How CDO & CDS’s Crushed the World Economy

How Derivatives, Collateralized Debt Obligations and Credit Default Swaps crushed the world economy

June 4, 4:51 PM  LA Bipartisan Examiner  Vince Flaherty

“The banks run the place… they give three
times more money than the next biggest group,” says Congressman Collin
Peterson, the Chairman of the Agriculture Committee. Peterson, who says
banks are controlling Congress, has introduced a bill to bar
Derivatives trading in any clearinghouse regulated by the New York
Federal Reserve, and thereby bring Derivatives trading out of the
shadows of the private clearing houses, and onto public exchanges.
see, it finally took someone who knows about agriculture, to get down
to the nitty-gritty of the Derivatives dilemma. The trouble is,
according to Congressman Peterson, that his bill will not pass unless
it is materially changed to the satisfaction of his colleagues in
Congress, the ones who are accepting the contributions and perks from
their bankster superiors.
Derivatives, along with their
cousins the Collateralized Debt Obligations (CDO’s), and Credit Default
Swaps (CDS), are the financial instruments that have in recent times
been defined as a bottomless pit of incomprehensibly written economic
jargon, or Wall Street hocus pocus. They are being blamed by many
bankers, politicians and high government officials, to be the
underlying cause of AIG’s recent quarterly loss, over 67 billion
dollars, and the ongoing world financial crisis, among a few other
Specific people are not being held to blame mind
you, just Derivatives, Collateralized Debt Obligations and Credit
Default Swaps. This is almost like saying that Hitler didn’t do
anything wrong, it was National Socialism… and since I mentioned
National Socialism… well, never mind, for the time being…
what really happened. This is how bankers just caused the largest
economic collapse in the history of the world. Up until about 2007,
Wall Street and their international counterparties got away with
running what amounted to a colossal pyramid scheme. They started by
selling millions of bundled together mortgages in packages called
Structured Investment Vehicles, to the world’s banks, trusts,
institutions, and municipal, corporate or government entities. In order
to sell these investments to municipalities and other state entities,
that are regulated to keep their portfolios conservatively safe, many
of those pools of mortgages were packaged into larger, supposedly more
stable instruments called Collateralized Debt Obligations (CDO’s) that
contained several kinds of debt such as corporate or credit card debt,
in addition to mortgage loans. The main theory behind the structuring
was that diversification of different kinds of debt within the CDO’s
would diminish the overall risk of default.
As the banks
endeavored to create more attractive terms and yields to entice further
end buyers, the terms of the underlying mortgage loans became ever more
egregious to American homeowners. In many instances, cash incentives
were awarded to brokers and loan officers at the banks, as a reward for
steering borrowers into more profitable sub-prime (predatory) loans,
when the borrowers were actually qualified for better terms. In other
cases, “liar’s loans” for undocumented or unqualified borrowers were
pushed through with predatory terms and rates in order to enhance the
yields of the packages, and feed the pyramiding machine.
of those aggressive mortgage documents were written in such a way that
the interest payment would often double or triple within a few years,
often placing the borrowers within an astoundingly unethical debt-
to-income ratio of 80% or even more. In other words, the rate of
interest, and hence the rate of return, promised on much of that paper,
was clearly unsustainable, and designed by the banks to fail sometime
in the future after they had packaged and sold the paper to unwitting
investors in the secondary market.
To conceal the high
risk nature of such mortgage instruments, and the CDO’s into which they
were packaged, our largest American banks used three different rating
agencies to rate the risk for purchasers. Unfortunately, our own
government was conveniently looking the other way, as the banks, who
just happened to own the rating agencies, and apparently our government
as well, paid the agencies to rubber stamp the mortgages Triple A (AAA)
so that they could be bundled into “Triple A” Structured Investment
Vehicles and Collateralized Debt Obligations, and sold all around the
As a measure to manage the risk, and as a further
inducement to facilitate more trades, the banks utilized a device
called the Credit Default Swap (CDS), under which for a monthly
premium, another institution, bank, or insurance corporation such as
AIG, would agree to pay off the debt if the borrowers defaulted. The
Federal Reserve and the Office of the Comptroller of the Currency
thought it was such a great idea, that they exempted banks from having
to keep cash reserves for the Credit Default Swap protected obligations
the banks held. This allowed the banks to make more loans with their
cash reserves that previously under federal law would have been
required to remain in the banks to balance their loan to reserve
ratios. That the secretive Federal Reserve led the way in allowing the
banks to do such a thing, was no real surprise because the Chairman of
the Federal Reserve has always been appointed by the President of the
United States from a list of three people supplied by the banks.
main problem with the scheme was that the institutions providing the
Credit Default Swap protection were not even required by government
regulators to prove that they had enough reserves to actually pay off
the debts in the event that, God forbid, defaults occurred and world’s
financial institutions, real estate trusts, worldwide municipal and
government entities that bought the Structured Investment Vehicles,
CDO’s and Derivatives, started to suffer losses and demanded that Wall
Street buy back the bogus “Triple A” rated paper.
One can
imagine that if the stalwart individuals who structured this debacle
were really sharp, they would have at least thought of a way around the
annoying buy- back clauses in the contracts. But you see, they were
busy trying to figure out how the CDS, CDO’s and the Derivatives were
going to work mathematically. Not even past chairman of the Federal
Reserve Alan Greenspan, nor present chairman Ben Bernanke, nor former
Goldman Sachs CEO and Secretary of the Treasury Henry M. Paulson Jr.,
nor former head of the New York Federal Reserve and current Secretary
of the Treasury Timothy F. Geithner, or anybody else for that matter,
could accurately figure out how these Derivatives, Collateralized Debt
Obligations (CDO’s) and Credit Default Swaps (CDS), were supposed to
actually work, because the language and the formulas in the instruments
was incomprehensible, and there wasn’t nearly enough money in reserve
to insure potential losses.
The sad news at the moment… is
that less than half of the underlying time bomb mortgages in the United
States have yet to adjust dramatically upward and fall into default.
Meanwhile, due to the “credit freeze”, many borrowers who thought they
would be able to convert to more reasonable loan terms, have been
forced to continue to make unreasonably high interest payments compared
to their income, draining all of their savings reserve and retirement
accounts, while our government and their superiors at the banks, in
spite of their rhetoric to the contrary, continue to make it extremely
difficult for such borrowers to have their loan terms modified.



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