Lesson 20:  Anatomy of a Recession Part 3:  Orchestrated Chaos
Section C: Sports-Betting and Game-Rigging
         After Paulson and the Democrats took power, 3 things happened that added volatility to the market,
    made a lot of investment bankers rich, and paved the way for the 2008 elections:

    3.  The third significant event of 2007 (see Lesson 17) was the creation of the TABX index.  To
    understand its significance, you must first understand the Credit Default Swap (CDS).  The CDS is simply
    a sports bet, except instead of betting that a team will win or lose a game, you bet that someone will
    default on a loan. It is politely referred to as insurance, and the bets are called premiums.  But insurance
    insures you against the risk of losing something.  With the CDS, the only thing you risk losing is the bet.  
    That is because you don't have to own anything or buy anything to place the CDS.  You don't have to own
    the loan or owe the loan.  You can just be a spectator.  If the loan you're betting on defaults, you collect.

            The CDS was originally started for insurance purposes.  In 1997, they were created by the
    commercial bank JP Morgan in order to hedge against defaults on the loans they had made.  They were, in
    a way, insuring their own loans.  The reason the CDS market degenerated into spectator betting is because
    it was completely unregulated, which made it better than a casino.  Regulation was prevented by  the
    Commodity Futures Modernization Act of 2000, championed by Senator Phil Gramm and signed by
    President Clinton.  A CDS could be written on a napkin; it could be placed on anybody; it  could be traded
    and re-traded.  The CDS market became an incestuous orgy, where loan risk was passed around until
    every major bank was wed to each other like a bizarre harem.  By the end of 2007, the CDS market was
    estimated to be worth 60 trillion dollars, 3 times the value of the stock market.  

            Around 2004, the folks at Dow Jones tried to come up with some standardization of CDS contracts,
    and an index to guide the price of CDS.  But the Dow's index only applied to commercial loans.  It took
    Paulson's pals at Goldman's Sachs to dream up a specialized index just for CDS placed on Mortgage
    Backed Securities (MBS, see Lesson 17).  They did just that in 2006, 6 months before the Senate
    confirmed Henry Paulson as U.S. Treasurer.  Spear-headed by Goldman Sachs executive Brad Levy, the
    index was called ABX, and it was based on a few securites owned by just 16 investment banks.  Because
    of its narrow focus, it was easy to manipulate.  All you had to do was take out a bunch of CDS on a
    company or two out of the 16.  Buying a CDS is betting that something bad will happen.  When a bunch of
    those bets are made, confidence grows that something bad WILL happen.  That drives down the ABX,
    makes it harder for the involved companies to borrow and lend, and the bets become a self-fulfilling
    prophecy.  Then you can go to the stock market and short-sell shares of the company (see Lesson 18).  

            However, that wasn't easy enough (or risky enough).  So in 2007, Levy's group created a sub-index of
    the ABX just for sub-prime MBS.  The index was called the TABX.  After that, it only took 3 months for
    Bear Stearns, one of the biggest of the ABX companies, to face bankruptcy.  Bear Stearns assets in March
    2007 were full of MBS, but even more full of CDS.  Over a weekend, in the office of New York Fed
    president Timothy Geithner, the fate of Bear Stearns was decided by executives from Goldman Sachs and
    JP Morgan (who invented the CDS), mostly without input from Bear Stearns.  The Federal Reserve would
    loan JP Morgan 30 billion dollars to buy Bear Stearns.  This opened the door to the idea of government
    bailing out private investment banks.  Bear Stearns was sold for just $2 per share, less than the value of its
    office property.  

            It turns out that unregulated gambling wasn't so great after all.  At least in a casino, the House has to
    pay if you win.  With the CDS market, the House didn't have enough money to cover the winners.  So now
    you're covering them.  You may have heard of this casino: A.I.G.