Capital cannot be invested everywhere at the same time. Capital invested in things which are useful only to a few who receive a payoff means that that same capital is not available for investment in things that benefit the many -- say, roads, schools, factories, infrastructure.
That is the amazing story behind the story of Credit Default Swaps which, as readers of this Blog know, is really an unregulated substitute for Credit Insurance. Since CDSs are unregulated, their twin shortcomings are hidden from investors.
First, CDSs are deliberately made hard to understand, since the persons holding the rights to CDS payoffs face no requirements to make them understandable. This means that someone is needed to 'explain' CDSs to the marks or other investors. The "someone" is always a person who (silently, surreptitiously) holds the rights to CDS payoffs or their intermediaries.
Second, CDSs are undercapitalized. In Insurance parlance, they are under-reserved. This is one more consequence of evading regulation as Credit Insurance: Parties issuing CDSs are not equipped to pay off their 'counterparties' or Insureds. Who do you think that leaves to make the payoff? Taxpayers?
These twin issues are currently suspected in the European money situation. Everything is changing, nothing is new, as they say. "These are the same twin market flaws that helped hide the problems at the American International Group -- problems that arose from insurance that A.I.G. had foolishly written on crummy mortgage securities." Gretchen Morgenson, "Fair Game / Sad Proof of Europe's Fallout" p. 1, col. 1 (New York Times Nat'l ed., "SundayBusiness" Section, Sunday, November 6, 2011).
To be sure, 'investment vehicles' involved in the European situation include the same old things with new names, such as "credit-linked notes" and "bespoke deals". They are all unregulated Credit Insurance. They are all headed to the same unregulated end.
Whoever this is good for, it does not sound like Good Faith for you, or for me.
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