Wednesday, December 31, 2008

Financial Reporting and the "$62 trillion" securitization market

I do have to say that economic reporting on the financial crisis has been amazingly good. Sure I've had my gripes but venues (especially This American Life's Planet Money) have done on the whole pretty well.

One failure though is the failure to note the winners along the way. The millions of people who were able to purchase a home who otherwise wouldn't have.

The other failure is just accounting, making the $62 trillion notional value of the credit default swap market sound like a big deal. It is a meaningless number.

Two reasons in particular.

1) Many of the trades are double, triple, etc. counted. It's like if I sold a pen to R- for $1, who sold it back to me for a $1, and then we repeated this 1 trillion times. That would create $1 trillion of notional value, but no real value. The swap market is counted this way.

2) The trillion is the notional value, but it is not representative of how much money is changing hands. You can think of these as insurance contracts. Taking out $1 million in life insurance doesn't mean $1 million is changing hands, far less. Just the premium. The insurance company is not taking up a $1 million obligation.

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