Thursday, 30 July 2009

Betting against the house and OTC credit default swaps

John Galt in a comment at SeekingAlpha sums up the "clearing house" problem with over the counter credit default swaps very nicely with this simple allegory

If I have a 100 Billion dollar bet on Red with Caesars Palace, and a 100 Billion dollar bet on Black with the Bellagio ( and there's no green 0 & 00), then yes, it isn't as bad as it "sounds".

BUT, what happens if I have to pay out my losing bet to the Bellagio with my winnings from Caesars Palace but Caesar's Palace goes out of business and doesn't pay me?

Being stuck paying out your losers but not collecting your winnings could destroy companies. That's why the former Goldman Sachs people in the government wanted to protect AIG so hard.

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