As described in the Reuters article, “Credit default swaps, or CDS, are derivatives that let a buyer transfer loan default risk to a seller, making them a kind of insurance against default. CDS can also be bought by speculators without direct interest in the debts involved.”
The derivative market, including credit default swaps, is a $600 TRILLION off-exchange market.
“It’s a banking function that’s been converted by this small group of banks into a trading instrument,” said Karen Shaw-Petrou, managing director at consulting firm Federal Financial Analytics. “It is not a transparent market,” said Shaw-Petrou. “… there’s no real proof of value other than moment-to-moment exchanges that are then impossible to verify because it’s not a public exchange.”
In some cases, the same entity that bundled the original loans into derivatives, subsequently purchased credit default swaps against the same bundled loans. Simply stated, they knew certain original derivatives were bogus investments and covered their backsides against the inevitable default with credit default swaps.
Credit default swaps played a central role in the near collapse of AIG in 2008, which led to a massive U.S. taxpayer bailout of the former insurance giant as well as the bailout of other U.S./multinational financial giants.
“The European Commission, the EU’s executive body, said it is probing whether major investment banks, including Goldman Sachs and JP Morgan, colluded in their operations in a market that is already under scrutiny by U.S. authorities and being subjected to broad, new regulations,” as reported by Reuters. The European Commission, which regulates competition in the EU, said it would investigate whether 16 investment banks had colluded or abused a dominant market position. The U.S. Justice Department in 2009 launched a more tepid inquiry into “anti-competitive practices” in the trading, clearing and pricing of CDS in the United States.
Analysts say that Credit Default Swap trading was too concentrated. “Eighty percent of derivatives transactions on both sides of the Atlantic are done by about eight banks,” said Karel Lannoo of the Center for European Policy Studies, a think tank.
The 16 banks being examined are: JP Morgan, Bank of America Merrill Lynch, Barclays, BNP Paribas, Citigroup, Commerzbank, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, Morgan Stanley, Royal Bank of Scotland, UBS, Wells Fargo Bank/Wachovia, Credit Agricole and Societe Generale.
Former Goldman Sachs principals have held positions in the U.S. at the right-hand of U.S. presidents and in the Treasury Department:
Robert Rubin, employed for 26 years by Goldman Sachs and member of the Board, and Co-Chairman from 1990-1992; served from 1993 to 1995, as Assistant to President Bill Clinton for Economic Policy and in that capacity directed the National Economic Council.
Henry Paulson, Jr. served as the Chairman and Chief Executive Officer of Goldman Sachs and as U.S. Treasury Secretary under President George W. Bush. Paulson was Treasury Secretary at the time of the economic meltdown in 2008.
Lawrence H. Summers, a former top economic adviser to President Barack Obama and Timothy Geithner, U.S. Treasury Secretary in the Obama Administration also have strong ties to Goldman Sachs and other banking institutions under investigation.