Next Mega-Credit Problem Looming?

Experts: "Credit Default Swap" Woes Could Be Next Sub-Prime Mortgage-Like Blow To Economy

(CBS)  An economy already reeling from the sub-prime mortgage mess could be in for a big hit from another type of financial instrument, experts warn.

They say possible problems in the gargantuan "credit default swap" market could cause credit-tightening and interest rate-hiking ripple effects, making it harder for consumers and companies alike to obtain credit.

CBS News correspondent Kelly Wallace explains that credit default swaps constitute a shadow financial system, out of sight and unregulated, that greases the wheels of business.

The swaps are a form of insurance, Wallace observes, with "big players -- banks, pension and hedge funds -- engaging in a high-stakes crap-shoot, trying to protect themselves if companies fail."

"This is a big one," cautions Harvard Economics Professor Kenneth Rogoff. "If this one got into trouble, it would be a big problem."

Wallace points out that the market for the exotic financial instruments has leaped, by some measures, from $1 trillion to $45 trillion -- about twice the size of the entire United States stock market.

What could be scarier than a market about defaults when things go bad, Wallace asks, rhetorically? How far-reaching could the problem be if they all start going belly up?

"Remember," says Forbes magazine Associate Editor Matthew Mill, "that ... everything in the economy is tangled together."

And, Financial Times U.S. Managing Editor Chrystia Freeland told Early Show co-anchor Harry Smith Thursday, "An estimate from (one very bearish economist) this week was about $250 billion could be the hit from credit default swaps, which is similar to the hit from the sub-prime mortgage instruments."

Credit default swaps, Wallace says, could be the next financial domino to fall: If companies default on their obligations, buyers of credit default swaps would lose millions, banks would tighten credit, and interest rates on everything would go up.

Says Harvard's Rogoff, "We're going into a downturn now, so everybody holding this stuff is getting a little panicked, and we'll see how the market does."

There are already signs of trouble, Wallace notes: A recent government report warned of a significant increase in trading in swaps during the third quarter of last year, while the Federal Reserve Board this week downgraded its forecast for the economy, blaming the housing slump and credit crunch.

Freeland told Smith, "Part of what has been going on is financial institutions are discovering that they weren't that good at really understanding the value of lots of different things on their balance sheets.

"And if banks get worried that they're not quite sure what the value of their assets is -- the credit default swaps are interesting, because it's a form of insurance. That was supposed to protect people's assets.

"So, if you're not sure that insurance is going to work, suddenly how valuable is the stuff you have? So banks are getting worried about it."

[cfin5]

"Gentlemen, I have had men watching you for a long time and I am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You tell me that if I take the deposits from the bank and annul its charter, I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin! Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves." - President Andrew Jackson, when he forced the closing of the Second Bank of the U.S., by revoking its charter

[dredre2k]

Good. Maybe then my mail box will stop being flooded with New Credit Card offers every day! Credit will always be accessible because our economy is now driven by the creation of new debt! When companies borrow, they build things... when people borrow, they buy things! When the gov''t borrows, we go to war! Industries boom...

If everyone were to stop borrowing, our economy would stop... Madness! :-P

[brianbwb-2009]

"...deregulation of drug use, or murder. If we deregulate these things and let the drug users and murderers alone they will eventually "suffer the consequences", right?" Posted by timothyone

For murderers, you are right, it does sound stupid, but for drug users you are not, they could pay the consequences themselves, if not for the illegality of them that makes them so expensive that users disturb others to get the money. Deregulate pot and coke, for example, and the price will drop to the point that the users will only harm themselves, if any real harm is done.

[brianbwb-2009]

Posted by donyang2000

Reported, again.

[brianbwb-2009]

"In order to save the economy from eventually hitting bottom, Americans will need to do some serious belt tightening." Posted by omded

Americans have been tightening their belts ever since Mr. Carter was president, the problems that now exist are because there are no more notches in the belt, it is already so tight that the wearer is dying.

Sub primes exist because the middle class was decimated, there was no one left to give standard loans to. Swapping is just banks trying to gamble their burdens to other banks, the sharks'' feeding frenzy has gotten to where the sharks are beginning to eat each other.

Hard sacrifices? As long as the super rich continue to corrupt the economy, they are the only ones left with anything to sacrifice, and they would rather see America collapse, they can always jump ship, and live like royalty in other countries.

[timothyone-2009]

"Government regulation doesn''t make anything ethical or even safe. The key to keeping people honest is to make them pay the consequences for bad choices."

Government regulation''s other name is ''THE LAW'' and to claim that we shouldn''t try to control people with laws is idiotic. People only use the term "regulation" when they are trying to discredit it as weak or unnecessary. What you have said is like calling for the deregulation of drug use, or murder. If we deregulate these things and let the drug users and murderers alone they will eventually "suffer the consequences", right? See how stupid that sounds? Law is Law and should apply to all, especially the right-wing rich who control our economy.

[hypnotoad72]

I heard that some credit card companies have dropped peoples'' line of credit - for example; Person X has a balance of $4000. Their line is $10,000. For whatever reason, the line is dropped to $3000. As a result, they are now $1000 over the limit and are socked HUGE fees, amongst other things.

Now I''d only heard that off the rumor mill, so take it with a grain of salt.

And random_radar, you cannot legislate morality. Each person has to make a choice and stick with it. But I wonder if immorality is being legislated - or even championed?

[omded]

When the Federal Reserve lends money, is it required to actually have the money to lend? If not, then the money must be "printed" or, in other words, new money must be created and put into circulation. The problem is, when the Fed "prints" new money, it''s like adding more water into a punch bowl. The punch becomes more and more diluted every time someone throws more water in. The punch gets less tastey. Likewise, as the Fed prints new money, the dollar loses more value. The Fed may call it "lowering interest rates", but, what they''re really doing is encouraging more people to borrow money - money the Fed doesn''t have to loan. So, they lower interest rates, print more money, and loan it out. America is in an economic downslide, however, that downslide is caused by problems that run very deep - indeed into the very core of the American economy. In order to save the economy from eventually hitting bottom, Americans will need to do some serious belt tightening. Are we tough enough to make the hard sacrifices, or are we going to let our economy slide past a point of no return?

[random_radar]

"Another absolutely perfect example of what you get with no regulation! Thanks to all who support deregulating everything. The financial business is run by total greed. I''''m not against investing at all but it should be ethical.

Posted by bm6005 at 02:13 PM : Feb 21, 2008"

Government regulation doesn''t make anything ethical or even safe. The key to keeping people honest is to make them pay the consequences for bad choices. That means liquidation, bankruptcy, and financial ruin instead of government funded bailouts. The reason such risky deals are made is because people are counting on government bailouts if they go bad.

In the absence of taxpayers footing the bill, people would be very careful about how they invest their money. Government regulation lulls people into believing that everything is okay so that sharp operators can take advantage of them. The reason we are having these disasters is BECAUSE and DESPITE government regulation that already exists.

Take away all government regulation and stupid people will still lose their money, and there is nothing wrong with that. But intelligent people will be more careful because they are investing at their own risk. You can''t legislate ethics or morality, can you? Our nation is declining even though the government enacts more laws and regulations every year. It isn''t ever going to save us.

[payasyougo]

The only fact that is apparent in this article is that reporters will continue to talk a lot about stuff theyknow very little about.

There were six sentances with "if" in them.

If reporters knew what they were talking about they wouldn''t look so stupid. That''s why they are reporters and not financial experts.

Was Dan Rather on the support staff for this article?

[walt1944-2009]

THE GREAT BUSH DEPRESSION IS APPROACHING RAPIDLY!!!
THE GREAT BUSH RECESSION IS ALREADY HERE!!!

It has been rumored that the real reasons why the Great Emperor Bush II is doing so much traveling during the last year (maybe!) of his reign, is to find out what country will give him asylum in the even that the economy of the USSA falls apart, and the Great Emperor Bush II has to "get out of town" quickly before the angry mobs of citizens and businesses storm the Oval Office to put a noose around his neck!

In this respect, the Great Emperor Bush II has taken a lesson (which is surprising in that he did learn something after all) from his father The Great Emperor Bush I who took to traveling the last year of his reign as well.

Unfortunately for the Great Emperor Bush I, he made the mistake of barfing on most foreign dignitaries he met, which does not give a favorable impression if you are looking for a country to run to when the HEAT is on!

The Great Emperor Bush II is not making that mistake in that he has brought gallons of bottled water from his own private stock, and is refusing to eat the native food, eating cheese sandwiches prepared on Air Force One instead!

SIG HEIL, BUSH!!!!
sig heil, McCain????

[bm6005]

Another absolutely perfect example of what you get with no regulation! Thanks to all who support deregulating everything. The financial business is run by total greed. I''m not against investing at all but it should be ethical.

[greeneyes222]

"a shadow financial system, out of sight and unregulated, that greases the wheels of business."

How is something like that even legal? It sounds like a swindle.