Smeagol is right. If people didn't stretch their finances to the limit, pushing into debt so far that they have no extra money when some prices rise, they would still be buying goods and services that would keep the economy alive.
We, as consumers, allowed all the to happen because we were marketable to it.
This problem is embeded far too deep in America's society that it cannot be one group's fault. It's been brewing for more than 20 years.
It is easy to find escape goats. Yeah . . . those greedy bankers! No question there are greedy bankers. But that is just telling part of the story.
I'm not talking about escape goats I'm talking about the bulk of the real problem with the financial meltdown. I agree that in general Americans live beyond their needs. I'm not down playing that. I'm mearly pointing out that the dollar amount of foreclosures dwarfs the dollar amount of MBS that put the financial ins ution in shambles. Foreclosures are probably a tenth of what MBS's amounted to. Those MBS's were a creation of JP Morgan which were then exploited by our government to help push Freddie and Fannie. I'm not going to look up the figure again but somewhere around 60% of the second chance lending done wouldn't have qualified under Freddie and Fannie's original criteria.
This is like those people who blamed the old hole in the ozone on hairspray users.
You guys sit on here every day and look at these auto bailouts as a bailout because of a poor business model or ty vehicles or lack of breakthru technology. The big three or two of the three are in trouble for one reason and one reason only. The financial sector has cut lending by 80%. Sure the cars could be better and sure the business models could be more efficient but make no mistake about it if the banks were still lending the auto world would be putting along nicely. even if they only cut out 15% of the worst lends out there the auto would would still be getting by.
If you think the financial meltdown is predominantly attributed to Americans living above their needs you really need to step back and take a second look at the big picture because you're way way off.
Not only Americans . . . there's also some Europeans.
The problem, simply put, is that loans were made to people who cannot pay them back. You can do all the research you want, but in that simplest of statements lies the center of this whole mess.
No. The ability to hedge large amounts of money on the very idea that they wouldn't pay them back eclipsed the actual failed mortgage 10 fold.
The very loan itself was an ins ution promoted by your government not the moron living above his means. Its the ability to exploit the loan that created the mess not the loan itself.
Why are you incapable of seeing everything around it?
Its like saying a nuclear missle caused massive destruction. Its the missles fault.
Really because I could have sworn the people shooting it off were.
That is clearly not the main problem, no matter how many times you cling to your idea of poor blameless investors being the victims. My analogy with the school shooters is exactly in line with your reasoning, as you don't want to acknowledge the group that escalates a bad situation way forward to the breaking point is the one that deserves most of the blame. Pretty easy to preach from your high horse when it isn't your tax dollars going to waste in this heist.
I have been paying US taxes for the last 12 years so you can kiss that argument goodbye . . .
This is what economists, bankers, and money managers in the United States and Europe have told EIR without exception, over the first three weeks of August.
Since late July, both of the two "bookends" of Sir Alan Greenspan's last and greatest debt bubble have been collapsing in on it: the U.S. mortgage-securities bubble, on which the banks of Europe and Asia were feeding, and which had already grown to 49% of all bank assets in the United States; and the now-unwinding "yen carry trade," which was feeding some $500 billion annually in "free money," by some estimates, into that and related financial bubbles. That cheap-yen carry trade shrank as the yen rose steadily against the dollar during August, and more rapidly against the euro and, especially, the British pound sterling.
By the second half of August, financial news services were also reporting that the $1 trillion-plus asset-backed commercial paper (ABCP) market was in crisis, and thus the credit-market meltdown was starting to hit the savings of the general public directly. Some 40 million Americans, for example, invest savings in "money-market funds"; and those funds commonly invest in ABC paper because it is supposed to be both very safe—keeping the constant $1 value of every share in those money-market funds—and very liquid, allowing people to write checks on those funds.
Now, the ABC paper market is apparently anything but safe, and anything but liquid, with one big British bank, HBOS, attempting to organize a rescue Aug. 21 of its ABPC fund which could neither roll over, nor redeem, $30 billion of the stuff. The entire Canadian ABCP market froze up in the week of Aug. 13, and when temporarily bailed out, some of that "immediately liquid" commercial paper involuntarily became eight-year loans! One Canadian economist told EIR that the money-market funds—worth about $3 trillion total—have $100 billion invested in ABC paper, and another $100 billion in the mortgage derivatives called collateralized debt obligations (CDOs) which are laying low hedge funds and banks around the world.
The case of America's biggest mortgage lender, the $200 billion-asset Countrywide Financial Corp., is vital not only because its looming collapse involves the credit of the U.S. government-backed housing/mortgage enterprises known as Fannie Mae and Freddie Mac, but because the Countrywide case shows the folly of the bank-bailout policies pursued in this crisis so far by the Federal Reserve, European Central Bank, and other central banks.
Some $400 billion in extraordinary injections of central bank liquidity, into the banking systems, were carried out Aug. 9-21, and are still continuing.
On Aug. 16, a big chunk of that new Federal "bank bailout credit" clearly went to save Countrywide, which, as a Merrill Lynch analysis had just reported, was staring at a huge bankruptcy. Countrywide had been originating 17% of all new mortgages and home loans in the U.S. residential real estate bubble, and had accounted for fully one-third of all the mortgages being purchased by Fannie Mae and repackaged into mortgage-backed securities (MBS).
Even as the Federal Reserve injected $17 billion into the banking system on the morning of Aug. 16, an $11.5 billion emergency credit line for Countrywide was provided by 40 banks, organized by Treasury Secretary Henry Paulson and at the insistence of the Fed. One of those banks, for example, Impac Mortgage Holdings, was a real estate investment trust whose stock had fallen 80%; yet it put $500 million into that credit line. Another emergency lender, Capital One Financial Corp., had to shut down its own mortgage company four days later, laying off 1,900 employees.
The connection between the Fed injection into the banks, and the banks' bailout of Countrywide, was unmistakable. Equally unmistakable was the source of the $2 billion that the Goldman Sachs investment bank used to attempt to bail out one of its failing hedge funds, Global Equity Opportunities Fund, on Aug. 13. But the Countrywide salvage operation was a much more massive use of an emergency injection of Federal credit to try to save a huge financial corporation and its mortgage-backed securities. The day after the $11.5 billion credit line was organized, the Fed lowered its discount lending rate to banks by 0.5%, and New York Fed governor Timothy Geithner called the major banks, begging them to borrow from the Fed against their (so-called) AAA-rated (failing) MBS.
For the real economy of the United States, this attempted salvage of Countrywide did no good whatsoever. Countrywide's debt now being rated "distressed," the banks giving the credit line set interest rates too high for the loan to be used to originate new mortgages. Countrywide had already cut back its mortgage originations 15% from June to July, and announced on Aug. 16 more categories of mortgages it would no longer offer, and higher interest rates on those it would offer. It also immediately began laying off employees. What purpose, then, the $11.5 billion in credit lines—which Countrywide immediately drew down in full? Simply to enable the huge company to continue to refinance, and to buy back its MBS outstanding—to bail out Wall Street's mortgage securities holders.
Bottom line: banks, financial ins utions and other American businesses are grossly overleveraged and can't pay off now that their bets have gone the wrong way. The word for this situation is insolvency. The usual medicine is default followed by reorganization or liquidation. Instead, we're turning American finance and manufacturing into a gigantically subsidized zombie, and the medicine being used is more unserviceable debt.
The generally accepted wisdom is that any amount of money must be spent to prevent deflation from occurring. The downsides of this policy are:
1.) It may not work. You can bet against the trend, but when the Fed tells you that any amount of money can be spent without fear of inflation, we should all be very, very afraid. If Keynesian stimulus fails, we will have thrown trillions into a black hole, instead of planning for foreseeable human needs.
2.) If the size of inflation targeting is wrong, or it is mistimed, it could cause currency collapse. A bubble in treasuries appears to be a foregone conclusion. A loss of confidence in the US could cause it to burst. Hyperinflation and treasury default are both possible results post-recession.
3.) Assuming that the witches brew of nationalization, monetization of debt and the T-bubble are successful in preventing a deflationary spiral and do not lead in the near term to national default or currency collapse, we will have done so at the cost of the efficiency and profitability of whatever has been nationalized or reregulated, and more importantly, at the cost of the standard of living of all Americans.
4.) Assuming again that Rooseveltian stimulus works in the short term, it may only be setting us up for an even worse collapse later on. The strain the rescue will put on productivity, the USD and the national balance sheet are unprecedented.
Last edited by Winehole23; 12-22-2008 at 07:42 PM.
Huh?
Huh?The very loan itself was an ins ution promoted by your government not the moron living above his means. Its the ability to exploit the loan that created the mess not the loan itself.
Why are you incapable of seeing everything around it?
I'm capable of seeing what happened. The financial system's regulators were sleeping at the wheel. They allowed banks to lend money to people who were not able to repay it. They allowed banks to create financial instruments around those loans.
Here we go this explains it better than I can.
What’s the Subprime relevance
Subprime and Alt “A” have a relatively low share in the US Mortgage market (around 15% each). The traditionally subsidised mortgage brokers Fanny Mae and Freddie Mac where making more than 55% of mortgages.
But Subprime and other “specials” developed fast since 1998. Subprime loans were over 1300 billions USD by March 2007. They were at 150 Billions in 2001 and 600 Billions in 2005…..
And they were backed by a powerful string of financial derivatives. It is the “collateralization” process which gave Subprime mortgages their relevance.
The development of Mortgage Based Securities
Credit Default Swaps (CDS).
Collateralized Debt Obligations (CDO).
Collateralized Loan Obligations (CLO).
“Selling” risk on financial markets: MBS are actually a kind of insurance system for the emitter and they are attractive bonds for buyers till the default rate is low (usually 0.5%).
But MBS have spread the risk throughout the financial system and everybody can become an insurance company if it buy a CDS or a CDO
The Banking crisis
Banks have been the main user of MBS (40% of ulative total).
Strong compe ion in a deregulated market has made Subprime-ARM based CDS attractive to boost Banks profit rates.
The use of SPV and SPV-based Securities-baskets by banks has decreased transparency.
New accounting rules (“Mark to Market”) have increased Banks and Insurance companies vulnerability to financial market fluctuations.
What you showed me makes no sense.Through a MBS. I just showed you in my post above. You could insure that MBS at 10% of the full value which is why they wanted the debt to out. 10% collects 100% of the loss.
So you agree with me, the government was asleep at the wheel.I showed you above where the implemented MBS was pushed by the government to help ease the risk of the high risk loan.
Correct and those financial insturments around those loans are what created this mess. Had it just been the loans themselves it would have been bad but not catastrophic.
Those financial instruments were the ones who allowed the banks to be able to unload risks and make more loans in order for everybody to share the benefits of leverage.
We are back to square one.
The Toyota Prius falls in this price range. It's an hybrid so most of the limitations you've listed can be avoided, on the other hand it is not greehouse gas free but still very efficient especially for urban driving.
It's just ing ugly...
That you do not understand it, doesn't mean it doesn't make sense. B2B's posts reflect the generally accepted explanation.
Problem is, they didn't evaluate the risk, but relied instead on mathematical models to predict outcomes. Now that the risk is payable, the big banks are insolvent and instead of letting them fail, the US taxpayer is left holding the bag.
Why don't you explain it to me, because what B2B said makes no sense in the context of explaining the current economic crisis.
Problem is, they didn't evaluate the risk,
I'm with you
Not in the case of sub prime lending. The outright made bad credit decisions.but relied instead on mathematical models to predict outcomes.
Now that the risk is payable, the big banks are insolvent and instead of letting them fail, the US taxpayer is left holding the bag.
If the banks are left to fail, the US taxpayer would suffer much more than chipping in for the bailouts.
Is this so hart to understand?
It makes no sense on the context of what we are talking about. Hedging MBS positions is just that, hedging on a certain risk. This (hedging) is done throughout the financial world accross all asset classes, even the less risky ones (AAA corporate bonds).I know it makes no sense to you.
People who hedged MBS did the right thing. People who were on the other side of the trade and took the risk have to honor their obligations.
Thats what we've been telling you all along when you wanted to pin the blame on average greedy Joe.
Everybody is to blame, including the average Joe. All I'm saying is that the blame does not relay soley on Wall Street, like many in here are portraying it.
Yeah. They promoted the very plan that created this mess. It wasn't boiled down to greedy average joe it was greedy Wallstreet who wanted to get theirs.
Guilty parties: the Government, Wall Street, Average Joe.
Those financial instruments were the ones that allowed average Joe to get a loan in the first place.Exactly "those financial instruments" not greedy average Joe.
He, you and me. It is everybody's fault.Sure he's played a part.
My point has always been that the collapse has to do with everything surrounding the bad loan not the loan and person itself.
Your point then does not tell the whole story. And don't limit this to MBS. Cheap financing for almost any durable good is also to blame. And average Joe going for every cent of credit that was out there.
That instrument allowed banks to have more liquidity. And they used that additional liquidity to continue lending to average Joe, who was not complaining two years ago when he had all that cheap credit to buy cars, computers and washer-driers.That instrument created a mess far worse than what could have been created by a few risky loans.
That instrument did not creat the risky lend.If that instrument created the risky lend and the instrument was implemented by full government support then you have your answer.
If this doesn't lead you to believe that Americans living above its means wasn't the source of the problem then I don't know what else to tell you.
How could a bank make a risky loan if there was no counterpart ready to accept it? Of course that the root of this mess is greedy people avid for credit they were not able to repay.
Its all explained right here. How to do the loan and how to exploit it. This was about Wallstreet not middle or low class America.
So we are back to everybody's favorite partyliine: putting the blame on Wall Street.
No obviously not.
A security is an instrument of financial value; stocks and bonds are securities. a mortgage backed security is where a bunch of mortgage loans are grouped together to create a large pool of debt. This debt is then sold to investors the same way a bond is; you buy it at a discount and rely on the mortgage payments for the payout. It was supposed to be a relatively safe investment, partly thought so because of these odd rating rules for bond insurers.
The primary holders of these mortgage-backed securities (and there are also these other very complicated things called collateralized debt obligations , or CDO’s, which are made up of various types of mortgage related securities) were corporate and ins utional investors and investment banks like Bear Stearns, who bought them in droves during the height of the real estate boom, often touting them as “undiscovered gems”.
They were pawns in the plan. Without the plan there is no economic meltdown. Average Joe was just a cog in the machine. A lemming. Not the source of the problem the source is the mastermind of the plan not the parts that were used to pull it off. Had no plan been put in place none of this would have happened.
Here is nice read. You need to look at the machine not the cog.
PAUL SOLMAN, NewsHour Economics Correspondent: With so much in the news about the subprime mortgage crisis, foreclosures and even threats to the global financial system, people are asking one simple question, among many: How could so much money the world over have financed such seemingly lousy loans?
There are lots of reasons, of course. But the one we'll focus on, with the help of some low-rent toys from around the house, is a technique without which the globalization of the subprime housing boom would probably have been impossible. It's called securitization. We'll explain it in a bit, but first a reminder of how home lending used to work.
A buyer bought a house by putting down maybe 20 percent of the price, borrowing the rest of the money from a bank, which had taken in the money as deposits mainly from people in the local area. The bank took a cut by charging the borrower a little more in interest than it paid the depositors. This is the system whose virtues Jimmy Stewart so classically extolled to his Bedford Falls bank depositors in "It's a Wonderful Life."
JIMMY STEWART, Actor: Your money is in Joe's house. That's right next to yours, and in the Kennedy house and Mrs. Macklin's house and a hundred others. You're lending them the money to build, and then they're going to pay it back to you as best they can.
PAUL SOLMAN: With Stewart's bank in between.
ACTRESS: How much do you need?
PAUL SOLMAN: And that's pretty much how it was right up through the savings and loan crisis of the late '80s, the last time we used Jimmy Stewart on the NewsHour to explain the way banking used to be.
So what was new this time around? Well, with the end of communism, the globalization of China, India, and the like, continuing prosperity in the U.S. and Europe, there was way more wealth in the world to be invested. Why not lend some of it for mortgages in the United States, where housing is the collateral, continually rising in price, and the interest rates are pretty high? But you don't do that through Jimmy Stewart's bank.
Instead of banks like the Bailey Building and Loan, the main way to get money from lenders to borrowers has become securitization. To help us explain it, Wellesley economist Karl Case.
Securitization, what's that?
KARL CASE, Professor of Economics, Wellesley College: It used to be that when you signed a mortgage and borrowed money, the bank put the paper in its vault and held it. Now, almost all mortgages are sold in the secondary market. Wall Street firms package these mortgages up and then issue what are called mortgage-backed securities against them.
It finally gets to the A-minus and the A. So there are different kinds of bonds against the same pool, some people accepting a lot of risk, some people not.
The pooling of mortgages
PAUL SOLMAN: Securities are what so-called secondary markets typically trade, what investors get when making their investment, a stock, a bond, a futures contract, a share of a pool of mortgages, which is called a mortgage-backed security.
Some pools are guaranteed by quasi-government agencies like Fannie Mae, for example, but more and more the mortgages have gone straight to Wall Street. Say Professor Case works for a Wall Street firm.
So if I buy a mortgage-backed security from you, the collateral is the mortgage you're holding, and you're paying me an interest rate for my buying this security.
KARL CASE: That's exactly right. And I pay you a little less than I'm getting.
PAUL SOLMAN: So I just have, in effect, paper promising me an interest rate, backed by a whole pool of mortgages of varying quality. Some mortgages, that is, more likely to be paid back than others, such as these, generally held by folks with the worst credit. Many of these are the subprime mortgages you've heard so much about it.
But the mortgages are all pooled together. Then, mortgage-backed securities get issued against the whole pool, risky mortgages, safe ones, the lot. Now, the beauty is that I, the investor, can pick the interest rate I want. If I don't want to take much risk, a low interest rate. A little riskier, a little higher rate. And if I'm willing to take the riskiest bonds, the so-called B-minus, says Professor Case...
KARL CASE: You might get paid 18 percent for buying those, but you agree with the other pool-holders that you're going to take the first losses.
PAUL SOLMAN: That is, to simplify, when some of these mortgages go belly up and stop making payments, then there's less money coming out of the pool for the mortgage-backed securities, and those of us with the riskiest securities get crunched; our payments, stopped.
KARL CASE: When you're wiped out, it goes to the B people, BBB and so forth. And then when they're wiped, it finally gets to the A-minus and the A. So there are different kinds of bonds against the same pool, some people accepting a lot of risk, some people not.
In a rising housing market, there are no losses on these things. And so you get the impression from looking at the performance over the last 10 years that you're getting a pretty good return for a level of risk that's quite low.
Other countries assume risk
PAUL SOLMAN: So if I'm a conservative investor, I take a low rate of return, but I'm the last guy standing after all these foreclosures and defaults?
KARL CASE: That's exactly right. So there are layers of risk being passed all around, presumably to people who want to take that risk in exchange for a higher return.
PAUL SOLMAN: But what risk? It was a virtuous circle, ever rising prices, ever more home buyers, ever more investors, from U.S. hedge funds and European banks, says Case, to...
KARL CASE: ... the Chinese, and the Russians, and people from all over the world.
PAUL SOLMAN: But why would the Chinese, say, invest in something as risky as a subprime American mortgage?
KARL CASE: Well, we didn't perceive it to be so risky a few years ago. Right? In a rising housing market, there are no losses on these things. And so you get the impression from looking at the performance over the last 10 years that you're getting a pretty good return for a level of risk that's quite low.
PAUL SOLMAN: Indeed, hardly anyone appeared to think this stuff risky. Consider the hype on cable TV, where one could watch folks flip this house on A&E, flip that house on the Learning Channel, buy and sell on House and Garden TV. Even PBS got into the act with pledge specials around the country featuring financial gurus like Robert Kiyosaki, here on his own Web site pushing real estate investment where you don't even live in the home you're buying.
COMMERCIAL NARRATOR: Homeowners, want to refinance and get cash?
PAUL SOLMAN: Meanwhile, the explosion of mortgage-backed securities made home buying and refinancing more affordable for everyone, including unsophisticated first-time buyers, easy prey for brokers who'd often lend them more than the house was worth, with little or no down payment and low so-called teaser rates for two years that would then readjust dramatically upward, the monthly payments ballooning.
The brokers would slip in all sorts of fees, then sell the mortgages, more and more of them subprime, to Wall Street to securitize. Now, the teaser rates have expired, mortgage payments are ballooning, and homeowners across the country are being squeezed, their houses snatched away from them. Many of the brokers, meanwhile, have taken the money and, in some cases, run.
Is this securitization's fault, though? Doesn't it just transfer risk to those willing to take it?
KARL CASE: Well, there's nothing wrong with securitization. It's a good tool, and it's been used for a long time. What's different now is the subprime end of the mortgage market is being tested by a down housing market and the fact that we extended a lot more credit than we probably should have.
Banks are highly regulated. And there are strict standards on the kind of paper they can hold. But if a Wall Street firm goes out and buys mortgages, those are private transactions that aren't tightly regulated.
Lack of regulation
PAUL SOLMAN: Perhaps because there were no regulators in the picture. Now, back in Jimmy Stewart's day, the misplacement of a mere few thousand dollars triggered terror. Government regulators were watching the store.
ACTOR: George...
JIMMY STEWART: What?
ACTOR: That man is here again.
JIMMY STEWART: What man?
ACTOR: Bank examiner.
JIMMY STEWART: Oh, oh. Harry, talk to Eustace for a minute, will you? I'll be right back. Wow.
PAUL SOLMAN: But in the era of securitization, with investors holding loans instead of banks, much of the mortgage market has been, in effect, deregulated, not a bank examiner in sight, because so many mortgages were now held not by banks but by investors via Wall Street.
KARL CASE: Deregulation happened without anybody doing it, because a lot of this stuff moved into an unregulated sector.
PAUL SOLMAN: What do you mean?
KARL CASE: Well, banks are highly regulated. And there are strict standards on the kind of paper they can hold. But if a Wall Street firm goes out and buys mortgages, those are private transactions that aren't tightly regulated.
More risk for more payoff
PAUL SOLMAN: And when Wall Street securitized, repackaging the mortgages and selling them to investors the world over, that was unregulated, too. So what's new is the global, unregulated market for U.S. mortgages, made feasible by securitization.
What's old is the end of the virtuous circle, the inevitable unwinding, because markets are built on trust. It's often been said that the word credit comes from the "credere," "to believe." When belief collapses, investors panic and global markets can spin out of control.
ACTOR: Better to get half than nothing.
JIMMY STEWART: Randall, now, wait a minute, wait. Now listen, now listen to me. I beg of you not to do this thing.
PAUL SOLMAN: Bank runs were the fear in Frank Capra's 1946 world, which still remembered the Great Depression and FDR's declaration of a bank holiday.
Today, the fear is of runs on markets, as we've seen recently, which reminds some of perhaps the most durable rule of finance: For every extra bit of reward you get, you take that much more risk.
KARL CASE: It is true that the more risk you took, the harder you're going to get hit this time around. So it's the higher you fly, the further you fall.
PAUL SOLMAN: With investors here and abroad buying mortgage-backed securities and thus providing the financing for iffy U.S. mortgages, the flying was high. The fall? Well, the U.S. housing boom has certainly been turned on its head. Mortgages harder to come by, lenders suddenly less willing to take risk.
That's why there's talk of a credit crunch, much less money available to be borrowed, except at high interest rates, for anything. That could lead to slower economic growth, even a recession, which is why the Fed has been pushing money into the economy to prop up the housing market and to prevent a situation which could be pretty messy for us all.
Definition of Credit Default Swap - CDS are a financial instrument for swaping the risk of debt default. Credit default swaps may be used for emerging market bonds, mortgage backed securities, corporate bonds and local government bond
The buyer of a credit default swap pays a premium for effectively insuring against a debt default. He receives a lump sum payment if the debt instrument is defaulted.
The seller of a credit default swap receives monthly payments from the buyer. If the debt instrument defaults they have to pay the agreed amount to the buyer of the credit default swap.
Example of Credit Default Swap
Example, suppose that Lloyds TSB has lent money to riskymortgage.co.uk in the form of a £1,000 bond.
Another party (e.g. hedge fund) may buy a credit default swap in this bond. Over time, the hedge fund will pay say a £1,050 (5% premium) to Lloyds TSB. If the riskymortgage.co.uk payback the loan, Lloyds TSB make a profit. However, if riskymortgage.co.uk default on the loan, then Lloyds TSB have to pay the remaining amount of the bond to the hedge fund.
Why Would People Buy Credit Default Swaps?
1. Hedge against risk.
Suppose an investment fund owned mortgage bonds from riskymortgage.co.uk. It might be worried about losing all its investment. Therefore, to hedge against the risk of default, they could purchase a credit default swap from Lloyds TSB. If riskymortgage.co.uk defaulted, they will lose their investment, but receive a payoff from Lloyds to compensate. If they don’t default, they have paid a premium to Lloyds but have had security
2. Speculation e.g. risk is underpriced.
Suppose a hedge fund felt riskymortgage was very likely to default because of a rise in home repossessions. They would buy a credit default swap. If the debt was defaulted, then they would make profit from Lloyds TSB. Note you don’t have to actually own debt to take a credit default swap.
Clearly the more risky a bond is the higher premium will be required from a buyer of a credit default swap. It is argued that credit default swaps provide an important role in indicating the riskiness / credit worthiness of a firm.
3. Arbitrage
If a company’s financial position improves, the credit rating should also improve and therefore, the CDS spread should fall to reflect improved rating. This makes CDS more attractive to sell CDS protection. If the company position deteriorated, CDS protection would be more attractive to buy. Arbitrage could occur when dealers exploit any slowness of the market to respond to signals.
I'm now done explaining this whether you understand or not. The sources above clearly explain it. They also clearly explain how betting against the house pays off.
This is the problem. The man buying the house isn't the problem its the people that want to profit off his success or lack thereof in paying the house that are the real problem.
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