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View Diary: Some Credit Swaps knowledge, Please (51 comments)

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  •  I explained it to my brother in law this (0+ / 0-)

    way. Now I was only trying to explain the concept, without getting into the nitty gritty. I said:

    Imagine you have an account receivable from Joe, for $100. Joe is depending on two account receivables of $50 from Pete and Paul to pay you. Pete is relying on receivables from Jane and Sally to pay him, and Paul is relying on Pete, Joe, Paul and Dick to pay him. As it turns out, Dick and Sally are both relying on payments from Fred who is relying on you to pay his obligations. Now you don't know any of these people, except Joe. How much value would you place on this receivable? He said, "zero." I said that's right and that is what has been happening to these institutions when they woke up to the fact that they have no way to value the assets on their books. Worse yet, the values are unknowable. People pretended to know because they looked at individual instruments in isolation in normal economic circumstances. Those rules don't apply when there is a major upheaval in the economy.

    BTW, good post. Thanks.

    •  damn, you are hurting my head. (0+ / 0-)

      Joe owes me $100 in goods that I sold him.  I don't care who owes him or what their financial health is downstream.

      Joe owes me $ up according to the agreed upon terms or its legbreaking time ;-).

      Seriously, if Joe bails on me, I get what I can through bankruptcy proceeding...and it won't be close to the $100.  And I may have to fight Sally,Peter, Paul, and Dick at the door to Joe's place to beat them to any compensation.

      So "IF and WHEN" I FIND OUT JOE CAN'T PAY ME, my $100 accounts receivables item then may be worth $0 then.

      Until then the debt is worth $100.

      I must be missing something here.

      How does having a circle jerk between all parties prevent my $100 from sitting on my books as $100?


      •  Joe's account might be worth $100 to you, (1+ / 0-)
        Recommended by:
        Gary Norton

        absent that bankruptcy, but to the bank considering whether to lend you money or not, it is worth $0.  

        Steny Hoyer = a slam dunk argument for term limits

        by jlynne on Tue Oct 07, 2008 at 03:38:07 PM PDT

        [ Parent ]

      •  Banks have to value their assets (0+ / 0-)

        which are primarily loans based on the borrower's ability to repay. In this instance there is no ability to analyze, let alone calculate, the first debtors ability to pay. You may value it at $100 as a person, but as a business, your accountant will say say you can't do that because you would be misleading your shareholders and investors or other creditors as to the company's financial health. Failure to follow accounting rules can land you in jail. Just ask Jeff Skilling and a few others.

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