This is all deeply rooted in the ideology of deregulated free market capitalism where we let financial institutions, banks & corporations dictate and everybody is at the mercy of big business & a tyrannical government willing to back them up at tax payers expense. The government knew what was going on but allowed it for the sake of profit. And AIG is too big to fail because of contracts & we’re all just supposed to sit back & take the abuse. Why don’t we just overthrow the government? (-A-)
This is all deeply rooted in the ideology of deregulated free market capitalism where we let financial institutions, banks & corporations dictate and everybody is at the mercy of big business & a tyrannical government willing to back them up at tax payers expense. The government knew what was going on but allowed it for the sake of profit. And AIG is too big to fail because of contracts & we’re all just supposed to sit back & take the abuse. Why don’t we just overthrow the government? (-A-)
@lilpenguinboy The point Sal is trying to illustrate is that these insurance companies and other entities who hand out swaps don’t need to set aside money for the risk of default.[cos of loosely defined mandate (pre-crises)]
Thus making them in Buffet’s words “financial weapons of mass destruction”.
Absolutely, my thoughts exactly but there’s no way to reconcile it other than perhaps the Pension fund accepting 6% and the insurer 4% because then the insurer could still have the $1 billion in the bank accruing say 6% a year and then if they need the cash out they can just withdraw it.
I think the ‘lessons’ we’re supposed to learn from this crisis are false ones, the fact is that almost every business relies on credit and gives credit, and the world’s better for it.
Now, Goldman is using CDS to bet on Greece’s default. Of course, Goldman would be H1 and Greece would be Corp B in the video. P1 and P2 is probably the EU countries, such as Germany. I am curious to know who plays the role of the insurer, I 2 in the video, in terms of the situation in Greece?
This is so poorly explained! I shudder to think of the number of people who believe that this is how it works.
Just enough text for one point. If the CDS (Insurer) issuer had to hold the billion dollars for the insurance why would they EVER offer it? They could get 8% return on the same amount of money by investing the company directly instead of the paltry 1%.
@Hudson4351 That is correct. Insurance rates are based on actuarial tables that predict the probability of various events happening ie. car crash, age of death, etc. CDS are different though because it is as though 1000 people could get insurance for one car. Even if the probability of this car crashing and the insurance having to be paid out is the same as all other cars, in the event that this car actually does crash (the company defaults) then the insurance company is screwed.
At around 3:55, you said that the companies issuing the CDS only have to keep enough money aside to cover the probabilistic amount of debt defaults rather than the entire amount of CDS issued. You imply that this is one of the major problems with CDS, but don’t car/house/life insurance companies work the same way? They don’t actually have to set aside $1 for every dollar of insurance they issue, right?
It is probably debateable whether a financial instrument ‘CDS’ would be a weapon of mass destruction in the financial market or the credit rating companies themselves whom rated those insurance companies as good enough to insure those financial institutions like pension funds and hedge funds
Thank you for this great video! But what happens if insurance company doesn’t have enough money to the pension fund in case the company A or B is bankrupt? Thanks
so why can’t this be resolved like this: moody’s should be very strict and verify all those insurance companies or banks before every insurance/loan is being set?or if not for every transaction, then periodically check ups.. so in that way, insurers wouldn’t be so overrated…why isn’t the blame put on moody’s?
kudos guys, your work is very important. the more I understand this, the less chance I have of becoming a victim of the financial system. keep it up! perhaps a video on the big carry trade?
An.Apple
25 Comments
Again Khanacademy.. awesome videos
you make something confusion to something totallly understandable 
This is all deeply rooted in the ideology of deregulated free market capitalism where we let financial institutions, banks & corporations dictate and everybody is at the mercy of big business & a tyrannical government willing to back them up at tax payers expense. The government knew what was going on but allowed it for the sake of profit. And AIG is too big to fail because of contracts & we’re all just supposed to sit back & take the abuse. Why don’t we just overthrow the government? (-A-)
This is all deeply rooted in the ideology of deregulated free market capitalism where we let financial institutions, banks & corporations dictate and everybody is at the mercy of big business & a tyrannical government willing to back them up at tax payers expense. The government knew what was going on but allowed it for the sake of profit. And AIG is too big to fail because of contracts & we’re all just supposed to sit back & take the abuse. Why don’t we just overthrow the government? (-A-)
@lilpenguinboy The point Sal is trying to illustrate is that these insurance companies and other entities who hand out swaps don’t need to set aside money for the risk of default.[cos of loosely defined mandate (pre-crises)]
Thus making them in Buffet’s words “financial weapons of mass destruction”.
Absolutely, my thoughts exactly but there’s no way to reconcile it other than perhaps the Pension fund accepting 6% and the insurer 4% because then the insurer could still have the $1 billion in the bank accruing say 6% a year and then if they need the cash out they can just withdraw it.
Jay..Many European banks are I2!! Thats why they are so nervous…….
Sal Thanks!!!
I think the ‘lessons’ we’re supposed to learn from this crisis are false ones, the fact is that almost every business relies on credit and gives credit, and the world’s better for it.
great lecture!
Now, Goldman is using CDS to bet on Greece’s default. Of course, Goldman would be H1 and Greece would be Corp B in the video. P1 and P2 is probably the EU countries, such as Germany. I am curious to know who plays the role of the insurer, I 2 in the video, in terms of the situation in Greece?
This is so poorly explained! I shudder to think of the number of people who believe that this is how it works.
Just enough text for one point. If the CDS (Insurer) issuer had to hold the billion dollars for the insurance why would they EVER offer it? They could get 8% return on the same amount of money by investing the company directly instead of the paltry 1%.
Wonderful explanation. Thank you.
@Hudson4351 That is correct. Insurance rates are based on actuarial tables that predict the probability of various events happening ie. car crash, age of death, etc. CDS are different though because it is as though 1000 people could get insurance for one car. Even if the probability of this car crashing and the insurance having to be paid out is the same as all other cars, in the event that this car actually does crash (the company defaults) then the insurance company is screwed.
There is no mention of increased Collateral Calls when the ratings are downgraded whereby depletion of capital happens, sort of like run on banks
I wonder how many H1’s bet on General Motors 10 years ago?
great job sir. i really enjoy the way you lecture.
At around 3:55, you said that the companies issuing the CDS only have to keep enough money aside to cover the probabilistic amount of debt defaults rather than the entire amount of CDS issued. You imply that this is one of the major problems with CDS, but don’t car/house/life insurance companies work the same way? They don’t actually have to set aside $1 for every dollar of insurance they issue, right?
It is probably debateable whether a financial instrument ‘CDS’ would be a weapon of mass destruction in the financial market or the credit rating companies themselves whom rated those insurance companies as good enough to insure those financial institutions like pension funds and hedge funds
Excellent video!
hey just clarify the relationship with corporation B and Insurance 2 in that explanation
Thank you for this great video! But what happens if insurance company doesn’t have enough money to the pension fund in case the company A or B is bankrupt? Thanks
Great video. Very informative, thanks.
Derivatives are WMD! so true!
so why can’t this be resolved like this: moody’s should be very strict and verify all those insurance companies or banks before every insurance/loan is being set?or if not for every transaction, then periodically check ups.. so in that way, insurers wouldn’t be so overrated…why isn’t the blame put on moody’s?
faaaantastic
kudos guys, your work is very important. the more I understand this, the less chance I have of becoming a victim of the financial system. keep it up! perhaps a video on the big carry trade?
the dollar is propped up by being the currency oil is priced in.