Are "swaps" a good or bad thing?

[gonzomax]

@Freddy_the_Pig

Dinsdale, you can read some good background on what credit default swaps are, and why institutions write them, in this thread. mazinger_z seems to be discussing mortgage-backed securities, not swaps.

Swaps are insurance on the mortgage backed securities. In many cases the securities did not exist. They just sold a ton and got rich. The SEC had a staff of one assigned to tracking them. The regulators were gutted because who needs them, the financial system is self correcting. Guys on this board actually said that in the past.
They knew they could not pay off. But. they just kept selling. Gaming the system for all they could.
Sullivan at AIG had his bonuses determined by a compensation committee. One committee for the top 700 execs of which Sullivan was a member. Then another for the top 70. He told the committee that the fact that they lost 5.3 billion in a quarter should not be taken into consideration. They agreed and he got 5.2 million more in bonus. It was a big setup.

[Little_Nemo]

Individually, the swaps were financially sound. The problem was that the businesses that sold them treated them as if they were all independent risks. They obviously were not - the failure rate was dependent on real estate prices which meant that a collapse in real estate prices would trigger the majority of swaps at the same time. The result was the equivalent of a run on the bank where all the depositors want to withdraw their money in the same day. No business will survive an outflow of cash like that.

Which is not to say the businesses that sold swaps were not responsible for their failures. The problem was forseeable to anyone who bothered to think about it.

[Leaper]

Also, Fortune Magazine says that, while they do pose a potential problem, $50 trillion plus number is misleading:

… the volume of CDS has exploded with nuclear force, nearly doubling every year since 2001 to reach a recent peak of $62 trillion at the end of 2007, before receding to $54.6 trillion as of June 30, according to ISDA.

Take that gargantuan number with a grain of salt. It refers to the face value of all outstanding contracts. But many players in the market hold offsetting positions. So if, in theory, every entity that owns CDS had to settle its contracts tomorrow and “netted” all its positions against each other, a much smaller amount of money would change hands. But even a tiny fraction of that $54.6 trillion would still be a daunting sum.

[Leaper]

Oh, and here’s an opinion that argues for the basic soundness of the CDS market.