Archive for March 3rd, 2008
3rd March 2008
Another Bubble Bursts
If free-market fundamentalists’ belief in the invulnerability of capitalism hasn’t already taken a bit of a battering of late then it seems another even darker cloud is on the near horizon. Type in ‘credit default swaps’ to Google news and you’ll soon see what I mean. Swaps were invented in 1995 by someone at J.P. Morgan and somehow survived the famous collapse of Long-Term Capital Management and the dot-com crash. They are basically a form of insurance where someone who holds a bond from company or institution X agrees to pay an annual income to Company Y that agrees in trun to pay the full value of the bond in the event of X defaulting.
CDS have been phenomenally successful; the notional amount of over-the-counter credit default swaps rose from $13.9 trillion in December 2005 to $42.6 trillion by June of last year. But the party is now well and truly over. The big American ‘monoline’ insurers who traded heavily in swaps against bundles of mortgage-backed securities called CDOs (collateralised debt obligations) have announced massive ‘write-downs’ of their assets as the implications of the sub-prime crisis have filtered down into the derivatives market. But it doesn’t end there, banks that have relied on the triple AAA status of these insurance policies like Merill Lynch have begun to radically write-off some of their own assets too. As with the sub-prime crisis nobody knows how far this reaches and where it will end, but rising defaults could bankrupt insurers and the insured alike in a financial meltdown akin to the Japanese banking crisis of the 1990s from which they are only just recovering.
Credit default swaps are virtually unregulated; and yet they could cause financial misery for millions. This Government’s policy of low or even no taxation for the City and the once lionised light-touch regulatory system helped London see off New York as the world’s pre-eminent financial centre. But sitting atop a house of cards is not always the best position to be in.