Steve Titterud’s comment on my Roubini post yesterday gets at the aspect of the financial crisis that I’ve found most surprising–please pardon the naivete–as I’ve worked the economy beat since last fall: “We are financing the losses in a craps game!” He’s talking about AIG bailout money, but the murky world of derivatives is crammed to the gills with contracts that amount to no more or less than gambling on the performance of assets owned by others. Remember the phrase “casino capitalism,” which enjoyed a brief vogue a few years back? We didn’t know the half of it.
Pure speculators aren’t the only problem. For a lot of investors, credit default swap positions can mean you’re actually better off seeing your investment go belly up. As Bloomberg reported a few days ago:
Amusement-park operator Six Flags Inc. and automaker Ford Motor Co. may be pushed toward bankruptcy by bondholders trying to profit from credit-default swaps that protect against losses on their high-yield debt….
Investors who bet on the collapse of a company are pitting themselves against traditional debt holders at a time when Moody’s Investors Service projects defaults will more than triple this year to the worst level since the Great Depression. The clash may stall restructuring efforts to prevent bankruptcies, as basis traders may be less inclined to participate in distressed debt exchanges, said Matthew Eagan, an investment manager at Boston-based Loomis Sayles & Co., with $7 billion in high-yield assets.
“Before, you really had to worry mostly about where you were in the” company’s capital structure, he said. “Now, you have to consider the possibility that you might have this large holder of CDS incentivized to see it go into bankruptcy. It’s something that’s going to come up more and more.”
Casino capitalism indeed. Isn’t there supposed to be an underpriced buffet where the suckers who get fleeced can at least score a decent meal? Or is that what charity foodshelves are for?