On Thu, Sep 18, 2008 at 8:14 AM, Sabri Oncu <[EMAIL PROTECTED]> wrote:
> Shane: > > > With "fair" bets winnings and losses exactly offset each other, leaving > no net income > > to go into the National Income Accounts no matter how many trillions > > flow between the bettors. > > This is true, only if the bets are fair. Think about the credit > default swaps where both of the counter-parties can transfer the legs > they are holding to other parties. Although in theory the price of one > leg is the negative of the other, we know from the markets that both > parties get paid money, since opinions about the prices of the legs > differ. So, income is created out of thin air. Also, think about a > mortgage pass-through and create a CMO with several tranches out of > it. In the absence of transaction costs, the price of the pass-through > should be equal to the sum of the prices of the tranches of the CMO > constructed from it since if you buy all of the tranches what you are > holding is the pass-through. But we again know that sum of the prices > of the CMO tranches is larger than the price of the passthrough, and > again income is created out of thin air. The same goes for all of the > CDOs. > Excellent point Sabri. Is this really at the heart of why unwinding the credit derivatives is so systemically dangerous: it has less to do with complexity and large number of counter-parties and more to do with bogus and inconsistent valuations of those securities? -raghu. -- "He may look like an idiot and talk like an idiot but don't let that fool you. He really is an idiot" - Groucho Marx
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