at all but an outright speculative bet against the market—and this was the second way to think about it.

The problem wasn’t that the banks were, in and of themselves, critical to the success of the U.S. economy. The problem, he felt certain, was that some gargantuan, unknown dollar amount of credit default swaps had been bought and sold on every one of them. “There’s no limit to the risk in the market,” he said. “A bank with a market capitalization of one billion dollars might have one trillion dollars’ worth of credit default swaps outstanding. No one knows how many there are! And no one knows where they are!” The failure of, say, Citigroup might be economically tolerable. It would trigger losses to Citigroup’s shareholders, bondholders, and employees—but the sums involved were known to all. Citigroup’s failure, however, would also trigger the payoff of a massive bet of unknown dimensions: from people who had sold credit default swaps on Citigroup to those who had bought them.

Goldman Sachs itself—and so Goldman was in the position of selling bonds to its customers created by its own traders, so they might bet against them. Secondly, there was a crude, messy, slow, but acceptable substitute for Mike Burry’s credit default swaps: the actual cash bonds. According to a former Goldman derivatives trader, Goldman would buy the triple-A tranche of some CDO, pair it off with the credit default swaps AIG sold Goldman that insured the tranche (at a cost well below the yield on the tranche), declare the entire package risk-free, and hold it off its balance sheet. Of course, the whole thing wasn’t risk-free: If AIG went bust, the insurance was worthless, and Goldman could lose everything. Today Goldman Sachs is, to put it mildly, unhelpful when asked to explain exactly what it did, and this lack of transparency extends to its own shareholders. “If a team of forensic accountants went over Goldman’s books, they’d be shocked at just how good Goldman is at hiding things,

Joseph Cassano of AIG Financial Products—known as “Mr. Credit-Default Swap”—led a unit that required a $99 billion bailout while simultaneously distributing $1.5 billion in year-end bonuses to his employees—including $34 million to himself. Robert Rubin of Citibank received a $10 million bonus in 2008 while serving on the board of directors of a company that required $63 billion in federal funds to keep from failing. Lower down the pay scale, more than 5,000 Wall Street traders received bonuses of $1 million or more despite working for nine of the financial firms that received the most bailout money from the US goverment. Neither

Say Bank A is holding $10 million in A-minus-rated IBM bonds. It goes to Bank B and makes a deal: we’ll pay you $50,000 a year for five years and in exchange, you agree to pay us $10 million if IBM defaults sometime in the next five years—which of course it won’t, since IBM never defaults. If Bank B agrees, Bank A can then go to the Basel regulators and say, “Hey, we’re insured if something goes wrong with our IBM holdings. So don’t count that as money we have at risk. Let us lend a higher percentage of our capital, now that we’re insured.” It’s a win-win. Bank B makes, basically, a free $250,000. Bank A, meanwhile, gets to lend out another few million more dollars, since its $10 million in IBM bonds is no longer counted as at-risk capital. That was the way it was supposed to work. But two developments helped turn the CDS from a semisensible way for banks to insure themselves against risk into an explosive tool for turbo leverage across the planet. One is that no regulations were created to make sure that at least one of the two parties in the CDS had some kind of stake in the underlying bond. The so-called naked default swap allowed Bank A to take out insurance with Bank B not only on its own IBM holdings, but on, say, the soon-to-be-worthless America Online stock Bank X has in its portfolio. This is sort of like allowing people to buy life insurance on total strangers with late-stage lung cancer—total insanity. The other factor was that there were no regulations that dictated that Bank B had to have any money at all before it offered to sell this CDS insurance.