Monday, September 22, 2008

Tell Uncle Sam Not to Buy Credit Derivatives

Unregulated Wall Street investment houses sold credit derivatives as a form of insurance on packaged loan securities. Credit default swaps are a bet on the failure of the borrowing firm. Their cost soared recently, effectively drying up the credit market.

No investor wants to pay through the nose for "peace of mind" on holding credit. Nor do they want to hold unprotected debt in today's market.

The failure of unregulated mortgage backed securities is clear, evidenced by the billions in quarterly write downs from financial firms. But the excesses in the credit default swaps market is a new development, one the SEC is investigating. News sources say some $62 trillion exists in credit default swaps, but I believe that's the size of the credit pool they cover.

One bank, Fairfax Financial Holdings sold some of their credit default swaps. Today's MarketWatch story said the following about this investment instrument:

The credit default swaps are extremely volatile, with the result that their market value and their liquidity may vary dramatically either up or down in short periods, and their ultimate value will therefore only be known upon their disposition. Similarly, the values of Fairfax's other portfolio investments, including Treasury bills, government bonds, other fixed income securities, equities and equity derivatives employed to hedge our equities, are also volatile, and particularly so given the increased volatility of current financial markets, and their ultimate value will only be known upon their disposition.

Uncle Sam's coffers may be the only place some of these volatile portfolio investments may land. Tell George Bush and Hank Paulson not to buy credit derivatives. Shoring up the underlying loan security should be enough. Just say no to credit default swaps.