From my class notes in Computers 1305... by notes I mean I was talking to my buddy Juan. Juan is a brilliant republican but didn't quite understand the Credit Default Swap system that imo required the bailout. I told him our corporate infrastructure was set up like dominoes in a line. If one fell they very well all could/would fail. Not necessarily for actual losses either more likely for accounting losses and write downs. See Businomics for a good understanding of it. After you read his then you can read mine. Or you can just read mine and if it doesn't make a whole lot of sense read his and come back. http://businomics.typepad.com/ http://businomics.typepad.com/businomics_blog/2008/11/credit-default-swaps-what-went-wrong-with-cds.html http://businomics.typepad.com/businomics_blog/2008/11/credit-default-swaps-a-simple-explanation-of-cds.html
OK so with the CDS’s… and why I think you needed to bail out money: The reason I said dominoes is this: CDS are third parties… but since almost every major financial and non financial institution engaged in CDS’s then it was a systemic risk. Basically a CDS was just a bet if someone could pay their debt. If they are in debt 40-1 because of leverage and investments not working out in the medium run then this gets to be disastrous… for example General Motors AC acted as a third party and got into the CDS market. Because CDS’s are priced by what the market is trading them for if the market suddenly stops trading them or trades them for a low amount than even though you might not have to pay the other parties debt because your bet failed you STILL have to put up collateral capital (Switch order) to satisfy the lower value (on your books) of the CDS. Since the CDS’s were systemic and everyone was a third party to everyone if someone fell than two things happen: Third party CDS holders now have to pay the debt of the bankrupt corporation, 2) the CDS values of everyone get lower and in particular the CDS values of the companies who just had to pay the debt of the bankrupt companies. See how this will be a negative destructive cycle? Because of consequences 1 and 2 that the market and accounting requires more companies will go bankrupt! It’s like dominoes.
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