There are a myriad of reasons out national economy has hit the skids (and is taking down the global economy with it). While Fannie Mae and Freddie Mac are on the receiving end of partisan finger-pointing, they aren’t the entire story. Not even close. They were a symptom, not the cause.
In my quest for knowledge regarding this financial bailout, a main theme keeps emerging: lack of regulation. I’m sure you’ve heard the term.
Well, this weekend, 60 Minutes’ “The Bet that Blew Up Wall Street” gave a very comprehensive explanation of yet another piece of the meltdown puzzle: the legalization of the derivative markets, which basically “allows you to wager on financial outcomes without ever having to actually buy the stocks and bonds and mortgages.” Side bets.
The rocket fuel was the trillions of dollars in side bets on those mortgage securities, called ‘credit default swaps.’ They were essentially private insurance contracts that paid off if the investment went bad, but you didn’t have to actually own the investment to collect on the insurance.
Dinallo (Eric Dinallo, insurance superintendent for New York) says credit default swaps were totally unregulated and that the big banks and investment houses that sold them didn’t have to set aside any money to cover their potential losses and pay off their bets.
‘As the market began to seize up and as the market for the underlying obligations began to perform poorly, everybody wanted to get paid, had a right to get paid on those credit default swaps. And there was no ‘there’ there. There was no money behind the commitments. And people came up short. And so that’s to a large extent what happened to Bear Sterns, Lehman Brothers, and the holding company of AIG,’ he explains.
The derivative market, basically gambling, was illegal for most of the 20th Century. A few lobbyists and campaign contributions later and the lame duck Congress in 2000 – when Bill Clinton was president – signed the bill that reopened the markets for these side bets. Without regulation, there was no body to even track how many of these bets were made or for how much.
I wonder if this next Congress will allow the law to stand, thus continuing to weaken our fragile Wall Street.
In any case, it’s worth having the knowledge and understanding of the role these derivative markets played in the meltdown, so I’m including Steve Kroft’s piece because it truly was an eyeopener. Very much worth the watch: