This article illustrates very clearly something that has been missing from a lot of commentary here: These products which serve no valid puropse, according to critics, have a lot of customers. Probably not all of whom are foolish. Maybe someone could ask these firms why they are so willing to be ripped off by overly complex instruments that provide poor value?

I call it the Duck Law* – if it looks like a security and behaves substantially like a security, then it is de jure a security.

/b
*http://vituscapital.blogspot.com/2008/10/venal-bastards-on-wall-street.html

Much is made of how the financial industry has soared in size relative to the rest of the economy, but this fact is not often equated to the massive increase in derivatives transaction fees and most especially CDS fees. When these two facts are looked at in concunction, it becomes clear that what we’ve done is allow casino economics to overwhelm our banking system. While this may be nice for the croupieres with their multimillion dollar annual bonuses, it’s effects on the rest of us have now become excrutiatingly obvious.

Whatever limited benefits the supporters of these transactions might claim they have, the externalities created by them have become a huge unfair tax on the rest of us; a tax yielding insufficient (if any) benefit, and a tax unapproved in advance by our legislatures. (Taxation without representation, if you will.) As such, they must be banned from our financial system and from any participating institutions in it. If people still want to enter into these contracts, fine, but they must do so with the crystal clear understanding that there will be no government oversight and NO GOVERNMENT AID in the event of couterparty default.

[For more on this, see Chris Whalen's prepared statement to the Senate Banking Committee, June 22, 2009: http://www.ritholtz.com/blog/2009/06/over-the-counter-derivatives-modernizing-oversight-to-increase-transparency-and-reduce-risks/ ]

So I agree with you that it is a “gambling casino”, but it is also a holding pen for money.

The thugs make their bets with the bookie AIG, then paulson says, don’t worry, the US Taxpayers will pay the bill because winning that massive value is the only way the world wont end as we know it–how bout good old fashion bankruptcy, unemployment, suffering—instead, the whole US is at risk for this massive devaluation of our currency.

these two simple changes, that could be done immediately would increase our/my financial security right away.
Michael

Twotenths’ last comment in his first post is key. The seller of insurance must add value to the transaction by some ability to mitigate the buyer’s risk better than the buyer (Twotenth’s client). He has not explained in any satisfactory way, nor has any other participant in this market, how the party who assumes the risks in my contract can mitigate them better or more cheaply than I. I take the collapse of this market to be overwhelming evidence that no such explanation exists because this abiity is illusory. This game is essentially a game of Old Maid with several Old Maid cards. When it stopped, Bear, Lehman and AIG (among others) were left holding the Old Maid.

chas asks good questions – how is this game productive for anyone but the dealers?

Especially since Paulson funneled taxpayer money through AIG to pay them off.

This is from Chris Whalen posted at Market Ticker:

In my view, CDS contracts and complex structured assets are deceptive by design and beg the question as to whether a certain level of complexity is so speculative and reckless as to violate US securities and anti-fraud laws. That is, if an OTC derivative contract lacks a clear cash basis and cannot be valued by both parties to the transaction with the same degree of facility and transparency as cash market instruments, then the OTC contact should be treated as fraudulent and banned as a matter of law and regulation. Most CDS contracts and complex structured financial instruments fall into this category of deliberately fraudulent instruments for which no cash basis exists.

The clear version of the above, in English.

To put this in “Joe Six Pack” speak this “market” is exactly like playing Blackjack against a dealer who has a supply of aces and kings under the table, and uses them to deal blackjacks to himself any time he would like.

Would you knowingly sit at such a table?

It is my view and that of many other observers that the CDS market is a type of tax or lottery that actually creates net risk and is thus a drain on the resources of the economic system. Simply stated, CDS and CDO markets currently are parasitic. These market subtract value from the global markets and society by increasing risk and then shifting that bigger risk to the least savvy market participants.

And let’s not forget who gets all the money. JP Morgan, Goldman, et.al.

Seen in this context, AIG was the most visible “sucker” identified by Wall Street, an easy mark that was systematically targeted and drained of capital by JPM, GS and other CDS dealers, in a striking example of predatory behavior. Treasury Secretary Geithner, acting in his previous role of President of the FRBNY, concealed the rape of AIG by the major OTC dealers with a bailout totaling into the hundreds of billions in public funds.