How Derivatives, Collateralized Debt Obligations and Credit Default


Part 1

“The banks run the
place… they give three times more money than the next biggest group,”
says Congressman Collin Peterson, the Chairman of the Agriculture
Committee. Peterson, who says banks are controlling Congress, has
introduced a bill to bar Derivatives trading in any clearinghouse
regulated by the New York Federal Reserve, and thereby bring Derivatives
trading out of the shadows of the private clearing houses, and onto
public exchanges.

You see, it finally took someone who knows about
agriculture, to get down to the nitty-gritty of the Derivatives
dilemma. The trouble is, according to Congressman Peterson, that his
bill will not pass unless it is materially changed to the satisfaction
of his colleagues in Congress, the ones who are accepting the
contributions and perks from their bankster superiors.

along with their cousins the Collateralized Debt Obligations (CDO’s),
and Credit Default Swaps (CDS) a type of derivative in itself, are the
financial instruments that have in recent times been defined as a
bottomless pit of incomprehensibly written economic jargon, or Wall
Street hocus pocus. They are being blamed by many bankers, politicians
and high government officials, to be the underlying cause of AIG’s
recent quarterly loss, over 67 billion dollars, and the ongoing world
financial crisis, among a few other things.

Specific people are
not being held to blame mind you, just Derivatives, Collateralized Debt
Obligations, Credit Default Swaps and a misleading device called a Repo
Transaction. This is almost like saying that Hitler didn’t do anything
wrong, it was merely National Socialism… and since I mentioned National
Socialism… well, never mind, for the time being…

Here’s what
really happened. This is how bankers just caused the largest economic
collapse in the history of the world. Up until about 2007, Wall Street
and their international counterparties got away with running what
amounted to a colossal pyramid scheme. They started by selling millions
of bundled together mortgages in packages called Structured Investment
Vehicles, to the world’s banks, trusts, institutions, and municipal,
corporate or government entities. In order to sell these investments to
municipalities and other state entities, that are regulated to keep
their portfolios conservatively safe, many of those pools of mortgages
were packaged into larger, supposedly more stable instruments called
Collateralized Debt Obligations (CDO’s) that contained several kinds of
debt such as corporate or credit card debt, in addition to mortgage
loans. The main theory behind the structuring was that diversification
of different kinds of debt within the CDO’s would diminish the overall
risk of default. 

As the banks endeavored to create more
attractive terms and yields to entice further end buyers, the terms of
the underlying mortgage loans became ever more egregious to American
homeowners. In many instances, cash incentives were awarded to brokers
and loan officers at the banks, as a reward for steering borrowers into
more profitable sub-prime (predatory) loans, when the borrowers were
actually qualified for better terms. In other cases, “liar’s loans” for
undocumented or unqualified borrowers were pushed through with predatory
terms and rates in order to enhance the yields of the packages, and
feed the pyramiding machine.

Many of those aggressive mortgage
documents were written in such a way that the interest payment would
often double or triple within a few years, often placing the borrowers
within an astoundingly unethical debt- to-income ratio of 80% or even
more. In other words, the rate of interest, and hence the rate of
return, promised on much of that paper, was clearly unsustainable, and
designed by the banks to fail sometime in the future after they had
packaged and sold the paper to unwitting investors in the secondary

To conceal the high risk nature of such mortgage
instruments, and the CDO’s into which they were packaged, our largest
American banks used three different rating agencies to rate the risk for
purchasers. Unfortunately, our own government was conveniently looking
the other way, as the banks, who just happened to own the rating
agencies, and apparently our government as well, paid the agencies to
rubber stamp the mortgages Triple A (AAA) so that they could be bundled
into “Triple A” Structured Investment Vehicles and Collateralized Debt
Obligations, and sold all around the world.

As a measure to manage
the risk, and as a further inducement to facilitate more trades, the
banks utilized a device called the Credit Default Swap (CDS), under
which for a monthly premium, another institution, bank, or insurance
corporation such as AIG, would agree to pay off the debt if the
borrowers defaulted. The Federal Reserve and the Office of the
Comptroller of the Currency thought it was such a great idea, that they
exempted banks from having to keep cash reserves for the Credit Default
Swap protected obligations the banks held. This allowed the banks to
make more loans with their cash reserves that previously under federal
law would have been required to remain in the banks to balance their
loan to reserve ratios. That the secretive Federal Reserve led the way
in allowing the banks to do such a thing, was no real surprise because
the Chairman of the Federal Reserve has always been appointed by the
President of the United States from a list of three people supplied by
the banks.

The main problem with the scheme was that the
institutions providing the Credit Default Swap protection were not even
required by government regulators to prove that they had enough reserves
to actually pay off the debts in the event that, God forbid, defaults
occurred and world’s financial institutions, real estate trusts,
worldwide municipal and government entities that bought the Structured
Investment Vehicles, CDO’s and Derivatives, started to suffer losses and
demanded that Wall Street buy back the bogus “Triple A” rated paper.

only people that appeared to worry when the fraudulently rated
collateralized mortgage securities began to default in record numbers
around the world, and when investors in that so-called secondary market
began to invoke their buy-back clauses and refuse to purchase any more
American mortgage securities, were not the government regulators whose
job it was supposed to be, but instead only the shareholders in those
Wall Street Firms. Those pesky shareholders were concerned about how
badly their firms were getting hit by the deterioration of the
market. No worries for the Wall Street Banksters however; they merely
cooked up another device called a Repo Transaction.

It worked like this. If their firm was
seriously upside down when it came time to report to shareholders, they
merely borrowed whatever amount of money they needed from another Wall
Street firm, and in the process transferred as much of their toxic debt
as they needed to that same firm, with the agreement that they would pay
back the money and take back the toxic debt within a month or so. Then
the transaction was recorded on their books as a sale, instead of what
it really was, a loan. The whole purpose of the transaction was to give
the misleading appearance that they were still solvent.          

can imagine that if the stalwart individuals who structured this
debacle were really sharp, they would have at least thought of a way
around the annoying buy-back clauses in the contracts. But you see, they
were busy trying to figure out how the CDS, CDO’s and the Derivatives
were going to work mathematically. Not even past chairman of the Federal
Reserve Alan Greenspan, nor present chairman Ben Bernanke, nor former
Goldman Sachs CEO and Secretary of the Treasury Henry M. Paulson Jr.,
nor former head of the New York Federal Reserve and current Secretary of
the Treasury Timothy F. Geithner, or anybody else for that matter,
could accurately figure out how these Derivatives, Collateralized Debt
Obligations (CDO’s) and Credit Default Swaps (CDS), were supposed to
actually work, because the language and the formulas in the instruments
was incomprehensible, and there wasn’t nearly enough money in reserve to
insure potential losses.

The sad news at the moment… is that less
than half of the underlying time bomb mortgages in the United States
have yet to adjust dramatically upward and fall into default. Meanwhile,
due to the “credit freeze”, many borrowers who thought they would be
able to convert to more reasonable loan terms, have been forced to
continue to make unreasonably high interest payments compared to their
income, draining all of their savings reserve and retirement accounts,
while our government and their superiors at the banks, in spite of their
rhetoric to the contrary, continue to make it extremely difficult for
such borrowers to have their loan terms modified.–Part-2

How Derivatives, CDO's and CDS crushed the economy, PART 1