Everything Clear Now?
Going short on bonds by buying a Credit Default Swap (“CDS”) contract carries limited risk but almost unlimited profit potential. By contrast, selling CDS offers limited profits but practically unlimited risks. This asymmetry encourages speculating on the short side, which in turn exerts a downward pressure on the underlying bonds. The negative effect is reinforced by the fact that CDS are tradable and therefore tend to be priced as warrants, which can be sold at anytime, not as options, which would require an actual default to be cashed in.
–George Soros, “One Way to Stop Bear Raids“; The Wall Street
There’s plenty of commentary out there already on the Treasury’s new initiative to buy the big banks’ toxic assets. So, I’m not going to add mine.
However, clearly the stock market (or at least Wall Street) loved it: it exploded to the upside yesterday, with the Dow Jones rallying 500 points, or about 7%.
Whatever the merits of Treasury’s plan, one thing it is not is clear. Or simple.
Of course, neither are the problems it is attempting to address (Exhibit A is Soros’ op-ed piece — and hundreds more like it. If you’re befuddled, Soros, a multi-billionaire and investing legend, is basically saying that flaws in the marketplace permited a “piling-on” phenomenon that led to the fall of financial giants like Lehman Brothers, Bear Stearns, and AIG).
And still . . . it seems like brain-numbing complexity isn’t just symptomatic of the problem in the financial markets, it is the problem. Which means the cure is simplicity.
Put it this way: after witnessing the financial system crash so spectacularly, you’d think the first order of business would be to impose lower speed limits.