Reply #7: I Appreciate the Thoughtful Post [View All]

[On the Road]

I just think that the implications of 2 or 3 of the big four banks failing is being greatly underestimated. The fallout from just one firm (Lehman) and the fire sale of Morgan Stanley took six months to recover from. FDIC insures most personal accounts, but most business deposits are not covered. Many business large and small would not survive a failure of their bank. The ripples would have been enormous.

This is why there was such widespread panic. You didn't need to listen to any spinmeisters, just read the financial sources that business people themselves go to -- WSJ, Barrons, Financial Times, etc. I have never seen anything like it. The recession we're seeing is much, much better than the alternative, and outside of AIG it didn't cost the taxpayers. In fact, the lower revenues and higher government costs (unemployment, etc) would probably have been far worse for the federal budget, not to mention the economy or employment.

As far as the options go, I have been thinking about it and believe that poster was correct only to the extent that the obligations were paid. When you go long or short and lose, someone who bet in the other direction benefits from your loss. When you pay up, it is indeed a zero-sum game. If AIG and all the other CDS abusers had actually paid up for their losses, it would indeed be a zero-sum game.

What's not clear to me is who was on the other end of those CDS bets, and how much of it was paid up.