Sunday, March 01, 2009

Page Two...

The NYTimes re-explains the AIG mess in a way that finally mirrors what some of us have been saying about it since it happened. The reality here is that the shadow banking system levered up - and i'm glad they're using the word - gambled on credit default swaps at a significantly larger number than the actual home mortgage values.

Or - to put it more simply - we know the housing mortgage mess from the flash video i posted last week. Ok. Now - imagine people putting side bets on whether the mortgages will stay sound or not (like an odds bet at craps). Why did they do it? to balance out their hedge fund equations. So for example - lets say you're playing roulette - and there are 34 numbers on the wheel - and you're getting 34:1 payouts (a zero-sum game). The players start putting more than a dollar down on each number (even though they dont have that much money) - it's ok, because it's zero sum - they cant lose it. Then people start taking risks... putting money down on every number except 12 - and making huge profits (brokers who take risks make more money for their investors - this means those brokers keep their jobs and get big bonuses, while other conservative cover all my bets use the system for what it's for people are pushed out of jobs). Someone was selling insurance on 'what happens if 12 comes up' - but they werent funding that insurance - and AIG was betting BIG on that. If there were 34 dollars on the table - a dollar at each number except 12 - AIG was betting 10 just on the fact that 12 wouldnt come up. They were a multiplier - and when they crashed out - if they hadnt paid out to all the other players there'd have been a domino cascade failure in the banking sector (as there almost was when lehman walked away and started off a the beginnings of the fire).

When people like Phil Gramm - paid pocket spokesman for UBS - are out there telling you this was all the fault of a few poor people who got loans for homes they couldnt afford by banks that were under political pressure - i would hope people would put it into the same crank garbage theory box where they stuff ideas like 'aluminum foil hats prevent space aliens from reading your thoughts via their bose wave radio mind control devices'.

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