What are the characteristics of a bear market?
The United States economy has been in a bear market since 2007, but what does that mean? We read all about the fantastic bull market that assisted Enron in all its success in the early 90’s, and we associate bad connotations with the bear market, but I was clueless about the details. There is no finite definition of a bear market but it is said to be a market condition in which there is a steady drop in the stock market price over a period of time. The accepted measure is a price decline of 20% or more over at least a two month period. It is accompanied by widespread pessimism. Investors anticipate further losses and are often inclined to sell. The graph below compares the bear markets from 1929 to the present.
How much is a trillion dollars?
Say you have a machine that shoots out a $100 bill every second, all day and all night. At the end of the first minute you would have $6,000. After the first hour $360,000, and at the end of the first day you would have more than $8.6 million. One year later you would have a little more than $3.15 billion. It would take your little machine 317 years to shoot out $1 trillion at a rate of $100 a second!
Credit Default Swaps for Dummies:
Say I lend Betty Borrower $100. I would like to get insurance on this debt incase Betty goes broke. I go to Ike Insurance and ask if he can guarantee Betty’s debt for me. Ike offers to insure the debt if I pay him $8 a year and I agree. Ike is willing to insure Betty’s debt because he did his homework and saw that she had a superb credit rating, and so, the credit default swap is written.
Unfortunately Ike’s business is having some problems and he no longer has the funds to pay me if Betty goes broke. The premiums I paid Ike are long gone. Credit agencies notice this and tell Ike to find cash or his credit rating will go down. Ike is in trouble because if his credit rating goes down he won’t be able to raise cash at good rates and keep his business open. Sure enough, he goes bankrupt.
The debt on my books that was insured is now uninsured and the agencies are now knocking at my door questioning the exposed debt. My credit rating is too downgraded and I, like Ike, must file for bankruptcy. I must come clean, I was also knee deep in the credit default swap game too. I wrote a ton of CDS’s to Susie Sucker insuring the debt owed to her by other parties. When I go down, the pressure is put on her, and like dominoes we all fall. It turns out that the ratings we used to judge each other’s debt worthiness were bogus from the start.
Credit default swaps were invented by JP Morgan in 1995 as an unregulated derivative. Turns out that the smart MBA’s in the business were able to turn a simple insurance policy into a means of making money. The swaps were used not only to insure against debt but to speculate if a company would fail or not.
Why was AIG in desperate need of being saved: they had about $78 billion worth of swaps when they went down.