Page 232 - TrumpsEconEra_Flat

Chapter 12: The Collapse!

policies have provisions for deductibles, policy limits,
and higher premiums for high risks. You cannot buy an
insurance policy on your house twenty times its value,
especially if it has burned down five times in the last
decade. You cannot purchase home insurance if you do
not own a home. If you have five convictions for drunk
driving, you may not be able to buy automobile
insurance, and if you can, it will be very costly—not so
with credit default swaps.

Unlike real insurance, credit default swaps have
no deductibles or policy limits and place no constraints
on buyers. If you have the money, there is no limit to
the quantity, even on the securities you do not own. A
naked credit default swap means you take out insurance
on bonds without owning them. You can bet that either
the security or the company issuing the security will
fail.

Wall Street was able to sell high-risk securities
because sellers convinced buyers that CDSs could
protect them from loss. Consider real insurance. In the
event of a disaster, the insurance policy limits the total
liability of the insurance company to the extent of the
damage. However, with credit default swaps, as long as
someone was willing to sell them, there was no limit to
the liabilities.

CREDIT DEFAULT SWAPS and CDOs

Credit default swaps and collateralized debt
obligations are sound business practices. The problem
was not the practice, but in the types of loans that banks
securitized in combination with the volume of sales. If

-231-