Wednesday, September 17, 2008

Poser for a poseur

This crisis is complicated by innovative financial instruments that Wall Street created and distributed. They're making it harder for officials and Wall Street executives to know where the next set of risks are hiding and also spreading the fault lines of the crisis.

The latest trouble spot is an area called credit-default swaps, which are private contracts that let firms trade bets on whether a borrower is going to default. When a default occurs, one party pays off the other. The value of the swaps rise and fall as market reassesses the risk that a company won't be able to honor its obligations. Firms use these instruments both as insurance -- to hedge their exposures to risk -- and to wager on the health of other companies. There are now credit-default swaps on more than $62 trillion in debt -- up from about $144 million a decade ago.

One of the big new players in the swaps game was AIG, the world's largest insurer and a major seller of credit-default swaps to financial institutions and companies. When the credit markets were booming, many firms bought this insurance from AIG, believing the insurance giant's strong credit ratings and large balance sheet could protect them from bond and loan defaults. AIG, which collected generous premiums for the swaps, believed the risk of default was low on many securities it insured.

As of June 30, an AIG unit had written credit-default swaps on more than $446 billion in credit assets, including mortgage securities, corporate loans and complex structured products. Last year, when rising subprime mortgage delinquencies damaged the value of many securities AIG had insured, the firm was forced to book large write-downs on its derivative positions. That spooked investors, who reacted by dumping its shares, making it harder for AIG to raise the capital it increasingly needed.

Few financial crises have been sorted out in modern times without massive government intervention. Increasingly, officials are coming to the conclusion that even more might be needed. WSJ

Let's ask the experts. What would Sarah do?

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Blogger jonhusband said...

Palin would probably check with her policy wonk, John McCain.

Here's what he had to say in one of the actuarial industry's professional magazines, Sept / Oct 2008 issue:

"Opening up the health insurance market to more vigorous nationwide competition, as we have done over the last decade in banking, would provide more choices of innovative products less burdened by the worst excesses of state-based regulation."

But on tv he's saying that Wall Street is bad and mean.

Mommy, mommy .. that man McCain on tv is scaring me.

9/19/2008 11:11 PM  
Blogger Tom Matrullo said...

Probably go to the root and font of all economic wisdom:

9/20/2008 10:19 AM  

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