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Credit-default swap is the culprit

Posted: June 4, 2009 9:40 p.m.
Updated: June 5, 2009 4:55 a.m.
 
Regarding Betty Arenson's Opinion column "Don't blame Republicans for the housing meltdown" (The Signal, May 20): I suppose it's normal to blame the other party, but let's not get carried away.

Sure, the Clinton administration worked to increase home ownership, but the real cause of the housing and credit crises was the ability of Fannie Mae and the other lenders to sell those marginal mortgages as investments.

They were able to do that because Senator Phil Gramm snuck a piece of legislation into a must-pass budget bill in 2000 that spawned an unregulated, shadowy investment vehicle called the credit-default swap.

It was the credit-default swap that enabled Fannie Mae and the other lenders to do what they otherwise wouldn't have been able to do: pass off the risk.

Risky mortgages were stripped of their documentation, bundled up and sliced and diced into unrecognizable investments called "collateralized debt obligations," then had their risk evaluated by a voodoo-math formula dreamed up by a Chinese economist, stamped AAA by the compliant rating companies and sold on to investors.

Those investors then used credit-default swaps to essentially place bets on whether the investment would default.

Making matters much worse, you could buy or sell a swap on an investment you didn't even own an interest in. Pure gambling.

Put simply, none of the credit-easing measures had any effect on the economy as a whole until there was a way for mortgage lenders to pass off the risk.

Another point that the author fails to grasp is that the housing meltdown is NOT simply a "sub-prime mortgage issue."

Consider that the entire sub-prime mortgage market at its peak was approximately $1.2 trillion. That used to sound like a lot, but since last September, more than $7 trillion has been dumped into this crisis.

That's more than five times what it would have taken to just buy up every sub-prime mortgage.

On the other hand, the unregulated credit-default swap market was estimated to be about $60 trillion at its peak in 2007 - which was about six times as large as the entire U.S. economy.

Most of this bailout money is going to clean up the swaps, not sub-prime mortgages.

Final thought: it takes some chutzpah to blame what the Bush administration and the Republican-controlled Congress didn't do when the Democrats who were out of power.

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