A sigh of relief (though maybe a small one, who knows)

The cds market is perhaps smaller than I thought, and I wonder if the numbers account for  positions closed out by issuing new contracts…

Alea | Misconceptions About the Credit Default Swap Market

I am rethinking a lot of the macroeconomics that I have learned.  In the end, it will be all about microeconomics.  Just like always.

I have started reading a nice paper called ‘The Panic of 2007,’ by Gary Gorton.  It is clear from that paper that most of the later subprime loans were designed to be refinanced in 2007-2008, by design.  I would characterize those loan contracts as short term leases with an extension option for the lenders, rather than mortgage loans.

The paper points out that the

No-trade theorem – Wikipedia, the free encyclopedia  has some force here.  Once the mortgage indexes were up and running, the value of the contracts became closer to common knowledge, and so there was no trade, and therefore leading to a run on the ‘shadow banking system.’  I don’t fully get the bank run part of argument yet, nor can I be sure it is all consistent, but it is an intriguing (and scary) suggestion.

I gave a short talk on Bear Stearns in the spring, with one of my colleagues–an expert in central banking–who said that the crisis will not  be over until after the election, when the congress can actually make a sensible decision. I guess he was right.

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