Contrary to Public Policy

It is so easy to get distracted, especially when people in trouble want you to be distracted. George Washington gets back to the important question: What ARE the toxic assets everyone is talking about?

The answer is that the toxic assets include:

• Credit default swaps (CDS)

• Collateral debt obligations (CDOs)

• Mortgage backed securities

In fact, these different classes of toxic assets are related. [He goes on to outline them briefly. - Ed.]

But what people should be discussing is cancelling the toxic CDS and CDOs. As I have written repeatedly over many months in different ways, the American people should demand that the government rescind the CDS and CDOs.

The government has that power. Indeed, the same arguments which have been made for the government's authority to cancel AIG's bonus contracts can be used to cancel CDS and CDO contracts. In order to receive any more bailout money (or to keep the money they already received), the CDS counterparties and CDO holders need to cancel their contracts. And for foreign CDS counterparties and CDO holders, the government could simply say "we will not loan your central banks any more money unless you cancel the contracts".

George Washington is correct, but you're not hearing talk like this coming out of DC. But these things need to be cancelled as being contrary to public policy. Meaning, since they threaten to collapse the world economy, they meet the criteria of being contrary to public policy.

The best explanation I ever read of this whole mess can be found at the Geronimo Manifesto.

First, a simple definition. A credit default swap is a form of insurance. A variant of mortgage insurance required of many home purchasers. An insurance policy that requires a company with financial strength to step up to the plate and pay the mortgage if for some reason the home buyer defaults.

A credit default swap is similar: If default occurs, an insurance company pays the income stream of the mortgage.

With one extremely important difference: Payments are made to the owner of the policy, not to the financial institution that stands to suffer a loss.

Financial institutions are allowed, through total lack of regulation, to buy and sell credit default swaps, or insurance they will be paid in event of default, on financial instruments in which they have no financial interest.

Start with a simple example. Assume I know the young son of the couple next door likes to crawl into closets and play with matches. I therefore see a reasonably good shot at "winning the disaster lottery" so to speak, by buying fire insurance on their $200,000 house.

In simple terms, I now have a financial interest is seeing that disaster occurs. If the house, for whatever mysterious reason, burns down an insurance company will pay me the insured value of the house - even though I suffered no loss, financial or otherwise. My neighbor's misfortune is thus magically transformed into my good fortune. A polite way of saying I was paid $200,000, the insured value of my next-door neighbor's house, after I paid the $400 insurance premium.

Being bright and suitably equipped with an MBA from a prestigious eastern university, I well and fully understand the desirable objective of maximizing my return on investment. I can accomplish this in one or both of two ways - increasing the return or decreasing the investment. [Aside, see here for where these clowns get their MBAs. - Ed.]

I can increase the return by artificially increasing the value of the house - say from $200,000 to $400,000. This will allow me to collect twice as much for suffering no personal loss. The easiest way to accomplish this would be to hire one of my buddies, who happens to be a real estate appraiser, to "document" the higher value.

I could also decrease my investment - meaning the premium I paid for the insurance, say from $400 to $200. The easiest way to do this would be to hire a widely acclaimed "fire risk rating agency" to send out an inspector who will look around (or perhaps only drive by without stopping) and then solemnly declare: "This house is fireproof".

Poors and Standard Fire Rating Company and Doomys Fire Rating Agency would be excellent choices, based on their prior experience.

In the real world, meaning Main Street as opposed to Wall Street, this would be illegal. Against the public interest, because it encourages houses to mysteriously burn down. The insurance policies owned by people without a financial stake in the fire would be declared null and void because they are contrary to public policy, which sees minimizing the number of mysterious house fires as a good thing.

Ding.

Rather than a bad thing, as now occurs under America's predatory capitalist system.

Now change an assumption. Assume I tell 99 of my poker-playing gambler friends about the boy's strange and dangerous interest. Starting with my appraiser buddy, who's predatory income as a result of a mysterious fire will double, as a direct result of his appraisal.

Now assume the $400,000 house burns to the ground. One hundred or so insurance companies will collectively pay $40 million in claims on the loss of a single $400,000 house. The benefits of a $400,000 disaster are magically multiplied by a factor of 100 and transformed into a $40 million disaster - with one family suffering a loss and 100 families experiencing a gain.

That is what we are paying for. That is what we are bailing out with our hard-earned money. And everyone involved knows it. So somebody tell me, why hasn't anyone in power said this entire casino is contrary to public policy and therefore these contracts are Null and Void?