Re: 18-Sep-10 News -- Near-zero CPI hints at deflation
Posted: Wed Sep 22, 2010 7:37 pm
The wealth is "created or destroyed" as the derivative fluctuates between it's notional value and zero at expiration. The only initial money that transferred is the premium that was paid which is usually a small fraction of the notional value. Of course the real problem is in the counter party risk. If I bought a $10 million credit default swap on AIG for $10,000 from GS and AIG went bankrupt (never mind that they already have), Goldman would have to come up with the $9,990,000 difference to pay me. That is GS would have a $10 million liability for which they only received $10K. If they couldn't pay, they would have to declare bankruptcy too and I wouldn't get my money either. If I was an insurance company that also held AIG bonds worth $10 million, I'd be out that too. In which case CDSes on GS would have to be paid too. That is what is meant by TBTF. Alternatively if we pretend that AIG did not go bankrupt, I'm out the $10K premium when the contract expires and I still have $10 million in bonds that are not paying dividends, but I get to pretend on my books that it will eventually be paid back. So quite obviously derivatives do "create or destroy" wealth in a nuclear destruction scale as Warren Buffet once said before he figured out he could make a lot of money selling them knowing that the Fed would never allow them to be paid out. So perhaps you are right that the Fed doesn't consider them "money", but they are treated as money for calculating bonuses.vincecate wrote:...
Given that a derivative is a real liability for one party and an equal asset for another, there is no real net wealth produced when the price changes. It is just transferring wealth from one party to another.
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