The Unregulated Chain of Events

Well its been a hectic week lately with a plethora of chores which I had been procrastinating for some time.I finally completed How I met your mother season 4,watched two amazing crime thrillers 'Dial M for murder' and 'Following' on the same day and ended the week with a highly unusual emotional drama,'Boy A'.I found 'Following' so impressive and absorbing that I watched it again after a day.In this scheme of things I read 'To Kill A Mocking Bird' which addressed issues of racism and snobbishness observed through infantile protagonists.The most noteworthy deed I did this week was to continue perusing those articles on financial crisis and tried to understand a couple of terms like commercial paper market and Credit Default Swap.

Commercial paper is basically the means for big companies to borrow money.Treasurers issue commercial paper and people who want to loan them money do it through banks on Wall Street.Here the role of money marker managers come to the fore.These managers lend money on commercial paper market with the prospect of a little return, like a company guaranteeing a million in return for 900,000$.

With Lehman Brothers going bankrupt due to those risky mortgages,all the money being lent to them from Reserve Fund came into some serious trouble. Also the fund managers who had bought commercial paper from them incurred losses.To add fuel to the fire AIG nearly collapsed,courtesy the Credit Default Swap,considered to be the financial weapon of mass destruction.

Credit Default Swap(CDS),invented by a physicist,Gregg Berman,is nothing but buying of protection,like the insurance of someone else's house.It is different from normal insurance in terms of the collateral being set aside as means of protection.What is most shocking about CDS is

that its unregulated.It resulted in a horrendous vicious chain where every deal is kept private and no one has any clue about the financial stabiliities of others,exacerbating the situation.

AIG,the biggest insurance company in the world had promised 400 million dollars of credit default swap agreements.Bankers who had got skeptical of their insurance with AIG started increasing their collateral.AIG,then was hit by an onslaught of collateral packages.It was eventually rescued by the government through its bailout package using the tax payer's money.So ultimately it is the tax payer who has to bear the brunt of this crisis.

What made the system even more dangerous and made the AIG case kind of anomalous was the concept of netting.There wasn't much in those articles I read to explain it in detail but I got the basic tenor of it through an example.If a company's future looks bleak and someone had already bought its protection through CDS then he would be able to sell that protection at double its original value merely from the fact that in dire conditions the insurance becomes more expensive.This indeed sounds lucrative.