Replies to post #743 on Wells Fargo and Company (WFC)

[Investorman]

I don't know if the carnage is over yet. We have a long, tough summer to get through.

AIB might be on the mend from its bottom since the meltdown in Ireland started earlier.

I still don't like BAC.

[Investorman]

"That’s where the similarity ends. Unlike your homeowners insurance, credit default swaps are unregulated. Investors were allowed to buy insurance on bonds they didn’t even own, and companies like AIG were allowed to write credit insurance many times over on the same bond. These bonds, many of them backed by subprime mortgages, often were rated triple-A, so no one expected them to default. Collecting premiums looked like easy money.

But when the housing market began to unwind, AIG had to begin making good on those credit default swaps. Worse, instead of just paying once, it had to pay many times over for the same defaulted bond. That became the financial equivalent of paying a dozen people for the full cost of replacing each home wiped out by a hurricane."

[Investorman]

"In fact, it was a law approved by Congress in 2000 that allowed companies to place tens of trillions of dollars of these risky credit default swap bets.

After the 1998 collapse of Long Term Capital Management, a giant hedge fund that pioneered the use of derivatives, the Fed engineered a rescue to prevent the unwinding of risky bets from spreading to the larger financial system. That brought calls for tighter regulation of derivatives, including a push for greater derivatives regulation at the Commodity Futures Trading Commission, led by a former Wall Street attorney named Brooksley Born.

But strong opposition to the proposal from then-Fed Chairman Alan Greenspan and senior Clinton administration officials sank the idea. On Dec. 21, 2000, President Clinton signed into law the Commodity Futures Modernization Act, which further eased restrictions on derivatives like credit default swaps.

The new law cleared the way for an explosion in credit default swaps. In the first half of 2001, there were $632 billion in credit default swaps outstanding, according to the International Swaps and Derivatives Association. By the second half of 2007, that number was up 100-fold — to more than $62 trillion. Now, as the government tries to unwind the mess at AIG, much of tax money pumped into AIG has quickly flowed out to dozens of “counterparties” — the companies, investment funds, municipalities and others who bought credit default swaps from the insurance giant.

“AIG entered a lot of speculative derivatives gambles with banks that were operating in the role of a bookie who made bad bets,” said Stout. “And our taxpayer funds went to pay off the bookies.”