Granny Default Swaps

"Credit default swap" is one of those readily retrievable terms that has come to stand-in with four or five other acronyms for everything that was and likely continues to be wrong with modern finance. Always reaching for the same grab-back of sufficiently complicated sounding instruments, paragraphs like this one from Saturday's New York Times read to most of us like nursery rhymes that we only later find out are actually about the bubonic plague or infanticide or a compulsively masturbating rodent. We all know the words but only have a vague idea of what those words really mean.

In the aftermath of the financial meltdown, exotic investments dreamed up by Wall Street got much of the blame. It was not just subprime mortgage securities but an array of products — credit default swaps, structured investment vehicles, collateralized debt obligations — that proved far riskier than anticipated.

I don't know which newsroom first started stapling the word "exotic" to every other noun in their business section, but somewhere along the way a term that otherwise suggests miniature umbrellas dropped into rum filled coconut halves became the descriptor of choice applied to every poorly understood financial product that made our national job market go away. But regardless of the adjectives employed, unlike most generally accepted simplifications you might read in your morning paper, the one which holds that credit-default swaps deserve if not the lion's than some lesser feline's share of the blame for the financial crisis part of the financial crisis is largely true. This is one lesson that most of us non-bankers can accept. CDSs didn't work so well and it would probably be best if we put them in a very small cage where they can be accessed only under very specific circumstances, if at all.

Consider how bad this sounds: I'll give you some money this month and the next and the next as long as my friend pays off his mortgage. If he doesn't you have to pay me 110% of the 2005 level value of my friend's house. Neither of us have any direct financial interest in the mortgage. You are an investment bank (soon to be bankrupt) and I am hoping that my friend turns out to be even more of a dead-beat than I am.

This is the rationale behind a credit default swap: we should figure out a way to benefit when someone loses their home. So you might ask yourself, if we continue to regulate Wall Street with kid's gloves, what's next? Are we going to sit back and watch as some Armani-sporting succubus with an M.B.A. devises a way to make bets on the life expectancy of elderly cancer patients and welfare-recipients?

...What? Why is everyone looking at me like that?

The bankers plan to buy “life settlements,” life insurance policies that ill and elderly people sell for cash — $400,000 for a $1 million policy, say, depending on the life expectancy of the insured person. Then they plan to “securitize” these policies, in Wall Street jargon, by packaging hundreds or thousands together into bonds. They will then resell those bonds to investors, like big pension funds, who will receive the payouts when people with the insurance die.

I want them all arrested.

But first, let me back up. I do not think this is the financial equivalent of Soylent Green. I do not think the SEC will permit investment banks to start assassinating the elderly in order to collect on their life insurance policies. Not during a President's first-term anyway. The argument has been made that naked CDS are especially dangerous because buyers have no so-called "insurable interest" in the value of the underlying asset. That argument is not illogical and is based on the empirically validated theory that very powerful people are willing to do very illegal things for money. But applying the same argument to life insurance policies requires a whole new degree of conspiratorial thinking.

But it does raise the question: what the fuck are these people doing? On both a practical and a philosophical level, how is it that securitized life insurance policies will pave the way to a better society? How does tempting the desperate with short-term cash flows and depriving their loved ones of a financial safety cushion in the event of a death in the family make for a more efficient economic system? What and whose purpose does it serve to have a secondary market for a product the fundamental purpose of which is to give holders peace of mind that their family is taken care of in the event of their unfortunate demise? The ideal purpose of finance is to take current savings and to reallocate it towards the production of future consumption goods. That is, to take what we aren't using to make ourselves better off today and use it to make ourselves better off tomorrow.

Instead we have banks putting money on which of this country's geriatrics will drop dead first. Imaginatively speaking, Marx had nothing on these people.