I had read the two Reuters articles sandwiched in between what I’ve written here about it -

Unfunded Liability – that means there is nothing but air and bullshit backing it up.

Credit Default Swap – I’ll cover a bond that will never go into default in trade for a premium of several million dollars a year just in case it does, but there are no assets to back it up.

Illiquid Debts – pieces of paper known as “instruments” in the financial industry that aren’t worth the paper they are printed on, representing a promise to pay out billions of dollars if a bond defaults or some other financial “instrument” defaults but have no physical assets underwriting it.

Off Balance Sheet – means that anything detracting from the bottom line is kept on a separate record unless asked for in total available liquid assets in which case these items are added in the total to make it look better.

Distressed Debt – assets built on air, promised in value by bullshit, collateralized by lies and very creative loose interpretations of reality that nobody wants to buy for any price but everyone is using as an asset class (for leverage) to get credit.

Leverage – opaque ways to hide the risk and get moneys available to you anyways as a business. In common usage, this means having $5.00 to buy $5,000,000,000 worth of stock, options, and/or properties, companies, bonds, physical assets.

Government Regulators – a group of friends that you hire to work in the government run office that covers your industry that agree with your way of doing things and are normally appointed by the people whose campaigns and campaign shindigs you funded.

Government Regulations – something in the way of making the profits you think you deserve and serving no other useful purpose.

Derivatives – market products that are “made up” by the imaginations and machinations of those working with them – completely unregulated, high-risk, and profitable with no requirements on the part of those who create them.

Tax-base / US Treasury / Federal Reserve – private bank to cover any potential losses that might occur if and when things don’t do as planned.

Liability – something that financial institutions incur when their favored political party isn’t in power. Sometimes, it also means a column on the off balance sheet accounts that doesn’t count against any other financial influx.

Poker – a low risk game similar to golf with less margin of error than financing.

This glossary (above) written by Cricket Diane C Phillips, 09-19-08, USA

http://www.reuters.com/article/reutersEdge/idUSMAR85972720080918?pageNumber=1&virtualBrandChannel=0

How AIG fell apart
Thu Sep 18, 2008 1:55pm EDT

By Adam Davidson

(The Big Money) When you hear that the collapse of AIG or Lehman Bros. or Bear Stearns might lead to a systemic collapse of the global financial system, the feared culprit is, largely, that once-obscure (OK, still obscure) instrument known as a credit default swap.

So, what is a CDS, and why is it so dangerous?

At first glance, a credit default swap seems like a perfectly sensible financial tool. It is, basically, insurance on bonds. Imagine a large bank buys some bonds issued by General Electric. The bank expects to receive a steady stream of payments from GE over the years. That’s how bonds work: The issuer pays the bondholder some money every six months. But the bank figures there’s a chance that GE might go bankrupt. It’s a small chance, but not zero, and if it happens, the bank doesn’t get any more of those payments.

The bank might decide to buy a CDS, a sort of insurance policy. If GE never goes bankrupt, the bank is out whatever premium it paid for the CDS. If GE goes bankrupt and stops paying its bondholders, the bank gets money from whoever sold the CDS.

Who sells these CDSs? Banks, hedge funds, and AIG.

It’s easy to see the attraction. Historically, bond issuers almost never go bankrupt. So, many banks and hedge funds figured they could make a fortune by selling CDSs, keeping the premium, and almost never having to pay out anything.

In fact, beginning in the late ’90s, CDSs became a great way to make a lot more money than was possible through traditional investment methods. Let’s say you think GE is rock solid, that it will never default on a bond, since it hasn’t in recent memory. You could buy a GE bond and make, say, a meager 6 percent interest. Or you could just sell GE credit default swaps. You get money from other banks, and all you have to give is the promise to pay if something bad happens. That’s zero money down and a profit limited only by how many you can sell.

Over the past few years, CDSs helped transform bond trading into a highly leveraged, high-velocity business. Banks and hedge funds found that it was much easier and quicker to just buy and sell CDS contracts rather than buy and sell actual bonds. As of the end of 2007, they had grown to roughly $60 trillion in global business.

So, what went wrong? Many CDSs were sold as insurance to cover those exotic financial instruments that created and spread the subprime housing crisis, details of which are covered here 1. As those mortgage-backed securities and collateralized debt obligations became nearly worthless, suddenly that seemingly low-risk event-an actual bond default-was happening daily. The banks and hedge funds selling CDSs were no longer taking in free cash; they were having to pay out big money.

Most banks, though, were not all that bad off, because they were simultaneously on both sides of the CDS trade. Most banks and hedge funds would buy CDS protection on the one hand and then sell CDS protection to someone else at the same time. When a bond defaulted, the banks might have to pay some money out, but they’d also be getting money back in. They netted out.

Everyone, that is, except for AIG. AIG was on one side of these trades only: They sold CDS. They never bought. Once bonds started defaulting, they had to pay out and nobody was paying them. AIG seems to have thought CDS were just an extension of the insurance business. But they’re not. When you insure homes or cars or lives, you can expect steady, actuarially predictable trends. If you sell enough and price things right, you know that you’ll always have more premiums coming in than payments going out. That’s because there is low correlation between insurance triggering events. My death doesn’t, generally, hasten your death. My house burning down doesn’t increase the likelihood of your house burning down.

Not so with bonds. Once some bonds start defaulting, other bonds are more likely to default. The risk increases exponentially.

Credit default swaps written by AIG cover more than $440 billion in bonds 2. We learned this week that AIG has nowhere near enough money to cover all of those. Their customers-those banks and hedge funds buying CDSs-started getting nervous. So did government regulators. They started to wonder if AIG has enough money to pay out all the CDS claims it will likely owe.

This week, Moody’s Investors Service, the credit-rating agency, announced that it was less confident in AIG’s ability to pay all its debts and would lower its credit rating. That has formal implications: It means AIG has to put up more collateral to guarantee its ability to pay.

Just when AIG is in trouble for being on the hook for all those CDS debts, along comes this credit-rating problem that will force it to pay even more money. AIG didn’t have more money. The company started selling things it owned-like its aircraft-leasing division 3. All of this has pushed AIG’s stock price down dramatically. That makes it even harder for AIG to convince companies to give it money to pitch in. So, it’s asking the government to help out.

AIG might be in trouble. But what do I care? Because the global economy could, possibly, come to a halt.

Banks all over the world bought CDS protection from AIG. If AIG is not able to make good on that promise of payment, then every one of those banks has lost that protection. Overnight, the banks have to buy replacement coverage at much higher rates, because the risks now are much worse than they were when AIG sold most of these CDS contracts.

In short, banks all over the world are instantly worth less money. The numbers seem to be quite huge-possibly in the hundreds of billions. To cover that instantaneous loss, banks will lend out less money. That means other banks can’t borrow to pay this new cost, and weaker banks might not have enough; they’ll collapse. That will further shrink the global pool of money.

This will likely spur a whole new round of CDS payouts-all those collapsed banks issue bonds that someone, somewhere sold CDS protection for. That new round of CDS payouts could cause another round of bank failures.

Generally, with enough time, financial markets can adjust to just about anything. This, though, would be an instantaneous transformation of the global financial system. Surely, the worst part will be the confusion. CDS are largely over-the-counter instruments. That means they’re not traded on an exchange. One bank just agrees with another bank to do a CDS deal. There’s no reliable central repository of information. There’s no way to know how exposed a bank is. Banks would have no way of knowing how badly other banks have been affected. Without any clarity, banks will likely simply stop lending to each other.

Since we’re only just now getting a handle on how widespread and intertwined they have become, it seems possible that AIG, alone, could bring the global economy to something of a standstill. It’s also possible that it wouldn’t.

© Thomson Reuters 2008 All rights reserved

http://www.reuters.com/article/newsOne/idUSN1837154020080918?pageNumber=3&virtualBrandChannel=0&sp=true

Buffett’s “time bomb” goes off on Wall Street
Thu Sep 18, 2008 1:42pm EDT

By James B. Kelleher – Analysis

CHICAGO (Reuters) – On Main Street, insurance protects people from the effects of catastrophes.

But on Wall Street, specialized insurance known as a credit default swaps are turning a bad situation into a catastrophe.

When historians write about the current crisis, much of the blame will go to the slump in the housing and mortgage markets, which triggered the losses, layoffs and liquidations sweeping the financial industry.

But credit default swaps — complex derivatives originally designed to protect banks from deadbeat borrowers — are adding to the turmoil.

“This was supposedly a way to hedge risk,” says Ellen Brown, the author of the book “Web of Debt.”

“I’m sure their predictive models were right as far as the risk of the things they were insuring against. But what they didn’t factor in was the risk that the sellers of this protection wouldn’t pay … That’s what we’re seeing now.”

Brown is hardly alone in her criticism of the derivatives. Five years ago, billionaire investor Warren Buffett called them a “time bomb” and “financial weapons of mass destruction” and directed the insurance arm of his Berkshire Hathaway Inc (BRKa.N: Quote, Profile, Research, Stock Buzz) to exit the business.

LINKED TO MORTGAGES

Recent events suggest Buffett was right. The collapse of Bear Stearns. The fire sale of Merrill Lynch & Co Inc (MER.N: Quote, Profile, Research, Stock Buzz). The meltdown at American International Group Inc (AIG.N: Quote, Profile, Research, Stock Buzz). In each case, credit default swaps played a role in the fall of these financial giants.

The latest victim is insurer AIG, which received an emergency $85 billion loan from the U.S. Federal Reserve late on Tuesday to stave off a bankruptcy.

Over the last three quarters, AIG suffered $18 billion of losses tied to guarantees it wrote on mortgage-linked derivatives.

Its struggles intensified in recent weeks as losses in its own investments led to cuts in its credit ratings. Those cuts triggered clauses in the policies AIG had written that forced it to put up billions of dollars in extra collateral — billions it did not have and could not raise.

EASY MONEY

When the credit default market began back in the mid-1990s, the transactions were simpler, more transparent affairs. Not all the sellers were insurance companies like AIG — most were not. But the protection buyer usually knew the protection seller.

As it grew — according to the industry’s trade group, the credit default market grew to $46 trillion by the first half of 2007 from $631 billion in 2000 — all that changed.

An over-the-counter market grew up and some of the most active players became asset managers, including hedge fund managers, who bought and sold the policies like any other investment.

And in those deals, they sold protection as often as they bought it — although they rarely set aside the reserves they would need if the obligation ever had to be paid.

In one notorious case, a small hedge fund agreed to insure UBS AG (UBSN.VX: Quote, Profile, Research, Stock Buzz), the Swiss banking giant, from losses related to defaults on $1.3 billion of subprime mortgages for an annual premium of about $2 million.

The trouble was, the hedge fund set up a subsidiary to stand behind the guarantee — and capitalized it with just $4.6 million. As long as the loans performed, the fund made a killing, raking in an annualized return of nearly 44 percent.

But in the summer of 2007, as home owners began to default, things got ugly. UBS demanded the hedge fund put up additional collateral. The fund balked. UBS sued.

The dispute is hardly unique. Both Wachovia Corp (WB.N: Quote, Profile, Research, Stock Buzz) and Citigroup Inc (C.N: Quote, Profile, Research, Stock Buzz) are involved in similar litigation with firms that promised to step up and act like insurers — but were not actually insurers.

“Insurance companies have armies of actuaries and deep pools of policyholders and the financial wherewithal to pay claims,” says Mike Barry, a spokesman at the Insurance Information Institute.

“SLOPPY”

Another problem: As hedge funds and others bought and sold these protection policies, they did not always get prior written consent from the people they were supposed to be insuring. Patrick Parkinson, the deputy director of the Fed’s research and statistic arm, calls the practice “sloppy.”

As a result, some protection buyers had trouble figuring out who was standing behind the insurance they bought. And it put investors into webs of relationships they did not understand.

“This is the derivative nightmare that everyone has been warning about,” says Peter Schiff, the president of Euro Pacific Capital at the author of “Crash Proof: How to Profit From the Coming Economic Collapse.”

“They booked all these derivatives assuming bad things would never happen. It was like writing fire insurance, assuming no one is ever going to have a fire, only now they’re turning around and watching as the whole town burns down.”

(Editing by Andre Grenon)

© Thomson Reuters 2008 All rights reserved

***

My thoughts -

Alright, these articles explain it very clearly. The financial members of Wall Street were allowed to sell pieces of paper built on air, bullshit and lies for premiums of $2,000,000,000+ a year. They were regulated by people engaged in the same folly who chose not to regulate it at all because they were participating in it.

And now, the US government is going to take all these worthless pieces of paper that have no value but complete liability and pay these companies to get them. There is currently something over $60 trillion dollars of these in the market and much of it is due for payout on defaulted bonds, mortgages, commercial loans and others. So, now we are going to pay them or are we going to buy these derivatives with our government moneys and what – hold these liabilities and do nothing?

Were we the ones that profited from this process? Did we cull profit from this “distressed debt”? Where are those that took premiums in the millions, billions and trillions of dollars for these instruments? They didn’t offer any value for the currency and security they counterfeited – expected never to return on its liability – failed to cover the risk involved – and took in unrestricted profits (free money) from them. Why were they allowed to sell something backed up by nothing that was based in lies and then repackage them, sell and trade them, profit from them again and again and again?

So, this means that while unsecured paper was being sold for millions and millions of dollars, the small business administration wouldn’t loan for a start up unless three banks had turned me down and I had enough collateral and good credit to essentially not need the loan at all. But at the same time, real value – real money – was being given for literally no back up, no assets underwriting it and no possibility of ever paying out what it was securing.

While government personnel required literally four crates of paperwork from me to prove that I was poor enough to need food and their very limited available help, and while I was required to provide this at a moment’s notice and can at any moment be put in jail for not getting every bit of it right – for about $600 a month and $70 in foodstamps a month, these financial institutions and investors were allowed to do whatever they damn well pleased however criminal it might be.

And, besides undermining the value of every retiree’s earned retirement funding, stealing their promised health care benefits through their companies, and closing plants, these same companies laid off people, refused to make wages commensurate with the real costs of living and the real value of talent and time, withheld raises, dropped benefits and made employees produce to cover four people’s manhours of work or more. These jackasses were doing unusual things and using unsound practices for profiting on these derivatives, credit default swaps, unfunded debt instruments. They also were paying millions in premiums to have these corrupt financial “insurance” products available knowing they were very likely worthless and are now going to rob the people of the United States to cover their liabilities and poor choices.

Apparently the only real value and opportunity in America is how well bullshit and unfunded, unsecured debt can be sold with no risks and nothing but profits to show for it. Then, by dumping the blame on the American people, in frustration and confusion they will continue to believe that the same opportunities exist for them in America. Although, it is also a lie because they have no way to understand what has happened that diminished and in some cases destroyed these opportunities for them and for anyone they know.

This isn’t going to be a class war. That is not going to describe what it is that will happen as a result of all this. For every dollar that the US government puts in to “solve” these problems by bailing out these greedy short-sighted, profiteering companies, investment houses, insurance businesses and others, that dollar meant a sacrifice of something a family did without, an hour worked, a vacation not taken, a house going into foreclosure, a car payment not made so that those taxes could be paid. It wasn’t free money then and it damn sure isn’t free money now.

I can’t even get a job that will keep a roof over my head and buy groceries for my table, but our government gives hundreds of billions of dollars to these companies that gambled, played games with investor’s moneys, made poor and in some cases criminal choices, created confidence schemes for profit at the expense of everyone else, extended themselves without any reasonable level of resources to back up their “plays” and generally, have run our country, our economy and our government slap into the ground along with their companies’ profitability. What kind of USA is it that has allowed this to happen, has encouraged it, has failed to regulate it, has essentially allowed a counterfeit currency to be developed and spread throughout our financial system?

Written by Cricket Diane C Phillips, 09-19-08

What sum gain that is worthwhile is being offered by these investment houses, banks and financial institutions besides being bigger and better at lies and stealing than the rest of us?