Friday, February 27, 2009

Economic Mess for Dummies

Having a hard time understanding the economic mess. In October I tried to explain it with words:

"The bailout doesn't seem to be working. The problem isn’t just $1 trillion in subprime loans, the problem is $62 trillion in credit default swap liability (CDS) for collateral debt obligations (CDOs) [NOTE: it should read collateralized debt obligations] that no one can unravel or value (or even understand).

What is a CDO or CDS? Imagine taking paper debt like mortgages, subprime mortgages, car loans, credit cards loans, and pretty much anything you can imagine. Now combine and mix the paper in a blender, spiking it with worthless rhetorical hyperbole that derivatives are the new paradigm of investments. Then pour the mixture in a pyramid of champagne glasses, to represent the varying levels of return (and risk), with the higher the glass, the lower the return and risk. That represents the CDOs. Now as you sell the mess, insure against the risk of the CDOs decreasing in value with CDSs. Presto, $1 trillion of bad loans is transmuted into $62 trillion in faux wealth. An alchemist would be proud.

That I think is a fair metaphor for the problem, and because of the scope of the problem the Feds don't know what to do."

Now watch the movie version, The Crisis of Credit Visualized:

Good movie, but I think it understates the role of CDSs. The estimates now are that credit default swap liability is nearly $600 trillion!!

UPDATE: Two additional movies, both from from Marketplace Whiteboard. The first, Uncorking CDOs:

The second Untangling credit default swaps:

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