1/12/09

The Unreal Economy

How detached from reality did we become as the world of derivatives grew ever larger and profitable for those who peddle them? Here’s a story one Fortune 500 CEO told me when I shared my fears that credit default swaps could be the next big shoe to drop:
I have no unique perspective on CDSes, but I have to admit that when I first learned of them, some years ago, and got an explanation of how one worked on our own company, it went like this: “Say you own company X’s bond but don’t want to take company X’s credit risk. Then you sell a CDS, pocket the difference, and you’ve eliminated your risk of default by X. You basically then own a government bond.” My reply was: “I used to work on Wall Street. In those days, if you owned an XYZ bond and didn’t like the credit risk, you would sell the XYZ bond and buy a government bond. Then you didn’t 'basically' own a government bond. You actually owned a government bond.” The banker I was talking with had no reply to that.

1 Comments:

Blogger mfidelman said...

There's something really missing in a lot of the current discussion - or at least its presentation.

Right now, there seems to be a serious focus on spending too little vs. spending too much vs. deficits (good or bad).

But.. most of the stimulus package will be going into infrastructure - investments that, under any accounting system except the Federal one, would would show up as assets that offset increased dept on a balance sheet.

We're also talking about assets that will generate income, though perhaps not in forms directly available to cover debt service.

For energy investments, at least, we have models of how to achieve tremendous stimulus, that pays for itself. The Hoover dam comes to mind: most of the funding came from bonds, which were paid back, and the Government owns an asset that generates power and revenue to this day.

The Romer report shows payback in the form of jobs, but perhaps the concepts of "investment" and "return on investment" need to be given as much visibility as deficits.

January 12, 2009 at 5:04 AM  

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