Packaging of high-risk, high-yield debt papers with credit default swaps (CDS) on the same debt led to 2008 financial collapses?
This is a question I’ve pondered over a long time and also talked with the folks in ##economics and it’s never been shot down there.
Background to the 2008 collapses
Leading up to 2008 financial markets had been over excited for a long due to more and more sophisticated financial instruments coming onto the markets and growth of productivity from ever advancing automation ( this will be the backbone of an upcoming blog post where I argue for basic income based on the advance of automation ).
Money cost 4% and money paid 8% and the feeding into self by reapplication and reapplication fo debt bubble was largely debt levered.
In core the theory is as follows:
Wall Street packaged high-yield, “low-risk” debt bonds, the so called trash-bonds derived from the expensive sub-prime loans.
Their sales pitch for these composite instruments was good, save one fact they “forgot” to mention and went as follows:
“Either the debt-papers pay or the CDS on the debt pays ergo this instrument is low-risk.”
They had truth, almost, these 2 obvious scenarios should have been complemented by the 3rd scenario that then materialized bringing all sorts of negative shit on many facets of human life all over our precious Planet Earth.
The 3rd scenario is a true shit-hits-the-fan-type of situation where The debt-repayment fails in such massive amounts that the CDS sellers also go bust from their obligations there-by simultaneously collapsing both “promised” income sources for the investment into these treacherous composite instruments and has wretched effects on people’s housing security, savings security, job security etc. that got carried to foreign financial markets and economies such as Iceland, Ireland and Greece.
Some painting of other factors that came to play
I could go into lot of painting about the self-feeding cycles and self-slowing cycles that went into action to cause all the happenings of the financial melt-down of 2008. Suffice to mention the family economies that had been issued
- too large, too expensive mortgage loans leading to
- inability to pay back ( even before this started feeding into the equation and compounding and gathering power, via loss of home, loss of jobs ) leading to
- loss of home and probably still owing the bank because the housing real estates
- markets in near free-fall
- With advancing credit losses driving the interest rates higher, housing real estate prices down and unemployment up go to 1. and repeat till the economists say that we’ve stopped repeating the errors of the past.
and suddenly the real economies started feeling a lot of pain for what the Wall Street had been at.
Futher reading / resources: