Really. Take credit default swaps ....from Reuters.:
"This was supposedly a way to hedge risk," says Ellen Brown, the author of the book "Web of Debt."
"I'm sure their predictive models were right as far as the risk of the things they were insuring against. But what they didn't factor in was the risk that the sellers of this protection wouldn't pay ... That's what we're seeing now."
When insuring against insurance on insured risk, however, ingenuity and chutzpah (highly prized attributes of the mid-class MBA) didn't guarantee success:
In one notorious case, a small hedge fund agreed to insure UBS AG (UBSN.VX: Quote, Profile, Research, Stock Buzz), the Swiss banking giant, from losses related to defaults on $1.3 billion of subprime mortgages for an annual premium of about $2 million.
The trouble was, the hedge fund set up a subsidiary to stand behind the guarantee -- and capitalized it with just $4.6 million. As long as the loans performed, the fund made a killing, raking in an annualized return of nearly 44 percent.
Can you spot the obvious mistake?
As hedge funds and others bought and sold these protection policies, they did not always get prior written consent from the people they were supposed to be insuring. Patrick Parkinson, the deputy director of the Fed's research and statistic arm, calls the practice "sloppy."
Hedge funds? "Prior written consent?" Mr Parkinson intends a jest, surely. Dare we snigger?
Central bankers had been warning about "sloppy" back-office operations (i.e.: trades scribbled on the back of an envelope) and the unconscionable stacking of derivatives on derivatives for at least two years prior to Bear Stearns collapse. Jerome Kerviel got Société Générale out of a bunch of the bad stuff way ahead of time. They dumped their worthless positions long ago.
You might wonder, as you tackle your tax return or household accounts, how highly-paid high-flying moppets can get away with appalling "record-keeping". Well, it's because Hedgies are brokerage houses' best customers, and so they get the trades they want, as well as the ability to "unwind" after the market. In clear, they were able to reverse bad trades while you were sleeping.
They made up stories to go with the biggest upside they could grapple out of the market. But, hark! A time of reckoning dawns:
``If you have [hedge-fund] managers [not owners or investors, mind] actively engaged in false rumor mongering and naked short selling, I'd say go get them,'' said Bill Grayson, president of Falcon Point Capital LLC, a San Francisco-based investment firm. ``But a wholesale witch hunt is not going to be met with a lot of smiling faces in the hedge-fund community.''
What's that? This band of anti-social botherers is now a - did you hear that? - "community"? Not so fast! When did they incorporate, who elected their Mayor? Where's their Town Hall and what's their waste management policy?
That's not the only problemo, though:
The New York Stock Exchange's regulatory arm and the Financial Industry Regulatory Authority, which polices almost 5,000 brokerages, will conduct a parallel probe into short sales, including on-site visits to firms, the SEC said. Large declines in brokerage shares this month were often accompanied or preceded by moves in credit default swaps tied to those firms, the Wall Street Journal reported today.
Frontrunning? Why indeed would insurance companies need to pay out on defaulted credit default swaps? Insurance companies take the premiums and severely limit the terms of payout. Or go out of business.
Start with sub-prime lending (that's all it was), then go up the tree to the truly Free McMarket and unravel the knot of corrupt and criminal practices and you bump up against credit default swaps wherever you turn.
What could go wrong?