It’s the Derivatives, Stupid! Why Fannie, Freddie and AIG All Had to Be Bailed Out

Why the extraordinary bailout measures for Fannie, Freddie and AIG? The answer may have less to do with saving the insurance business, the housing market, or the Chinese investors clamoring for a bailout than with the greatest Ponzi scheme in history, one that is holding up the entire private global banking system. What had to be saved at all costs was not housing or the dollar but the financial derivatives industry; and the precipice from which it had to be saved was an “event of default” that could have collapsed a quadrillion dollar derivatives bubble, a collapse that could take the entire global banking system down with it.

38 Responses

  1. Yes, please link! Sorry I can’t write more on this blog; I’m at the American Monetary Institute conference right now and swamped generally. Hopefully next week! Exciting and dire times. I’ve got 3 articles almost ready to post but can’t quite get them finished. Thought I could while conferencing but it seems I can only really write that sort of thing alone in my room. Can’t hear the muse in a crowd. Best, Ellen

  2. Ellen, please keep up the excellent work. You are consistently providing an excellent service.

    And please feel free to link to or repost my recent OpEd News article, an easy-to-understand explanation of why credit default swaps are destructive, why the destruction is being intentionally undertaken, and a sane alternative solution.–THE-by-Chuck-Simpson-080924-49.html

    Chuck Simpson

  3. Hi Ellen,

    I saw this article today in the NY Times.

    One quote from the article:
    “..Bush will speak about the rescue package on Tuesday after touring Guernsey Office Products in Chantilly, Va., a Washington suburb…”

    I find it amusing that “Guernsey” is printed in an article about the financial mess. Isn’t this the name of the Island that has it’s own soveriegn currency that you praised in your book? I hope America wakes up and makes the right choice. This is about as close as the Bush Administration will probably get to the right solution. 😉

  4. one underlying question for ellen or anyone on this blog…

    why did people buy CDS’ when there is the likelihood that if they did actually have to default, the CDS sellers would not be able to cover the agreements? I would think that major investment banks would have some sense of that…

  5. To John Merryman’s post of 9/26: As former Geo. W. Bush’s director of Office of Management and Budget and current Govenor of Indiana Mitch Daniels (he along w/ Wolfowitz claimed that the Iraq war would cost no more than 50-60 bn $) would likely disagree…he has sold the Indiana Toll Road (Interstate 80) to an Australian/Spanish consortium. I’m waiting for the Daniels Dollar to start showing up in my change.
    To Ellen: Thank you!!!

  6. …”a collapse that could take the entire global banking system down with it” ? Really Ellen? You know when I was young here in Southern Africa, Chesterfield cigarette advertisements casually proclaimed the 20th Century an American one. But out here now we have some of the planet’s toughest anti-smoking legislation, we complain to the ISO about M$ products and we are intensely suspicious of our financial institutions and their instruments…..any surprise then that there have been no bank failures here? We perceive the average American though as distinctly naive and unworldly. Are we wrong?

  7. I an not the author of the quote below – if I remember correctly it came from a Reuters piece which I archived.

    As far as Hernando de Soto can establish, there is about $13 trillion of actual notes and coins in the world; about $170tn of traditional credit such as bonds and equity; and upwards of $600tn (but maybe as much as $1 quadrillion) of derivatives. He believes that the current difficulties are caused mainly by the derivatives market.

    So the derivatives market which has destroyed the banking sector is five or six times the size of its underlying credit market (which it purports to insure).

    How wise are we to allow instruments with even greater leverage “CDO squared” to be traded?

    Reuters article:


    CDO squared issuance has soared about 900 percent this year compared with last year’s first quarter, with seven deals worth $4.4 billion, JP Morgan said. Six more are in the pipeline.

    “We’re expecting to see a lot of CDO squared activity,” said Kedran Garrison, vice president at JP Morgan in New York.

    But the rise of CDO squareds, which were last popular a few years ago, could make a bad hangover from the subprime crisis worse if borrowers start defaulting in higher numbers.

    “You have the potential for a small change in the performance of the underlying (collateral) to completely blow you up,” said Mark Adelson, head of structured finance research at Nomura Securities International in New York.


    Cautious buyers like pension funds gobbled up traditional CDOs as interest rates fell because CDOs offered higher yields but still carried strong ratings from credit agencies.

    An average CDO might contain 100 bonds divided into different layers based on their exposure to default, with buyers of the lowest pieces getting the highest yield but paying higher-ranking investors if the CDO faced trouble.

    Many buyers have been skeptical of CDO squareds, however.

    “You have a mortgage inside a (mortgage) bond inside a CDO inside a CDO,” a trader at a Wall Street firm said. It’s “very complex. So in general investors don’t like them.

    “But the reason that there are so many coming to market right now is because the equity returns” are huge, he added.”


    Seems to me that this is where the regulators should be undertaking their enquiries!

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