On Thu, 30 Oct 2008 11:53:00 -0400, Tag <[log in to unmask]> wrote:

>As I read more about this financial collapse, it seems that the culprit
>wasn't so much the MBS as it was the CDS. My question is if many of these
>CDS were purchased for pennies on the dollar by players that weren't even
>involved (they have been described as side bets), why instead of a bailout
>didn't the government void those contracts and have the initial purchase
>refunded or have them get a modest return?

Well first, I think you have to realize that it's all a chain reaction which starts 
from the default on a house that shouldn't have been purchased, financed by 
money that shouldn't have been leant.  The MBS are really a key cog in that 
chain b/c they are the conduit through which troubles in the housing market 
got to Wall St. in the first place.  Of course, the whole CDS mess is indeed a 
big tihs show, and it is far more complex than anyone could dare to try and 
explain.  I honestly don't have an answer for you b/c I don't know enough 
about the derivatives market to make an informed opinion.  

For what it's worth, I wouldn't say that CDS were purchased at pennies on the 
dollar.  They act like any other sort of insurance policy.  You pay X amount in 
premiums for Y amount of insurance, and the size of X depends upon the 
perceived riskiness of Y.  In life insurance, they've got eons of actuarial data 
to work off of so as to properly price X, but X is always a small fraction of Y.  
For CDS, X was also a small fraction of Y, as it should have been, but there 
was a lot less data to work with and clearly both the regulators and risk 
managers at many firms were asleep at the wheel or, more likely in the case of 
the latter group, making too much money hand over fist to really care.

Again though, I really can't give you an answer on the "why not just 
unwind/invalidate" argument.  I suspect it has a lot to do with the complexity 
of same and very little to do with any effort to protect one's buddies at 
Goldman, if that's what you're looking for.

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