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Help me understand, please $$$

Rose Pink

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Note to TUG administrators: if this topic becomes political, I understand your decision to lock it.

I am hoping someone can explain--without getting political--how the proposed rescue plan is going to help Wall Street and the US economy. Who will get the money? What will they do with it? How will it help me? I really don't understand all the ins and outs of how Wall Street works--except it seems to me that they do alot of buying and selling of thin air.

Thanks.
 

AwayWeGo

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[triennial - points]
Might As Well Just Lock Up The Discussion Topic Sooner Rather Than Later.

Note to TUG administrators: if this topic becomes political, I understand your decision to lock it.

I am hoping someone can explain--without getting political--how the proposed rescue plan is going to help Wall Street and the US economy. Who will get the money? What will they do with it? How will it help me? I really don't understand all the ins and outs of how Wall Street works--except it seems to me that they do alot of buying and selling of thin air.

Thanks.
Unfortunately, Rose, & very sorry to say, there's no way of getting into the topic in any depth whatever -- not even for explanatory purposes -- without getting all political.

Some wise person advised generations ago that 2 ugly processes we don't ever want to see are sausages being stuffed & laws being created.

I'll be surprised bigtime if the Grand Pro doesn't have to shut this 1 off PDQ.

We'll see, eh ?

-- Alan Cole, McLean (Fairfax County), Virginia, USA.​

 

gmarine

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So as to not get into a political debate the easiest thing to do might be to google "bailout plan" or something similar and read the results.
 

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It's hard to answer with specifics, but right now we're in a severe liquidity crisis, and loans are hard to come by both for businesses and consumers.

Banks and other institutions are holding large amounts of securities that are either illiquid (not easily traded) and/or worth far less than what they paid for them. Also, banks are required to have a reserve for bad loans, and with all the people defaulting on their mortgages and the drop in value of many assets held by the institutions, the reserves have to be increased to higher levels because of all the bad paper that the banks currently hold. (And add to that any defaulted Lehman Brothers debt that they held.)

When you get this situation, banks and other lenders tighten up the amount of money they are willing to lend, and people and companies that might have been reasonable risks and qualified for loans in the past may not qualify right now or find a lender willing to lend money to them. Institutions that are either actually in bad shape, or perceived to be in bad shape (as with AIG) have a difficult time raising cash, and if they can raise cash, it costs them much more money.

So, now the banks have this large liability on their asset sheets that they have to write off, and when they write it off, they have to recapitalize in order to have more money to make loans again.

What the treasury wants to do is similar to what the RTC did during the Reagan years. They purchased the bad assets of the bank (at a discount), took possession of properties that were in default and sold them at auction. We don't know what the details of the plan are yet, but it involves purchasing the bad debt (at a discount) which will allow the banks and lending instutions to recapitilize.

Until the bad debt is written off, we will continue to be in a liquidity crisis, and very little money will be available for business expansion and consumers.

We still don't know the exact details of the administrations plan, though some details have leaked out.

When you add to this the failure and government takeover of Fannie Mae and Freddie Mac, institutions that used to purchase mortgages and repackage and sell them in the marketplace, there's even less money available for consumer mortgages.

Some people believe that we should allow market forces sort it out, and let companies and banks continue to fail, and stronger institutions will eventually emerge. Other people believe that the government can help by buying up the bad debt and lessen the time that it takes to get back into growth and recovery mode.

-David
 
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Icarus

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ok, so how will it affect you?

First, the bailout is incredibly expensive. The government proposes to increase our debt limit in order to finance the purchase and disposition of the bad debt. Some of that money will be recovered as they foreclose on defaulted loans and eventually resell the assets, and some money will be recovered in other ways, but the bottom line is they expect it to cost us a large sum of money, and the government will have to sell bonds in order to raise that money. Thus our interest payments go up, and the national debt goes up, and eventually that has to be repaid. Higher taxes are one way to finance that debt. Reduced federal spending below current levels (because we already spend much more than we take in at the Federal level) could also finance the debt. Or it could be a combination of both increased taxes and reduced spending.

The current crisis is already affecting you with higher unemployment now and in the future. Also if you want to refinance your mortgage or any part of your debt, you will have a much harder time doing that now. If you are a home seller in this market, you are pretty much screwed right now. Even if you find a buyer, they may not qualify or be able to find a loan.

Those are the immediate effects, but those immediate effects ripple through the economy and the risk is that the economy could spiral downwards out of control if things get bad enough. How much it could get out of control is debated daily by the pundits, and they say it ranges from a few more years of falling real estate values and recession to a global depression.

As the economy shrinks, state and local governments take in less money and are forced to either cut spending or increase taxes as well.

-David
 
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Passepartout

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Icarus: Good Job explaining in a non-political way the deep do-do we are in.
:clap: :clap: :clap:

Jim Ricks
 

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How did we get here?

Around 6 - 8 years ago, financial institutions decided to loosen their credit standards for mortgages. People were offered interest-only loans at a great rate for the first 5 years or so, and the banks that forgot how cyclical any investment can be, including real estate, thought they had a slim chance of losing money on real estate even if they had to foreclose on these mortgages. In short, both the buyers and the banks bought into the idea that real estate always grows in value. Things were great for a while as more people than ever became homeowners.

So, what did they do? They qualified borrowers at the teaser payment rates and not at the higher rates when the adjustment occurs after the teaser rate period ends, and they also loaned buyers 100% or more of the value of their homes. Re-insurance companies insured these mortgages.

Even the appraisers were in on the scam, as they were also pressured to inflate home values in order to continue to get business from the people that originate the loans.

So, what happens to a mortgage that was originated before the current liquidity crisis? The company the writes or originates the mortgage is often different from the company that owns the mortgage which can also be different from the company that services the mortgage. Over the past decade or two, wall street has found creative ways to package mortgages and sell them to investors. What they often do is package the interest rate portion of the mortgage separately from the principle part of the mortgage and create investments called derivatives. The resulting packages of investments are pooled and can be owned my mutual funds, retirement plans and any group of investors. That's why it's so difficult to just change the terms of the original mortgage as a way to try to help those people who can't afford the non-teaser rate when the adjustment occurs. On top of that, the derivative investments carry great risk with them.

The other thing that buyers thought they might be able to do to avoid the big interest rate adjustment when their teaser rates expired was to refinance their mortgages, using the new even more inflated value of their homes as real estate prices continued to go up. What they actually found is that they couldn't qualify for a decent mortgage and in many cases, they owed more than the property was worth as real estate values started to drop. So in many cases, they defaulted on their loans, walked away from their obligations, which just adds to the overall problem in the real estate market and with the banks and institutions that hold the the underlying investments. As that spiral continued, nobody wants to own those investments, however, nobody wants to buy them either, so they become illiquid and that adds to the capitalization problems that the financial institutions are seeing.

Most pundits see it as a failure of the regulators to take action before there was a problem. Some pundits blame deregulation or a hands-off policy by the policy makers. Many people blame it on the greed of the banks and Wall Streets view of ever increasing short-term quarterly profits. As the process began, the mortgage origination business flourished and companies that did that were making a ton of money which increased their profits, which lead to a higher stock price and larger executive bonuses. Companies that didn't do it, were left behind with less profits than their peers and punished by the stock market for being conservative.

There is no one single entity to blame here. It was really a massive failure of the entire industry and government and industry regulators.

Nonetheless, not every bank or financial institution participated in this shell game. Not every appraiser inflated values. But enough of them did that it lead us to where we are now.

-David
 
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AwayWeGo

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[triennial - points]
See, That's What I Was Getting At.

Most people see it as a failure of the regulators to take action before there was a problem. Some people blame deregulation or a hands-off policy by the policy makers. Many people blame it on the greed of the banks and Wall Streets view of ever increasing short-term quarterly profits. As the process began, the mortgage origination business flourished and companies that did that were making a ton of money. Companies that didn't do it, were left behind with less profits than their peers and punished by the stock market for being conservative.

There is no one single entity to blame here. It was really a massive failure of the entire industry and government and industry regulators.
What that leaves out is the political & policy component, which wasn't exactly insignificant in How Things Got That Way.

But delving into that will get real political real fast.

Better just to lock up the discussion topic where it stands, with many thanks to Icarus for spelling it out just about as completely as possible before getting down to the political Brass Tacks.

-- Alan Cole, McLean (Fairfax County), Virginia, USA.​

 

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Alan,

If anything, I've demonstrated that it's possible to discuss this without getting political. We're all adults here and should be able to continue to discuss it without getting political.

It is clearly possible to have reasonable non-political, respectful discussions about the economy and many other topics.

I haven't covered everything and other people might have things to add to what I said, and some people may have reasonable disagreements with some of what I said. As long as the discussion is respectful and non-political there's no reason to close the thread.

-David
 
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All good explanations without getting political but you left out another group to blame for the current mess - the accountants! When the Wall St. firms took losses some blamed the "mark-to-market" accounting rule for valuing financial assets.
As an accountant I just thought I would throw that in.
 

Timeshare Von

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Personal case in point in how this trickles down and affects a typical American . . .

Many regular readers here know I took a job that would move us back to Milwaukee from Ames, IA last summer. We put our $220k (on paper) house on the market the day I accepted the job in August07. Lots of (cheap) new houses being built, and those moving to Ames (mostly with jobs at the University) needing to wait to sell theirs before buying in Iowa created a lag for new residents to buy. In the old days, people would just buy "knowing" their former house elsewhere would sell within a reasonable amount of time often taking bridge loans to make it happen.

Money started tightening up last summer also making bridge loans expensive (thankfully as it discouraged people from even considering doing so). So now existing homes sit and sit . . . the sub-prime crisis hit the fan around that time too. Now buyers get skiddish and banks no longer will do creative financing to get buyers into homes quickly.

Fast forward to today . . . we have lowered the price on our home several times and finally have a contingent offer, which expires 12/1/08. The accepted/negotiated selling price is nearly $40k below the "on paper value" and $10k below what we paid for it four years ago.

Our buyers have a nice little starter home and is looking to buy up to something larger and nicer . . . but now they are dealing with potential first time home buyers with limited assets in terms of putting up the down payment. When you're young or without significant assets in the bank that are liquid, coming up with 20% on a $125,000 purchase is tough.

I fully expect that I'll be here on December 2nd whining about our deal falling through and still paying that $1,300 mortgage in Iowa while still renting and paying nearly a grand here to live in a rental. Thankfully, we have only had two housing expenses for five months as my husband was living in Ames until April . . . and I was living with a friend incurring no second housing expense for the first eight months of being here in Milwaukee.

The economy has me worried sick because of the bad news on Wall Street and in the banking industry. We may have to resort to some very undesirable options regarding the house in Iowa, if this doesnt come to a resolve soon.

P.S. I should say that we are fortunate in that we have a very good mortgage rate on the house in Ames and were able to build a ton of equity in just four short years. Our current balance on the 15 yr fixed is around $125k so at least we are not upside down or mortgaged to the hilt.
 
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Timeshare Von

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All good explanations without getting political but you left out another group to blame for the current mess - the accountants! When the Wall St. firms took losses some blamed the "mark-to-market" accounting rule for valuing financial assets.
As an accountant I just thought I would throw that in.


Well, accountants work for someone which in my book brings it back somewhat full circle to the CEOs who have gamed the system on so many levels.
 

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Thank you. I knew it could be discussed on the economic level without getting into the political arena. Thank you so much.

I remember many, many years ago going to our bank to get a small loan for I don't remember what now, and was shocked to find out we had been turned down. We had banked with this bank for years and years, had had several loans that were always paid on time and paid off. So, I couldn't figure out why we got turned down that time. Now, I've requested no credit card offers as we were getting two or three a day and it was irritating to have to spend the time to shred them all. Credit has certainly gotten looser and more available. Now it will go back the other way.
 

Rose Pink

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....the "mark-to-market" accounting rule for valuing financial assets.

Simple explanation of this rule, please? (I should have taken more economic classes. :eek: )
 

Rose Pink

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As I understand the current state of economic affairs, it is the mortgage machine (all its parts as Icarus explained it so well) that has driven us near the edge of the cliff. Besides that, what are the other key factors or is that one, alone, responsible for the mess? In other words, if it weren't for the mortgage crisis, would our economy be okay?

I remember hearing a developer of residential homes once saying, "people have got to have a place to live."
 

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caribbeansun

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An exceptionally simplistic definition of mark to market is that you can book profits based on what you think the asset is going to generate in the future.

This was at the root of the Enron debacle.
 

M. Henley

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Excellent!!

Concise explanation and to the point.
A most excellent presentation!!
:)
 

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You are correct, sir -- to a point.

Alan,

Maybe you just need to stop yourself from posting to this thread?

:hysterical: :ignore: :banana:

Instead of focusing on politics, focus on the non-political greed factor. We're all to blame. Remember the term "irrational exuberance"?

If we all bought $10 coffee pots and cheap sets of tires and lived within our means ...

-David
 
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rsnash

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I agree with Icarus: Alan, you are the one who keeps bringing up the politics. I think you are disappointed that a non-emotional non-partisan explanation of the overall, maybe simplified, facts was presented. If you would stop posting saying how this IS going to degenerate, perhaps it won't?

Ah, living within your means. It sucks, but I wish I had started doing it 10 years ago rather than 5. Fortunately we've worked ourselves out of cc debt and our mortgage, while high, is within our means and has at least a 65% LTV ration, despite the fall in housing prices (not that it would sell quickly even at a lowered price). We refinanced just before the bubble burst as we had some major home repairs to do (and to pay off debt). It increased our mortgage balance by 60K, while only increasing our payments by ~$100/month (lower interest rate). Thank G-d we did it when we did, because if we had waited, we might not be able to do it now.
 

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Comparisons Reveal Some Troubling Possibilities

Personal case in point in how this trickles down and affects a typical American . . .

Many regular readers here know I took a job that would move us back to Milwaukee from Ames, IA last summer. We put our $220k (on paper) house on the market the day


Fast forward to today . . . we have lowered the price on our home several times and finally have a contingent offer, which expires 12/1/08. The accepted/negotiated selling price is nearly $40k below the "on paper value" and $10k below what we paid for it four years ago.

Our buyers have a nice little starter home and is looking to buy up to something larger and nicer . . . but now they are dealing with potential first time home buyers with limited assets in terms of putting up the down payment. When you're young or without significant assets in the bank that are liquid, coming up with 20% on a $125,000 purchase is tough.

It is so revealing to consider the prices for homes in different parts of the country. You cannot buy a garage in Santa Barbara for $200,000. For those of you who visit NCV (Marriott Newport) take a look in the hills at the homes that are the size of hotels. Those McMansions cover our California mountains from Santa Barbara to San Diego. Tens of Thousands of multimillion dollar homes.

Are there really that many people who can maintain the payments on these homes? Did they exaggerate (lie) about their incomes to get those big homes hoping that the homes would quickly appreciate in price so that they could take out the “profits” by a re-fi and use those monies to pay their living expenses? If we have a bad recession how many of the owners of those homes will lose the incomes needed to maintain them?

If real estate prices in California decrease to the level where real people with real incomes can afford them then the real estate crash has a long ways to go. It will get really ugly.

[I have seen estimates that based on income affordability the average home in Orange County, California should be $300,000.]
 

AwayWeGo

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[triennial - points]
Disappointment Is In The Eye Of The Beholder.

I agree with Icarus: Alan, you are the one who keeps bringing up the politics. I think you are disappointed that a non-emotional non-partisan explanation of the overall, maybe simplified, facts was presented.
It's not so much that. It's more that the genesis of the financial crisis & its aftermath & potential corrections is nothing but politics. Sure, there are specifics & details whose workings are semi-interesting to know about. The the situation itself, however, is all-political all day any way you shake it.

Trying to understand the current financial crisis without discussing politics is like trying to understand timeshare exchanges without discussing RCI & I-I.

Full Disclosure: I am OK with an (attempted) TUG-BBS non-political discussion of the topic. I just don't think it will be fruitful or all that helpful to anybody's understanding of what the situation is, how it happened, & what's apt to come next.

Further Disclosure: I'm not specially interested in the politics or the workings of the economic-financial details of the situation -- with or without political discussion. I'd rather joke around about prostate cancer & playing horn & brewing coffee via el cheapo generic Mr. Coffees & snagging outstanding Instant Exchange timeshare reservations, etc. When the TUG-BBS discussion gets down to the political nitty gritty & the Grand Pro, reluctantly & with a heavy heart, shuts it down, there will be no need for surprise.

-- Alan Cole, McLean (Fairfax County), Virginia, USA.​

 

nightnurse613

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What I resent is the so-called investors that came in and started buying homes built on the premise that prices would go up-they created an artificial shortage and for a while prices did go up but, at some point supply exceeded demand and prices have now fallen drastically. Thanks to easy credit financing, inflated appraisals and the such they got caught on the downside of this curve and are holding property they can't pay the mortgage on (poor babies) :bawl: Of course, my favorite part of the paper is the weekly sales report of houses that are selling in the millions of dollars. :annoyed: I guess those people don't have the same financial problems that everyone else has. :(
 

Patri

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I think this has been a very nice, rational discussion. Thanks folks. :)
 

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Great explanation of what happened…I received this last week and forwarde it to friends and family to help them understand..



The Big Money: How AIG fell apart

-The following article is from The Big Money from Slate. Any opinions expressed are the author's own. -

By Adam Davidson

(The Big Money) When you hear that the collapse of AIG or Lehman Bros. or Bear Stearns might lead to a systemic collapse of the global financial system, the feared culprit is, largely, that once-obscure (OK, still obscure) instrument known as a credit default swap.

So, what is a CDS, and why is it so dangerous?

At first glance, a credit default swap seems like a perfectly sensible financial tool. It is, basically, insurance on bonds. Imagine a large bank buys some bonds issued by General Electric. The bank expects to receive a steady stream of payments from GE over the years. That's how bonds work: The issuer pays the bondholder some money every six months. But the bank figures there's a chance that GE might go bankrupt. It's a small chance, but not zero, and if it happens, the bank doesn't get any more of those payments.

For other news from The Big Money, click on www.thebigmoney.com/

* The Next Dominoes here

* The Definitive FAQ on AIG here

The bank might decide to buy a CDS, a sort of insurance policy. If GE never goes bankrupt, the bank is out whatever premium it paid for the CDS. If GE goes bankrupt and stops paying its bondholders, the bank gets money from whoever sold the CDS.

Who sells these CDSs? Banks, hedge funds, and AIG.

It's easy to see the attraction. Historically, bond issuers almost never go bankrupt. So, many banks and hedge funds figured they could make a fortune by selling CDSs, keeping the premium, and almost never having to pay out anything.

In fact, beginning in the late '90s, CDSs became a great way to make a lot more money than was possible through traditional investment methods. Let's say you think GE is rock solid, that it will never default on a bond, since it hasn't in recent memory. You could buy a GE bond and make, say, a meager 6 percent interest. Or you could just sell GE credit default swaps. You get money from other banks, and all you have to give is the promise to pay if something bad happens. That's zero money down and a profit limited only by how many you can sell.

Over the past few years, CDSs helped transform bond trading into a highly leveraged, high-velocity business. Banks and hedge funds found that it was much easier and quicker to just buy and sell CDS contracts rather than buy and sell actual bonds. As of the end of 2007, they had grown to roughly $60 trillion in global business.

So, what went wrong? Many CDSs were sold as insurance to cover those exotic financial instruments that created and spread the subprime housing crisis, details of which are covered here. As those mortgage-backed securities and collateralized debt obligations became nearly worthless, suddenly that seemingly low-risk event-an actual bond default-was happening daily. The banks and hedge funds selling CDSs were no longer taking in free cash; they were having to pay out big money.

Most banks, though, were not all that bad off, because they were simultaneously on both sides of the CDS trade. Most banks and hedge funds would buy CDS protection on the one hand and then sell CDS protection to someone else at the same time. When a bond defaulted, the banks might have to pay some money out, but they'd also be getting money back in. They netted out.

Everyone, that is, except for AIG. AIG was on one side of these trades only: They sold CDS. They never bought. Once bonds started defaulting, they had to pay out and nobody was paying them. AIG seems to have thought CDS were just an extension of the insurance business. But they're not. When you insure homes or cars or lives, you can expect steady, actuarially predictable trends. If you sell enough and price things right, you know that you'll always have more premiums coming in than payments going out. That's because there is low correlation between insurance triggering events. My death doesn't, generally, hasten your death. My house burning down doesn't increase the likelihood of your house burning down.

Not so with bonds. Once some bonds start defaulting, other bonds are more likely to default. The risk increases exponentially.

Credit default swaps written by AIG cover more than $440 billion in bonds. We learned this week that AIG has nowhere near enough money to cover all of those. Their customers-those banks and hedge funds buying CDSs-started getting nervous. So did government regulators. They started to wonder if AIG has enough money to pay out all the CDS claims it will likely owe.

This week, Moody's Investors Service, the credit-rating agency, announced that it was less confident in AIG's ability to pay all its debts and would lower its credit rating. That has formal implications: It means AIG has to put up more collateral to guarantee its ability to pay.

Just when AIG is in trouble for being on the hook for all those CDS debts, along comes this credit-rating problem that will force it to pay even more money. AIG didn't have more money. The company started selling things it owned-like its aircraft-leasing division 3. All of this has pushed AIG's stock price down dramatically. That makes it even harder for AIG to convince companies to give it money to pitch in. So, it's asking the government to help out.

AIG might be in trouble. But what do I care? Because the global economy could, possibly, come to a halt.

Banks all over the world bought CDS protection from AIG. If AIG is not able to make good on that promise of payment, then every one of those banks has lost that protection. Overnight, the banks have to buy replacement coverage at much higher rates, because the risks now are much worse than they were when AIG sold most of these CDS contracts.

In short, banks all over the world are instantly worth less money. The numbers seem to be quite huge-possibly in the hundreds of billions. To cover that instantaneous loss, banks will lend out less money. That means other banks can't borrow to pay this new cost, and weaker banks might not have enough; they'll collapse. That will further shrink the global pool of money.

This will likely spur a whole new round of CDS payouts-all those collapsed banks issue bonds that someone, somewhere sold CDS protection for. That new round of CDS payouts could cause another round of bank failures.

Generally, with enough time, financial markets can adjust to just about anything. This, though, would be an instantaneous transformation of the global financial system. Surely, the worst part will be the confusion. CDS are largely over-the-counter instruments. That means they're not traded on an exchange. One bank just agrees with another bank to do a CDS deal. There's no reliable central repository of information. There's no way to know how exposed a bank is. Banks would have no way of knowing how badly other banks have been affected. Without any clarity, banks will likely simply stop lending to each other.

Since we're only just now getting a handle on how widespread and intertwined they have become, it seems possible that AIG, alone, could bring the global economy to something of a standstill. It's also possible that it wouldn't.
 
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