Monday, September 25, 2006

Everyone Will Know What a Credit Default Swap is Soon

Fleckenstein references an article in Grant's Interest Rate Observer that was published last week. The article gave a good explanation why sub-prime mortgage companies are still able to sell the mortgages they originated, despite concerns the default rate is about to move higher. This Fleck article provides some decent perspective but misses the main question, which is why are people still buying sub-prime mortgages? The over simplifed answer is that the buyer of the mortgage can also now buy insurance (protection in market speak) against a mortgage default, thereby lowering the mortgage buyers overall risk profile. The protection is in the form of a derivative called a credit default swap (CDS). Basically, mortgage buyers still expect defaults, but they are able to offset the risk of default by buying a CDS. (The CDS market did not exist more than 5 years ago, which is why sub-prime lenders still have a market to sell their high risk in to.)


By Bill Fleckenstein

[The eyes tend to glaze over at the mention of "collateralized debt obligations" (CDOs) and "credit default swaps" (CDSs).

It's understandable. These financial instruments -- the glue that has held together the speculation in housing finance and the housing ATM -- have proved somewhat incomprehensible, even to the professionals. That's why I referred to them as "financial dark matter" in my column two weeks ago. (Special thanks to my friend Jim Grant for having gotten me up to speed on this subject in his past two issues of Grant's Interest Rate Observer.]

Full article

4 Comments:

Anonymous Anonymous said...

What if
a family tree
brought life to
Aig Credit Card Philippines?

Tuesday, September 26, 2006 2:54:00 AM  
Anonymous Anonymous said...

What I find most remarkable is that real estate is deflating in the face of still historically low interest rates. A 6.5% mortgage rate may seem high, but I remember thinking I got a bargain at 8.75% in the mid-1980s.

On another note, an Ocean City NJ realtor reports: "the market is prime for good deals. Buy at the bottom of the market and sell when it cycles back up. We are now at the bottom. Now is the best time to buy your home on the barrier islands."

I guess I better hurry up 'cause it sounds like prices are going to start to rise again!

Tuesday, September 26, 2006 2:15:00 PM  
Anonymous Anonymous said...

2:15 You're either the sucker PT Barnum told us of or you're a realtor looking for one if you think Ocean City has bottomed out.

Tuesday, September 26, 2006 7:01:00 PM  
Anonymous Anonymous said...

Anon 7:01 Either my sarcasm was too subtle for you or you are just plain stooopid.

Thursday, September 28, 2006 9:57:00 AM  

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