No, that's about bonds. Real liquidity evaporates there.
The effect of tumbling derivatives is complex, these
are risk transfer instruments that (in "theory") don't add any
value to the system. I guess,
in bonds some of these products effectively reduced rates
below where they should be by transferring risk to companies
with higher credit rating. This resulted in too low
rates for those less credit worthy borrowers. Now the opposite
is true, and those former AAA companies are losing their
rating because they guaranteed the debt of these risky borrowers.
On the other hand, the risky borrowers (who are not bankrupt yet)
can no longer get
a loan because nobody wants to write protection, and their
rates spiked much higher than where they would have been
without derivatives. So, now inverse dynamics is in place.
The REAL bond market suffers a lot
more as a result of derivatives, and REAL liquidity evaporates
there.
CDS is just an insurance contract written by a credit
worthy financial company against the default of
the borrower. When a contract is attached to the bond,
it's rating drastically improves.
That way those subprime bonds were rated
higher than they should have been, so folks who should
not have gotten a loan got it. Now that defaults happen,
these former AAA companies have to make good on their
insurance, and they don't have the cash. So, they lose
their rating. Bonds go from AAA to F, and a lot of
real liquidity evaporates. Borrowing costs for
everyone spike unreasonably high.
That's CDS. How do swaps blow up? We'll see.
Here is just a guess. Since Forex swaps produced an
artificial bid for the dollar for a very long time,
the dollar might just crash a lot lower than
where it would have crashed otherwise |
