Dallas Fort Worth Area Homes and Real Estate

One thing that's very hard for most people to comprehend about the current financial crisis is how exactly did a small portion of loans (Sub-Prime and Alt A) result in the impending collapse of our financial system when the vast majority of people are still paying their mortgage on time?  It just doesn't make sense that a small fraction of these loans are causing such a problem.  That's primarily because Wall Street greatly magnified the risk of the mortgage backed securities by creating all kinds of financial instruments that only the most sophisticated mathematician can even begin to comprehend.   Not only did Wall Street misjudge and misrepresent the true risk of these investments, they created a vehicle called a "Credit Default Swap" that was supposed to protect investors in case these mortgage backed instruments failed to produce the returns that investment bankers promised to their clients.  The Credit Default Swap market is estimated to be somewhere between 50 and 60 TRILLION dollars (yes, that's Trillion with a T) and the market is completely unregulated.  

So that begs an interesting question...Will this 700 billion dollar bailout even put a dent in the problem?  It's hard to say because nobody really knows how bad the problem will progress until all of the CDS contracts are unraveled.  Many experts believe there are still significant losses hiding on the books of many financial institutions that have yet to be discovered.  That could be a big reason for the nearly 800 point intra-day dip in the Dow Jones today, despite the fact that the bailout has been passed.   

So what exactly is a Credit Default Swap?  It is essentially a contract between two parties where one of them guarantees the payment of a debt on a particular debt instrument to the other party in case it defaults.  If that sounds like insurance, it's no coincidence.  But Wall Street cleverly used the term "swap" instead of insurance, which eliminated almost all regulatory requriements.  If an insurance company were to market this product as "Insurance", then regulations would have required they prove adequate financial reserves to cover the claims, much the same way State Farm or Allstate has to show they have sufficient capital to cover potential claims on the policies they insure.  But no such requirement exists on Credit Default Swaps, and that's one of the things that must be addressed with new legislation if we're to prevent a crisis like this from happening again in the future.  

"60 Minutes" aired a very informative special report on this "Shadow Market" of Credit Default Swaps last night.  CLICK HERE to watch this report online.

They say the "market" for these securities is 50 to 60 Trillion dollars.  Nobody knows because, well, it's UNREGULATED.  Almost completely.  If an impending recession were to cause corporate and municipal bonds to start failing in much higher numbers, would Wall Street drop another bombshell of illiquid Shadow securities?  And what other types of debt could be traunched and sold along with these insurance policies (or SWAPS as they so cleverly refer to it)? Perhaps some high risk consumer debt?  The ATM machine of home equity has run out of cash for many consumers looking to refinance high interest credit card and other consumer debt into their mortgage.  It makes sense that the defaults on consumer debt like credit cards and finance accounts will increase steadily if a major recession arises from the credit crisis.   A 60 Trillion dollar market?  That's huge.  What other kind of debt and dicey financial instruments are lurking in there?  Wall Street obviously highly misjudged the risks of their investments.  What other risky investments did they bet on that haven't played out to be losers just yet?

I know one thing.  We don't have 60 Trillion dollars to bail them out if that whole system turns out to be a big house of cards...