Credit Default Swaps Weapons of Financial Mass Destruction

The latest downward spiral in the global commodity and stock markets, coinciding with several high profile bank failures, is conjuring up fears of the calamities of the Great Depression of the 1930's. European and Asian stock markets are plunging as terror and panic hits Wall Street. The US Congress finally passed a massive $700 billion rescue package to unclog the credit markets, yet US stock markets have continued to plummet, shedding $1.5-trillion in value.

Hindsight is the best sight, but the chaos gripping the markets started with US Treasury's reckless decision to allow Lehman Brothers (LEH) to fail, which set-off an unstoppable chain reaction that unleashed a torrent of panic selling on global stock markets, and froze the European and US banking systems. LEH left its creditors holding $150 billion of near worthless bonds, and common and preferred shareholders were completely wiped out. “Until the day they put me in the ground I will wonder, why we were the only one that was not rescued,” former Lehman chief Larry Fuld told Congress.

However, there were also huge losses for companies who wrote credit protection on LEH's bonds over the past five-years. Those sellers of credit protection are now staring down the barrel of billions of dollars in claims, and are scrambling to raise money by selling anything they can get their hands on, including commodities and stocks. Warren Buffet has referred to these credit defaults swaps CDS's, as “weapons of financial mass destruction,” and the fuse on the time-bomb has been lit.

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