“As Calculated Risk notes, before moving to New York I worked for Mr. Geithner at both the Treasury and the IMF. Mr. Geithner was, by the end of the 1990s, in charge of Treasury’s International Affairs division, so almost everyone who worked there — Tim Duy and Nouriel Roubini to name two — also worked for Mr. Geithner. At the IMF, Mr. Geithner encouraged the IMF to pay more attention to balance sheet vulnerabilities — and helped to push a paper I worked on with a group of talented young IMF economists through the IMF’s internal review process.

It consequently is no surprise that I am thrilled that Mr. Geithner looks to be Obama’s choice for Treasury Secretary. I am also pleased that President Obama also found a way to pull Dr. Summers — a voracious consumer of economic and financial analysis, including economic and financial blogs — into the administration. The current, severe crisis will provide plenty of work for both. Like Noam Scheiber, I hope that the combination of Dr. Summers’ intellectual creativity and Mr. Geithner’s disciplined analysis and political acumen proves fruitful. I suspect that Felix is right.”

http://blogs.cfr.org/setser/2008/11/23/a-new-economic-team/

Facilitate a Fed bailout of the speculative elements of the financial world and their sponsors among the larger derivatives dealer banks, but leave the real economy to deal with the crisis via bankruptcy and liquidation.”

Hard to sum it up much better than that.

The notional principal is offset by seller of the protection (I’m not using the actual terms for user-friendliness). As such, there is not necessarily an equal amount offsetting. Let’s use a real example:

I’m a hedge fund, and you’re an I-Bank trying to offset your exposure to those shitty car bonds you took on to keep your cash management business with shitty car maker. I’m the hedge fund, and I know that, in the aggregate, BBB bonds default at a rate of 15%. I have a huge swath of BBB bonds, so I only reserve 15% of the capital and – wala – I’ve made this deal at nearly 7x leverage.

But, oh shit, my shitty car bonds from shitty car maker go tits up along with a whole bunch of other shitty bonds in other shitty industries at the same time. Now, I default, and we have the magical “double default” that is blowing up the system (the bonds default, default one, then I default because I don’t have enough reserves, default two).

ISDA’s doing their damndest, but you it’s pretty hard to ride to the rescue when I can use $5 to lose $75 (which is about par for the course; the above deal is actually fairly tame). Oh, and to answer your question, no, there’s not an equal amount offsetting CDO’s. Remember, you’re offsetting default risk, not swapping fixed for floating or something along those lines.

The path we each prefers to “rescue” the economy depends on our political and economic philosophy. The free-marketeers and libertarians seem to prefer the crash and burn scenario, while the majority of less ideological people prefer a more moderate approach that temporally incorporates socialistic remedies in order to minimize the pain inflicted on Americans who are not accustomed to it and may not accept it as well as previous generations did.

Many free-marketeers now appear to want to let the entire house of cards they constructed over the past 25 years to collapse. The more reasonable among us prefer to prevent a complete collapse so that many more people are not buried under its rubble.

IMO, this is not a time for ideology. Muddling through is much better than causing much more pain through further laissez-faire induced, self-inflicted wounds.

- The article makes the claim that the current bailout philosophy put forward by Paulson is also put forward by Geithner. My only question is this: to what extent do we know (from quotes or other sources) that the two are locked at the hip? I’m just curious if there is any separation between the two.

- My very limited understanding of the CDS market has this idea that the notional amount of risk in the current contracts is often offset by other contracts. Is that factored into the analysis?