As Wall Street stocked up on shaky subprime backed bonds, they did worry about defaults. So, they started buying default insurance ("Credit default swaps") from a little known place called ACA Financial Guarantee Corp. Business for ACA was good. They sold $69 billion worth of insurance. Trouble is, ACA only has $425 million to pay off claims. Now with all $69 billion worth of sub prime bonds getting ready to default, it just occurred to the combined financial geniuses of the Street, that (wait for it) they ain't gonna get paid.
In fact, now that the default insurance has become worthless, the biggies are writing down yet more sub prime paper.
Come to think of it, Why does a biggie like Merrill Lynch want insurance from a pipsqueak like ACA? Merill is plenty big enough to bear the risk of the occasional default. No pipsqueak insurance company has enough money to pay off a market crash, where everything defaults. So, what was Merrill thinking about when they wasted money on "insurance" that doesn't insure?
Kinda like flood insurance. The commercial insurers won't write flood insurance, 'cause when the river floods, every house gets swept away, and they know they won't be able to pay them all off. Nobody has that kind of money. A market downturn is like a flood, and nobody can pay off an entire market worth of defaults.
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