Tuesday, May 12, 2009

CDSs between the haves and have-nots

This sunny afternoon, while studying a bit what the Credit Default Swaps are all about, the idea came up of proposing a new financial instrument (an innovative financial tactic of sorts). Namely, a new application for CDSs.

Paul Krugman, winner of the Nobel Prize in Economics, in his book The Return of Depression Economics and the Crisis of 2008, answers the question "what is depression economics?" thus:

Essentially it means that for the first time in two generations, failures on the demand side of the economy - insufficient private spending to make use of the available productive capacity - have become the clear and present limitation on prosperity for a large part of the world.
Given that the demand side is always a problem during downturns in the economy, why not have contracts, CDSs, between the wealthy and the less fortunate that stipulate that once the wealth is diminishing at the Palace, the poor, harder hit by economic crises, receive a return based on the premium they previously paid. In this manner, during good times reserves are responsibly created for the eventual bad times. Not a social program, but unadulterated good old-fashion market action.

We leave the implementation to the sharper minds in the industry. The new sharper-and-regulated ones, given that the merely-sharp engaged only recently in what Gillian Tett describes so:
the [...] derivatives dream collided with the housing boom, and was perverted — through hubris, delusion, and sheer greed.
Though of course we volunteer to act as the Clearing House for the proposed instrument.

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