Maggie's Farm

Okay, so you had to put up the Rove link on Obama's economic team to incite me a bit.

We remain far from "the other side" of this financial crisis. The reason is a simple acronym - CDS.

There are trillion of dollars in CDS outstanding. Some were written to hedge an actual exposure. Some were written to speculate on the probability of default of a particular counterparty. As a result, a default of, let's say GM, would have a much larger impact on the financial system because the notional amount of the hedges are many times the notional amount of the underlying debt obligations.

It is the bailout of the speculative world that is occurring versus the real world.

Here is an article to ponder.

http://us1.institutionalriskanalytics.com/pub/IRAMain.asp

Now the world of CDSs is very opaque. Who are the holders, who are the writers and who have CDS been written against and in what magnitude is not fully known. There are no exchanges. These are OTC instruments. We do know AIG wrote many CDSs.

My guess is that the speculators have targeted the weakest corporates. I suspect that the post mortem analysis will find a certain amount of manipulation of these instruments. I also think that a portion of the cry to save the Big Three is to avoid another wave of in the financial crisis driven by an unknown magnitude of CDS bets against the Big Three.

Geithner and Summers are smart guys, but I think they are guessing here (as is everyone else). Paulson and Geithner have been in bed in the response by government through out the crisis. I am not sure what change there will be in terms of policy response to the macro economy. It will be more stimulus and much of it will be ineffective and drive the USA deeper into debt.

However, it seems clear that the risk to the world's financial system will not be over until the issue of CDSs is resolved.

The solution may be that all CDSs are canceled unless a direct hedge can be proven. The speculators would scream. CDS will likely become exchange traded instruments.