Bears Who Buy (Derivatives, That Is)

Andy Kessler's op-ed in The Wall Street Journal adds to my store of knowledge I wish I didn't have to acquire.

You can't just manipulate a $62 trillion market for derivatives. So what did the bears do? They looked and found an asymmetry to exploit in those same credit default swaps. If you bid up the price of swaps, because markets are all linked, the higher likelihood (or at least the perception based on swap prices) of derivative defaults would cause the value of these CDO derivatives* to drop, thus triggering banks and financial companies to write off losses and their stocks to plummet.

General Electric CEO Jeff Immelt famously complained that "by spending 25 million bucks in a handful of transactions in an unregulated market" traders in credit default swaps could tank major companies. "I just don't think we should treat credit default swaps as like the Delphic Oracle of any kind," he continued. "It's the most easily manipulated and broadly manipulated market that there is."

*CDOs are derivatives consisting of packages of debts derived from mortgage loans, commercial loans, etc. So we're dealing with derivatives of derivatives of derivatives? I'm too old for this!