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I think you are confusing the metaphor used by Mr. Liu with the Ponzi Scheme. He was refering more to a (demographic) age pyramid. Also, it is untrue to qualify the new credit derivatives as gambles. Gambles are the optional contracts (where the final pay off depends on decisions that one party may make later, hence they are often called "contingent claim" and not directly in the books of non-bank companies), or an arbitrary formula with conditions for the pay-off (e.g. "digital options" are pure gambles: e.g. you bet 100$ that the Apple Stock will hit 200$ by year's end... that or Jérôme's 100$/bl oil bet).

The CDS (credit default swaps) are actually just an insurance mechanism (you insure against failure of a debtor to repay). Only when you insure a risk that you do not have in your book, do you make a gamble. And it is not the primary goal.

The CDO (collateral debt obligations) are a risk and reward sharing agreement where everything is laid bare right at the start, no optional clauses, even if the risk-reward trade-offs are not homogenous between the tranches (tranche is slice, in french, I dunno why it is so, may be the first CDO's were "cooked" by a french chef). It is in concept no different than age-old practice of companies having preferential dividend shares, multiple-vote shares, golden shares, death-pill shares, etc, etc...

There are two Ponzi schemes in effect in the present crash, but they are not where you think. The first is simply the fractional reserve banking system itself. Techno just posted a diary which pretty much justifies it a mean of growth to get where we stand now (a mature industrial civilization), I doubt it will still be adequate for the post-peak contraction.

The second scheme is a classic ponzi bubble of selling an overvalued good for yet more money, to "some yet greater idiot": more and more bankers, brokers, realtors (all fee-earning), and yes even borrowers (who made capital gains refi after refi), where lured into a system of easy money that lasted until there was no more fools to bring in to keep the prices going up. And the last of the fools where simply those of the lesser quality (the subprime borrowers), and they were brought in as a last resort to keep the scheme running for another cycle because the guys before them didn't want to be the loosers.
 

Pierre

by Pierre on Sat Aug 18th, 2007 at 04:23:43 PM EST

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