Let's say a bundle of subprime mortgages are about to become worthless. You can buy a "credit default swap" to cover this event — that is, you can pay for insurance against the default. Of course, if the default is a virtual certainty you'll have to pay through the nose for the insurance.
Some organizations decided to speculate on the failure of a few bundles of securities that were about to default:
Traders can buy credit-default swaps on securities they don't own. At one point, at least $130 million of bets had been made on the performance of around $27 million in securities, according to a person familiar with the matter.In other words, they gambled.
The gamble didn't pay off. The company that sold the insurance made certain that all the loans were paid off and therefore the insurance payments wouldn't be made. All legal, of course, and investors who made the actual loans got their money back. The speculators are outraged because they can't profit from the pain of the actual lenders. There's a lesson here about disaggregation, finance, gambling investing, and disaggregation, but I'm not certain just what it is.
Topics: · finance
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