I feel there is one really major hole in the presentation of this story. It is linked to Leonard and his guest characterizing credit default swaps as "insurance contracts." While such a swap entered into by a party to a lending transaction operates as insurance, the credit default market is much broader. In a real insurance transaction the insured has what is termed in the biz an insurable interest. In the credit swap market there has been no requirement of such a relationship to the credit involved. In other words, Ford could enter into a contract that would pay it if GM defaulted even though Ford was not a lender to GM.

The guest mentioned a lack of regulation in this area, which is true, but doesn't go far enough. Until 2000, contracts like this where the parties had no direct stake in the action could be held as violations of state gambling statutes. In 2000, under Phil Gramm the Congress enacted a law that exempted wall street from state gambling statutes.

Does any one remember Ludwig Von Mises and the New York Objectivists? Plainly put, the "Welfare State" was judged such a moral problem that bankrupting the state was preferential to allowing social welfare to exist.

Who is John Gault, indeed...

Who made big profits on the finance disaster? There has to be two sides of every bet, so when losses took down AIG and Lehman and Bear and everyone else it seems, what group made an enormous fortune on what the aforementioned owed to derivative counterparties? Should the winners be made to subsidize the bailouts or be taxed?

if spreading risk reduces risk for those spreading it without reducing the total amount of risk in the system, does spreading risk tend to encourage more risk? IE, sort of parkinson's law effect?

did competition between regulated commercial banks and unregulated investment banks contribute to the problem?

I worked in OTC derivatives when credit default swaps started. They were always inconsistent with market efficiency, which is the cornerstone of derivative risk management.

The triple A's were getting a fee for magically improving the rating of a structure, making a "profit" while siphoning off their credit worthiness. It was even referred to as "renting out our balance sheet" or "renting our credit rating".

Why aren't the agencies (who were aware of the risk they were rating in structures) not being called out for not reflecting this risk in the bank ratings?

is it my imagination, or did the CPA/auditors drop the ball here (along with the Fed, et al)? all of these firms get audited. did the auditors and the bond rating agencies just not understand the instruments involved? Being a CPA, it smells to me like the typical giant-audit-client/CPA firm relationship wherein the partner in charge of the audit doesn't want to lose a high-paying client, so the client is allowed WAY too much leeway on their balance sheet.

Leanord,

Book Timothy Sinclair, who has a book out on the credit agencies.

Wasn't Sarbanes Oaxley suppose to prevent items and risk going off balance sheet? Didn't crack down on Special Purpose Vechiles and the like?

role of regulation in this narrative??

This sounds vaguely like the age-old system at Lloyds of London with its "names" -- the people, investors (if I understand it right), who contracted to support Lloyds in the event of trouble.

back in 2000/01 i remember that the big topic was "how to valuate derivatives". at that time i worked alongside key execs at a major accounting consultancy firm. right up until 9/11 it was "the" issue. after 9/11 it lost importance, given all the new business from andersen's collapse, new rules, crisis planning and outsourcing. the accounting scandals ironically freed all the remaining firms to do as they liked. sufficed to say today's mess was easily predictable and very much expected. of course, 7 or 8 years of exec profit also leaves many of the inventors of this scheme very much retired. my only surprise is that the financial system had the capacity to support the scheme for so many years after that button got pushed.