Lehman Brothers Crash: Inside the Accounting Trick That Destroyed the Economy
The first difference with an unregulated market, is that I can buy health insurance on anyone. So a credit default swap, phrased in terms of health insurance, would allow me to buy health insurance on you, where I get paid if you get sick. Moreover, I can do everything in my power to make you sick. So, I would be allowed to buy insurance on your health, and then loosen the lug-nuts on your car tires.
For example, hedge-fund manager Bill Ackman could buy a credit default swap on Fannie Mae or Freddie Mac even though he had no interest in the success of either company. There is nothing to stop him from going on CNBC to suggest that both companies were completely bankrupt, nor is there anything to stop a financial news agency like Bloomberg from repeating the story and passing Ackman’s self-interested lies off as truth.
The problem is a little worse than it sounds. Companies are legally required to provide financially accurate reports to the public. There is no corresponding requirement that “investors” in destruction who profit on the demise of a company have to provide accurate information at all. They are free to spread fear-mongering speculation. For example, Bill Ackman could say, “It doesn’t matter what the rating agencies say about their capitalization. Implicit guarantees don’t work in the market that we’re in now. What matters is capital.” He isn’t saying that these companies are broke, but rather that his credit default swaps are worth more than what the market thinks.