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Easter
and Credit Default Swaps
Today’s (March 16th)
headline news:
"There are a lot of terrible things that have happened in the last 18 months, but what's happened at AIG is the most outrageous," said Larry Summers, President Obama's chief economic adviser.
AIG will pay bonuses totaling $165 million. The money comes from taxpayers, funneled through the multibillion dollar bailout plan, but the president's top advisers and congressional leaders say they can't do anything about it.
AIG executives made trillions of dollars of bets that subprime mortgages could never go bad. When they tanked, the government felt compelled to prop up the company with $170 billion in taxpayers' funds. Even with the money, AIG recently posted a loss of nearly $62 billion — the largest corporate loss in history.
Summers, however, can't blame the owners of AIG: After the bailout, taxpayers now control 80 percent of the company. And Summers says those bonuses must be given to the people who ran the company into the ground — because they signed contracts before the company crashed.
This must make your blood boil! Taxpayer money is given in multimillion dollar bonuses to those who failed a large business. This must be one of the most outrageous finance stories of all times! So far!
How did we get here?
AIG and other financial institutions (e.g., Bearn Stearns, Lehman Brothers) collapsed because of CDS, or Credit Default Swaps, forms of financial derivatives. To make a complicated story simple, a bank would make mortgages that were subprime, i.e., lending to borrowers who do not meet prime underwriting guidelines. The banks wanted to spread the risk and insure themselves against defaults. So the bankers went to AIG and bought insurance policies against credit default – if the borrower defaults, the banks would be paid by the insurer, AIG.
This all makes sense. However, the practice increased the willingness of lending institutions to make more and more risky loans. But wait, there is more! The oddest thing was that anyone could buy insurance policies against credit defaults, not only the banks! With good connections you or I could have bought these privately traded policies on anyone’s mortgage or bond. We now had to hope that the borrowers in fact would default since that was the way we could get paid. It almost sounds like insurance fraud – but it was not. Everything was legal, but perhaps not moral!
The insurers were not regulated so they could sell the same bonds or insurance policies several times over, so that someone’s risky mortgage may have been insured several times over by others than the bankers! At its peak there were 62.2 trillion dollars of these derivatives. And how much money is that? The entire world annual economy is about 54.3 trillion, the US economy is 14 trillion. The value of all stocks on the NYSE is 50.5 trillion (numbers are from the end of 2007 and first quarter of 2008). So we are talking about the biggest money number there is or has ever been – and likely ever will be!
In the late 1990’s there was an attempt made to regulate the CDS industry. After all, casino gambling is heavily regulated whereas this, the truly big men’s casino, was without any oversight. These efforts were torpedoed with the help of Alan Greenspan and, of all people, Larry Summers!
The U.S. Congress passed a bill prohibiting all federal and most state regulation of CDS and other derivatives. The bills co-sponsor, Senator PhilGramm crowed that the new law "protects financial institutions from over-regulation ... and itguarantees that the United States will maintain its global dominance of financial markets." However, not everyone was as cheerful as Gramm. In 2003 Warren Buffett called CDS derivatives "financial weapons of mass destruction."
Last October Alan Greenspan conceded during a congressional hearing that he had erred on regulation and that he had put too much faith in the self-correcting power of free markets and had failed to anticipate the self-destructive power of reckless mortgage lending.
So where is the problem? Since the government failed to regulate, the insurers like AIG took risks that they could not handle if the defaults were large enough. Normally, insurers are required to have enough funds to cover losses. But this was not the case with the CDS market. You and I, the taxpayers are now helping the AIGs to pay their obligations. So far, AIG has used 170 billion dollars of our money.
All this has led to a major confidence crisis. The banks that made irresponsible risky loans are now practically making no loans at all. This has brought down the entire world economy. The difficulties at the top have somehow, unlike the wealth, trickled down to every household in the world.
The poor are, as always, of course, suffering the most. They are paying the biggest price for the mistakes of the few greedy at the top. The honest business people, that is, the great majority, are all taking a hit because of a relatively few reckless ones.
So what would Jesus say? What would he want us as his followers to do? The answer is that he would want to make sure that we take care of those who are suffering the most. The answer is that he would want us to make sure that this kind of greed will never again destroy the world economy.
Right now things still look pretty bleak. It is as if we all were stuck on Good Friday, or as it is called in Danish, Swedish and Finnish, Long Friday. You can imagine how disappointed the disciples were on Good Friday. They were utterly shattered, hopeless, without directions. Easter morning changed it all. Whatever the details are, one thing seems clear; something changed the disciples’ utter despair into unqualified joy and delight, hope and faith. They were filled with new life and energy, the body of Christ had risen.
As Christians we must not allow despair to overcome us. Jesus often told people not to fear because he knew that fear drowns us. Our trust is not in Credit Default Swaps, it is not in financial derivatives, it is not in that what can be taken away, but it is in God – as, ironic as it may be, the dollar bill confirms!
See you at Church and Happy Easter to Everyone!
Pastor Jarmo