Re: good question Credit Default Swaps

[David Farber <dave () farber net>]

________________________________________
From: Rod Van Meter [rdv () sfc wide ad jp]
Sent: Wednesday, April 02, 2008 5:09 PM
To: David Farber; eric.cecil () gmail com
Cc: ip
Subject: Re: [IP] good question  Credit Default Swaps

> IOW, how can you bet more than twice the amount of money than there exists in the entire U.S. economy?
>
> ... I simply attempting to grasp what it means when someone says $45 trillion is in play, but the U.S. economy = $22 
> trillion.

I would be the *last* person to know anything serious about markets, but
I think you've misunderstood something here: the value of the securities
(the debt on the mortgages, right?) is only $7T, but the amount of
trading of those securities was worth $45T.  That is, the average
mortgage traded hands 45/7 = ~6.5 times in *one year*.

So there is not twice the total size of the economy in debt "in play".
This is equivalent to asking the total value of the stocks that get
traded on the stock market in a year.  I have no idea what the number
is, but it's a *lot* more than the total sales of all the companies.

When a mortgage trades hands, obviously that's a financial transaction;
I have no idea what number is added to the size of the U.S. economy --
what "value" does that trade have?  If it were 100%, then the $22T total
economy would have to be greater than $45T, right?  But nobody could
afford to trade them at that rate.  It's probably a small fraction of a
percent of the value of the loan, or the banks couldn't afford to trade
them seven times a year.

We're wandering a little far from IP's primary mission, but I'm curious
what fraction of the total economy is "paper trading" of securities,
consulting with lawyers, and other back-end economic activities that are
not primary production.  (n.b.: I'm not saying that those are of no
value; they are very valuable to our complete economy.  (If you don't
believe in, say, the value of venture capitalism, look at a country
without it.) But there must be some ratio of primary to secondary
economic activity beyond which it's unsustainable -- *somebody* has to
actually grow the food and build the automobiles.  The same argument
applies to entertainment costs.)

                --Rod



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