...is what is bringing down the system. These are Ponzi type pyramid financial schemes which have reached critical mass and have exploded like a dirty fission bomb.
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Criticisms
Warren Buffett famously described derivatives bought speculatively as "financial weapons of mass destruction." In Berkshire Hathaway's annual report to shareholders in 2002, he said, "Unless derivatives contracts are collateralized or guaranteed, their ultimate value also depends on the creditworthiness of the counterparties to them. In the meantime, though, before a contract is settled, the counterparties record profits and losses--often huge in amount--in their current earnings statements without so much as a penny changing hands. The range of derivatives contracts is limited only by the imagination of man (or sometimes, so it seems, madmen)." The same report, however, also states that he uses derivatives to hedge, and that some of Berkshire Hathaway's subsidiaries have sold and currently sell derivatives with notional amounts in the tens of billions of dollars.<19> Berkshire Hathaway, with a market capitalization of $196 billion<20>, certainly does have enough equity to collateralize or guarantee these contracts.
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One large difference between credit default swaps and insurance, is you do not need to own the bond or instrument being insured in order to obtain insurance on it. If the bond fails, then, theoretically, you get paid, possibly along with many others. Yet the "insurer" of the bond is not regulated and the transaction is beyond federal or state regulation. This allow speculators to make money by purchasing insurance on a company's bonds and then shorting the stock of the company in great quantity and getting a payoff that exceeds their risk of shorting if the price of the company's stock increases. The fact that you need not be a party to owning the bond also explains why the total value of credit default swaps is so high, indeed higher than the total value of the bonds issued.
<MORE>
http://en.wikipedia.org/wiki/Credit_default_swapThe whole system is a racket and needs to be placed into immediate bankruptcy with all assets frozen, gambling debts dropped and balance sheets made realistic with a reorganization to pay-off legitimate debts dropping all others. Intentional fraud should be criminally prosecuted as well.
NOTE: A Ponzi scheme is a fraudulent investment operation that involves promising or paying abnormally high returns ("profits") to investors out of the money paid in by subsequent investors, rather than from net revenues generated by any real business. It is named after Charles Ponzi.<1>
<link>
http://en.wikipedia.org/wiki/Ponzi_scheme
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