Sunday, December 14, 2008

A Children's Guide to Credit Default Swaps and the Current Economic Situation

Billy wants to buy a pack of baseball cards. However, baseball cards are a dollar and Billy doesn't have a dollar. So Billy goes to his best friend Jamie and says, can I borrow a dollar? Jamie says, sure, but only if you pay me a dollar and a nickel back. Billy says okay, because he plans to sell the cards for two dollars. Jamie writes an IOU because he only has a quarter. Jamie isn't sure that Billy can pay him back, so he decides to sell a credit default swap. Jamie goes to Sally and says, I owe Billy a dollar and Billy owes me a dollar and a nickel back. Can I give you a penny a day in exchange for you signing your name on the IOU I gave Billy? Sally doesn't know Billy, so to her this proposal looks like a bargain. Besides, Sally just got ten dollars for her birthday so even if Billy can't pay back she can easily cover Billy's debt.

Repeat this process 70 trillion times.

Billy and the 69,999,999,999,999 other kids open their card packs. Most of them are worthless, and not all the children manage to sell their cards for two dollars as planned. These children now are not only unable to pay the Jamies of the world a dollar and a nickel, they can't even cover the interest on Jamie's loan. The cardshop owners of the world go to the Sallies of the world and ask for their money. The Sallies of the world had enough money to cover ten credit swaps, but because they used that as a rationale to take on several hundred, they are now totally broke. The Jamies of the world profusely apologize and swear they had no idea that this could have happened.

So, to summarize: Billy has no money, Jamie has no money, the cardshop owner has no money, and Sally has no money. They all do the logical thing, which is to ask their parents for money and promise to be good with it this time.

If that was confusing, fear not, it is all handily explained in the following cartoon:


  1. And Daddy gives them the money, but he goes to sleep worrying because he knows he owes lots of money to his creditors himself.

    Also, the end of that video can very easily be misinterpreted. Even in context.

  2. OMG, I'm reading more econ blogs!

    "KEVIN: But one day, people realize that Pokémon is stupid and everyone decides that the cards are overvalued. That's right - everybody turned 12 on the same day! Now your Charizard is only worth, say, $25."


  3. I actually came up with that bored at work one day about three weeks ago, I don't read Econ blogs. I'm studying for certification in Apple's Motion, and the animation is the byproduct of that, I was sick of tutorials.

    As for the ending, um, never thought of it that way. Ew.

  4. I just read too many econ blogs, I've started dreaming of CDSs

    Is Motion easier than After Effects?

  5. I've never used After Effects, though from what I gather Motion is not only more difficult to use, but also less widely used and less powerful. I'm not sure why anybody bothers. It's like Aperture, Apple's crude imitation of Photoshop.

    Why am I learning this again? Because 1. I have no legitimate copy of AE and 2. I have certifications in every other Final Cut Studio app and if you collect all five you get super-duper-gold-star-pat-on-the-head certification.

    Okay, it's actually referred to as "Master Pro" certification, and how badass is that? You can say to people, "I'm a Master Pro!" (and a complete idiot for wasting my time learning Motion!)