The Financial Bailout Fiasco

Credit Default SwapsThe reality is that neither the plan put forth by U.S. Treasury Secretary Henry M. "Hank" Paulson Jr. - nor any of the addendums offered up by Congress or the lobbyists - will resolve this crisis.

The key culprits are the structured financial products that reside on the balance sheets of banks, dead investment banks, insurance companies, hedge funds and all manner of other duped and unsuspecting investor entities worldwide, as well as the proliferation of the unregulated $62 trillion credit default swaps (CDS) market.

Because all these securities, and in the case of credit default swaps, bilateral contracts, are impossible to value and impossible to guarantee, no one trusts them. As a result, everyone is afraid of these securities and contracts.

Banks are currently not lending to one another because they are afraid that the next round of write-downs and losses may imperil some of their trading partner banks to which they formerly lent billions and billions of dollars to every night. If the answer were really as simple as adding liquidity, the Federal Reserve would have lowered the Fed Funds target. But that won’t work. It’s a vicious cycle that’s eroding banks’ faith in one another, and worse, our faith in our banks.

Unfortunately, I don’t see the Treasury Department’s much-needed rescue plan being effective without actually addressing the pricing of - indeed, the very existence of - credit default swaps and collateralized debt obligations. As well intentioned as it is, the Treasury plan will create more problems than it solves and will eventually saddle taxpayers with so much debt that it will tank the dollar. It could even put the U.S. government’s AAA investment rating at risk. That would be calamitous.

By Shah Gilani
More at : How to End the Credit Crisis