CDSs and you.
September 19, 2008 10:55 AM Subscribe
How AIG fell apart is a good article giving an overview of Credit Default Swaps (CDSs) and the role they played in AIG's struggle. CDS issues are a crisis that quite a few saw coming just a few months ago and one that was discussed here then, although AIG was thought be a special "safe" case among CDS issuers. Indeed it now seems that AIG's particular problem was that it had failed to hedge the CDSs they issued with CDSs acquired from other institutions, presumably on the premise that they were insuring assets too safe to fail.
your "AIG was thought to be a special" link... is that intended to call patricio out?
posted by shmegegge at 11:02 AM on September 19, 2008
posted by shmegegge at 11:02 AM on September 19, 2008
goddamn another thread I need to think up something halfway cogent to say just to get it into my Recent Activity?
So, uh, how 'bout them bankers? Bastards, eh? Forget the lawyer jokes, it's them should be at the bottom of the sea selling no-stated-income loans to real sharks. Or something.
posted by bonaldi at 11:06 AM on September 19, 2008
So, uh, how 'bout them bankers? Bastards, eh? Forget the lawyer jokes, it's them should be at the bottom of the sea selling no-stated-income loans to real sharks. Or something.
posted by bonaldi at 11:06 AM on September 19, 2008
It's more an instance of the conventional wisdom that said that because of the nature of the goods it insured, AIG was not really at risk.
posted by clevershark at 11:08 AM on September 19, 2008
posted by clevershark at 11:08 AM on September 19, 2008
I am completely clueless on the economy and how the insurance industry works (<- will come to haunt me when I run for President), so can someone answer this:
If the US now owns 80% of AIG, how does that affect a single-payer health insurance plan should Obama win? More likely? Or is AIG, as huge as it is, still a small part of the industry overall? Or is this irrelevant to that? Or is the "ownership" non-voting? Or some other technical thing?
posted by DU at 11:09 AM on September 19, 2008
If the US now owns 80% of AIG, how does that affect a single-payer health insurance plan should Obama win? More likely? Or is AIG, as huge as it is, still a small part of the industry overall? Or is this irrelevant to that? Or is the "ownership" non-voting? Or some other technical thing?
posted by DU at 11:09 AM on September 19, 2008
The government bailout of AIG was the event that got me off of my ass and down to the Obama campaign office yesterday. I'll be canvassing all weekend.
Thanks AIG!
posted by Ludi at 11:13 AM on September 19, 2008 [1 favorite]
Thanks AIG!
posted by Ludi at 11:13 AM on September 19, 2008 [1 favorite]
DU: They don't do health insurance.
posted by a robot made out of meat at 11:15 AM on September 19, 2008
posted by a robot made out of meat at 11:15 AM on September 19, 2008
Did We Say $500 Billion? Sorry, Bailout Will Cost $1 Trillion
U.S. tries 'comprehensive approach' to stem domino effect
Wall St. Turmoil Won't Hurt Defense Firms
How will federal plan affect a Wachovia-Morgan deal?
US 'bad bank' to staunch toxic debt losses
From Pelosi, Kerry May Share Investor Pain as AIG Stakes Evaporate, one reads:
John McCain, the Republican presidential nominee, avoided potential losses. Because of the Arizona senator's run for the White House, his wife, Cindy, last year liquidated a blind trust that had contained stock in AIG, Fannie Mae, Freddie Mac and Lehman. The amounts of stock she had owned weren't disclosed.
posted by ornate insect at 11:16 AM on September 19, 2008 [2 favorites]
U.S. tries 'comprehensive approach' to stem domino effect
Wall St. Turmoil Won't Hurt Defense Firms
How will federal plan affect a Wachovia-Morgan deal?
US 'bad bank' to staunch toxic debt losses
From Pelosi, Kerry May Share Investor Pain as AIG Stakes Evaporate, one reads:
John McCain, the Republican presidential nominee, avoided potential losses. Because of the Arizona senator's run for the White House, his wife, Cindy, last year liquidated a blind trust that had contained stock in AIG, Fannie Mae, Freddie Mac and Lehman. The amounts of stock she had owned weren't disclosed.
posted by ornate insect at 11:16 AM on September 19, 2008 [2 favorites]
Every article about credit default swaps says that they got to be such a big business because everyone was happy to sell them because they never expected to have to pay up because no one ever defaults.
What I don't understand is if everyone believed this, then who was buying the CDSs and why did they think this was a good deal?
posted by pombe at 11:17 AM on September 19, 2008
What I don't understand is if everyone believed this, then who was buying the CDSs and why did they think this was a good deal?
posted by pombe at 11:17 AM on September 19, 2008
CDSs and you.
No u. No one could have predicted...wait that's not right. Remember folks, there were roughly $596 trillion (notional value, gross market is $15 trillion) in OTC derivatives in the global market as of December 2007. This shit storm is not even close to being over.
$596,000,000,000,000
posted by ryoshu at 11:20 AM on September 19, 2008
No u. No one could have predicted...wait that's not right. Remember folks, there were roughly $596 trillion (notional value, gross market is $15 trillion) in OTC derivatives in the global market as of December 2007. This shit storm is not even close to being over.
$596,000,000,000,000
posted by ryoshu at 11:20 AM on September 19, 2008
Sadly, not facetious. Ah well, we must all be dumb and ignorant in our spheres.
posted by DU at 11:21 AM on September 19, 2008
posted by DU at 11:21 AM on September 19, 2008
I remember explaining to Ms. Vegetable that CDS don't require the buyers to own the underlying asset, and how little reserve was required to sell them. She shook her head and asked "Don't they have actuaries?"
posted by a robot made out of meat at 11:22 AM on September 19, 2008
posted by a robot made out of meat at 11:22 AM on September 19, 2008
I figured it was a parody of every other comment that starts with "I don't know anything about the economy, but..."
posted by smackfu at 11:24 AM on September 19, 2008
posted by smackfu at 11:24 AM on September 19, 2008
I was thinking about this while having a smoke just now -- if Paulson does create this weird "federal clearinghouse for bad debt" I would think that he's also triggering two derivative effects:
posted by clevershark at 11:29 AM on September 19, 2008
- in the short term, CDS issuers and bond insurers (is there a difference between the two?) are getting a free ride on currently-valid contracts, because the bailout mechanism will mean that bonds will not fail.
- in the long term, CDS issuers and bond insurers are toast because the Fed is essentially taking over their turf.
posted by clevershark at 11:29 AM on September 19, 2008
Why do I have to pay my bills when Citibank doesn't have to pay theirs?
I pay more taxes than those assholes..
posted by Lord_Pall at 11:31 AM on September 19, 2008 [5 favorites]
I pay more taxes than those assholes..
posted by Lord_Pall at 11:31 AM on September 19, 2008 [5 favorites]
Why do interrelated financial issues keep fragmenting into separate threads? I'm sorry, I'm new, but isn't there an AIG thread already, in addition to Brokergeddon?
posted by woodway at 11:32 AM on September 19, 2008
posted by woodway at 11:32 AM on September 19, 2008
Maybe there should be a "send your credit card bill to Hank Paulsen" day event in the near future...
posted by clevershark at 11:32 AM on September 19, 2008
posted by clevershark at 11:32 AM on September 19, 2008
I've been hearing for years about the incomprehensibly rich year-end bonuses paid to young Wall Street employees - looks like Uncle Sam is getting in on the act. Honest, I have no idea what's going on... but I'm quite sure the American taxpayer will be royally screwed in the end.
posted by letitrain at 11:36 AM on September 19, 2008
posted by letitrain at 11:36 AM on September 19, 2008
goddamn another thread I need to think up something halfway cogent to say just to get it into my Recent Activity?
My trick is one line, not quite offtopic, inoffensive, one line throw away comments everyone forgets... tills it's too late!
posted by chunking express at 11:39 AM on September 19, 2008
My trick is one line, not quite offtopic, inoffensive, one line throw away comments everyone forgets... tills it's too late!
posted by chunking express at 11:39 AM on September 19, 2008
clevershark: I think a better analogy would be to send defaults from dumb-ass prosper.com loans. In the letter add that you have no idea what due diligence is but need only $1M, so it should be a no-brainer.
posted by a robot made out of meat at 11:42 AM on September 19, 2008
posted by a robot made out of meat at 11:42 AM on September 19, 2008
Whatever CEO came up with this toxic debt bank deserves an extra big bonus this year - getting Uncle Sam to pay for all of his companies mistakes.
posted by dances_with_sneetches at 11:43 AM on September 19, 2008
posted by dances_with_sneetches at 11:43 AM on September 19, 2008
The fundamental problem, of which industry was long aware of before this event is that CDS' are over the counter (OTC) instruments, traded counterparty to counterparty.
In other words, there is NOT - unlike, for example, the equity markets - a centralised exchange. This presents a startlingly wide array of problems. Just to touch upon three from a very, very high level (I could probably write 10,000 words on the topic).
First of all, nobody is really certain about the overall size of this market. Trades are conducted largely in private, and may even reside in off balance sheet vehicles or in subsidiaries not domiciled in the home regime of the corporate parent.
Second, as there isn't an exchange nobody guarantees the performance of the counterparties. A bit of financial history is relevant here; other derivatives that are routinely used these days, for example, futures, had the same problems early on in the development of that market. Now futures are (largely, we'll talk about exceptions later) traded on exchanges such as London International Financial Futures Exchange, (LIFEE, trades futures contracts with underlying instruments such as Gilts, Short Sterling, FTSE index, Euribor, Cocoa, Coffee, White Sugar) or The Chicago Board of Trade (CBOT, trades futures on a wide variety of Interest Rate, Stock Market Index, Metals and Agricultural products). The exchange serves many vital roles, one of which is compeling performance of the counterparties . Exceptions to futures trading on organised exchanges are known colloquially in the business as Forwards or Forward Contracts. They exist, but are more expensive than trading through an exchange.
Third, these aren't standardised products; they can and will differ markedly in the specific details e.g., but not limited to notional, payment frequency, maturity, etc. This unnecessarily adds complexity not only to transactions but also the Risk Management function. Again, standardisation is a vital role that exchanges perform for other derivative markets.
Now an exchange or clearing house for Credit Derivatives is something that Industry has been arguing over for a long time now.
Unfortunately, like many business decisions this became political, with folks on both sides of the argument. Myself, I've always been in favour of an organised exchange for Credit Derivatives, simply because I knew from the history of finance (ah my favourite topic) the lack of one could hold back development of the market, as we observed during the development of other derivative markets.
There are also process issues that a central exchange would solve. When I was working on a Credit Derivative desk at DB (quant) our back office was so far behind in their process that we had several offices full with stacks of deal tickets that hadn't been entered into our systems yet. Part of the problem was the systems were in capable of capturing the details (this happens in new markets) but it was also due to to cost - that is, we needed people and the money wasn't available.
We weren't unique in that problem, and in fact it got so bad that in 2002 (can't recall exact date, I've surpressed it) The Fed in New York compelled all the banks to rent hotel suites and get together to manually process trade tickets every weekend until the problem was cleared up. I believe that effort took six months or so and wasn't ever really finished due to the markets rapid expansion (i.e., it doubled in size annually for five or six years in a row).
So, yeh, one thing that will shake out of this is we'll finally get our central clearing function for Credit Derivatives. Some of them at least. Remember, markets are global now, and just because the SEC compels US banks to trade through an exchange doesn't mean this will happen in Europe, Asia or even with the big hedge funds.
But any progress on this problem is good progress.
posted by Mutant at 11:45 AM on September 19, 2008 [16 favorites]
In other words, there is NOT - unlike, for example, the equity markets - a centralised exchange. This presents a startlingly wide array of problems. Just to touch upon three from a very, very high level (I could probably write 10,000 words on the topic).
First of all, nobody is really certain about the overall size of this market. Trades are conducted largely in private, and may even reside in off balance sheet vehicles or in subsidiaries not domiciled in the home regime of the corporate parent.
Second, as there isn't an exchange nobody guarantees the performance of the counterparties. A bit of financial history is relevant here; other derivatives that are routinely used these days, for example, futures, had the same problems early on in the development of that market. Now futures are (largely, we'll talk about exceptions later) traded on exchanges such as London International Financial Futures Exchange, (LIFEE, trades futures contracts with underlying instruments such as Gilts, Short Sterling, FTSE index, Euribor, Cocoa, Coffee, White Sugar) or The Chicago Board of Trade (CBOT, trades futures on a wide variety of Interest Rate, Stock Market Index, Metals and Agricultural products). The exchange serves many vital roles, one of which is compeling performance of the counterparties . Exceptions to futures trading on organised exchanges are known colloquially in the business as Forwards or Forward Contracts. They exist, but are more expensive than trading through an exchange.
Third, these aren't standardised products; they can and will differ markedly in the specific details e.g., but not limited to notional, payment frequency, maturity, etc. This unnecessarily adds complexity not only to transactions but also the Risk Management function. Again, standardisation is a vital role that exchanges perform for other derivative markets.
Now an exchange or clearing house for Credit Derivatives is something that Industry has been arguing over for a long time now.
Unfortunately, like many business decisions this became political, with folks on both sides of the argument. Myself, I've always been in favour of an organised exchange for Credit Derivatives, simply because I knew from the history of finance (ah my favourite topic) the lack of one could hold back development of the market, as we observed during the development of other derivative markets.
There are also process issues that a central exchange would solve. When I was working on a Credit Derivative desk at DB (quant) our back office was so far behind in their process that we had several offices full with stacks of deal tickets that hadn't been entered into our systems yet. Part of the problem was the systems were in capable of capturing the details (this happens in new markets) but it was also due to to cost - that is, we needed people and the money wasn't available.
We weren't unique in that problem, and in fact it got so bad that in 2002 (can't recall exact date, I've surpressed it) The Fed in New York compelled all the banks to rent hotel suites and get together to manually process trade tickets every weekend until the problem was cleared up. I believe that effort took six months or so and wasn't ever really finished due to the markets rapid expansion (i.e., it doubled in size annually for five or six years in a row).
So, yeh, one thing that will shake out of this is we'll finally get our central clearing function for Credit Derivatives. Some of them at least. Remember, markets are global now, and just because the SEC compels US banks to trade through an exchange doesn't mean this will happen in Europe, Asia or even with the big hedge funds.
But any progress on this problem is good progress.
posted by Mutant at 11:45 AM on September 19, 2008 [16 favorites]
Whatever CEO came up with this toxic debt bank deserves an extra big bonus this year - getting Uncle Sam to pay for all of his companies mistakes.
I'm partial to the "head on pike" bonus, but given the nature of today I'm also willing to go with "keelhaul" and "walk the plank."
posted by ryoshu at 11:46 AM on September 19, 2008 [1 favorite]
I'm partial to the "head on pike" bonus, but given the nature of today I'm also willing to go with "keelhaul" and "walk the plank."
posted by ryoshu at 11:46 AM on September 19, 2008 [1 favorite]
A survey?
Are we on the brink of major economic collapse?
yes [ ]
no [ ]
posted by lunit at 11:51 AM on September 19, 2008
Are we on the brink of major economic collapse?
yes [ ]
no [ ]
posted by lunit at 11:51 AM on September 19, 2008
She shook her head and asked "Don't they have actuaries?"
Yes, except when you're measuring credit risk, they're called "rating agencies." And they fucking suck.
posted by mullacc at 11:52 AM on September 19, 2008
Yes, except when you're measuring credit risk, they're called "rating agencies." And they fucking suck.
posted by mullacc at 11:52 AM on September 19, 2008
yes [x]
no [ ]
Great Depression II: Roosevelt's Robot Zombie
posted by sonic meat machine at 11:54 AM on September 19, 2008
no [ ]
Great Depression II: Roosevelt's Robot Zombie
posted by sonic meat machine at 11:54 AM on September 19, 2008
couldn't these links go in the other AIG post ... from 2-3 days ago?
I'm awful sick of people yelling at me about this "crisis" and why I should care.
posted by mrgrimm at 11:56 AM on September 19, 2008
I'm awful sick of people yelling at me about this "crisis" and why I should care.
posted by mrgrimm at 11:56 AM on September 19, 2008
We are on the brink of major economic collapse. Is this awesome?
yes [ ]
no [ ]
posted by Dr-Baa at 11:56 AM on September 19, 2008 [1 favorite]
yes [ ]
no [ ]
posted by Dr-Baa at 11:56 AM on September 19, 2008 [1 favorite]
Sadly, not facetious. Ah well, we must all be dumb and ignorant in our spheres.
Oh! Sorry...I had thought you had been posting in the other threads and were taking the piss out of the same kinds of questions that had been in the others. No insult intended.
posted by spicynuts at 12:01 PM on September 19, 2008
Oh! Sorry...I had thought you had been posting in the other threads and were taking the piss out of the same kinds of questions that had been in the others. No insult intended.
posted by spicynuts at 12:01 PM on September 19, 2008
I've been wondering this since the Frannie/Freddie mess: if companies like AIG keep getting bailed out because they are "too big to fail," would putting regulations in place to keep companies from getting too big to fail be a possiblity? And what would that look like?
posted by ahdeeda at 12:03 PM on September 19, 2008 [3 favorites]
posted by ahdeeda at 12:03 PM on September 19, 2008 [3 favorites]
I'm awful sick of people yelling at me about this "crisis" and why I should care.
Simple solution: avoid clicking the "more inside" button.
posted by ornate insect at 12:04 PM on September 19, 2008 [3 favorites]
Simple solution: avoid clicking the "more inside" button.
posted by ornate insect at 12:04 PM on September 19, 2008 [3 favorites]
A trillion here, a trillion there, pretty soon we'll be talking about real money. Remember when it was shocking when President Bush asked for $87 billion for Iraq? Those were the days.
posted by kirkaracha at 12:07 PM on September 19, 2008
posted by kirkaracha at 12:07 PM on September 19, 2008
quite a few saw coming just a few months ago...
I think the perils of CDSs were suspected long before then. Note that Phil Gramm, McCain's former economics advisor, got anti-regulatory legislation for CDSs passed in 2000.
The Shad-Johnson accord, which the Commodities Future Modernization Act of 2000 broke, seems to have been in place to prevent exactly the kind of shitstorm that is exploding now.
posted by benzenedream at 12:09 PM on September 19, 2008
Adam Smith's "invisible hand" just gave taxpayers a very visible finger
posted by Postroad at 12:12 PM on September 19, 2008 [8 favorites]
posted by Postroad at 12:12 PM on September 19, 2008 [8 favorites]
Are we on the brink of major economic collapse?
yes [ ]
no [x]
I'm going to guess no because the bailouts are a sign that the US government is willing to spend Iraq War Budget kinds of money to prevent a collapse. If the bailouts weren't happening, we would all be completely screwed. There's a decent chance that I'm wrong and we're screwed anyway though.
posted by burnmp3s at 12:19 PM on September 19, 2008
yes [ ]
no [x]
I'm going to guess no because the bailouts are a sign that the US government is willing to spend Iraq War Budget kinds of money to prevent a collapse. If the bailouts weren't happening, we would all be completely screwed. There's a decent chance that I'm wrong and we're screwed anyway though.
posted by burnmp3s at 12:19 PM on September 19, 2008
Ah, but the problem is that the Iraq War Budget kinds of money come from [i]us[/i] burnmp3s. Plus, they don't actually exist. Oops.
posted by sonic meat machine at 12:22 PM on September 19, 2008
posted by sonic meat machine at 12:22 PM on September 19, 2008
Bugger, I used bbcode.
posted by sonic meat machine at 12:22 PM on September 19, 2008
posted by sonic meat machine at 12:22 PM on September 19, 2008
Even if they had reinsurance, it wouldn't have ultimately mattered. It would have delayed the inevitable, but it wouldn't have stopped it. There's far too much debt in the world. It can't be paid back. Had AIG been insured, it would have just meant a whole network of insurers would have failed at once, instead of just them.
Derivatives do not work on a large scale. They depend on hedging risk against a larger economy, and there is no larger economy to hedge against when they get this big. They increase and increase risk until the entities involved die of it. That's what is happening now; there's so much risk in the system that it's seizing up and failing. Only massive bailouts are keeping things going, and those entities are just going to go create more risk, because that's what they do.
They have dug an enormous hole, and your government is in the process of dumping you and your children into that hole to drown, while the banks and Wall Street get started on the next hole. It will be even bigger, and you, once again, will be forced to take up residence once things start to go sour.
Now that we're on the bailout path, there's no way off.
posted by Malor at 12:35 PM on September 19, 2008 [11 favorites]
Derivatives do not work on a large scale. They depend on hedging risk against a larger economy, and there is no larger economy to hedge against when they get this big. They increase and increase risk until the entities involved die of it. That's what is happening now; there's so much risk in the system that it's seizing up and failing. Only massive bailouts are keeping things going, and those entities are just going to go create more risk, because that's what they do.
They have dug an enormous hole, and your government is in the process of dumping you and your children into that hole to drown, while the banks and Wall Street get started on the next hole. It will be even bigger, and you, once again, will be forced to take up residence once things start to go sour.
Now that we're on the bailout path, there's no way off.
posted by Malor at 12:35 PM on September 19, 2008 [11 favorites]
Mutant: what were the arguments against creating a clearinghouse for CDSs?
Re commenting to see the thread in Recent Activity, if you add it to your favorites you can see activity that way.
posted by yarrow at 12:39 PM on September 19, 2008
Re commenting to see the thread in Recent Activity, if you add it to your favorites you can see activity that way.
posted by yarrow at 12:39 PM on September 19, 2008
My theory is that they just want to make the collapse happen November 5 instead of September 19.
posted by sonic meat machine at 12:40 PM on September 19, 2008 [2 favorites]
posted by sonic meat machine at 12:40 PM on September 19, 2008 [2 favorites]
NOW, perhaps, you start to understand what I meant when I said we were headed for Zimbabwe. I remember lots of scoffing, but I'm not hearing so much of that anymore.
posted by Malor at 12:45 PM on September 19, 2008
posted by Malor at 12:45 PM on September 19, 2008
Looks like Bush got his way -- America is now truly The Pwnership Society.
We own Wall Street -- Wall Street pwns US.
posted by Herodios at 12:46 PM on September 19, 2008 [1 favorite]
We own Wall Street -- Wall Street pwns US.
posted by Herodios at 12:46 PM on September 19, 2008 [1 favorite]
Ah, but the problem is that the Iraq War Budget kinds of money come from [i]us[/i] burnmp3s. Plus, they don't actually exist. Oops.
Alsowe today's children already spent all the Iraq War Budget kinds of money on the Iraq War.
posted by TheOnlyCoolTim at 12:46 PM on September 19, 2008
Also
posted by TheOnlyCoolTim at 12:46 PM on September 19, 2008
The Great Depression is going to be Great in exactly the same way the Great War was.
posted by eriko at 12:48 PM on September 19, 2008
posted by eriko at 12:48 PM on September 19, 2008
President McCain Palin will clean all this shit the fuck up! Just you watch.
posted by you just lost the game at 12:55 PM on September 19, 2008
posted by you just lost the game at 12:55 PM on September 19, 2008
Why anyone would want to be the one left holding the bag the next President of the United States is beyond me.
posted by Stonewall Jackson at 12:58 PM on September 19, 2008 [1 favorite]
posted by Stonewall Jackson at 12:58 PM on September 19, 2008 [1 favorite]
"I've been wondering this since the Frannie/Freddie mess: if companies like AIG keep getting bailed out because they are "too big to fail," would putting regulations in place to keep companies from getting too big to fail be a possiblity? And what would that look like?"
That would look like socialism. And we can't have that, now, can we.
posted by mygoditsbob at 1:00 PM on September 19, 2008
That would look like socialism. And we can't have that, now, can we.
posted by mygoditsbob at 1:00 PM on September 19, 2008
So, who ends up pocketing the trillion?
posted by StickyCarpet at 1:05 PM on September 19, 2008
posted by StickyCarpet at 1:05 PM on September 19, 2008
His name was Hank Paulsen. His name was Hank Paulsen. His name was Hank Paulsen.
“...but I'm quite sure the American taxpayer will be royally screwed in the end.”
Been thinking about that myself. It’s entirely possible that all the misgivings I have about Obama (and this in the context of the utter lack of complexity in my concern for McCain, in that, I anticipate a complete disaster were he elected) are exactly the kind of thing the country needs.
I mean, if he does consolidate power within the Dems, work with outsiders, build the kinds of coalitions he would - in short - if he’s allowed to be as effective in getting things done as I’m aware he can be - I’d expect radical changes (which I have problems with).
But which might be what we need. Someone to grab the country by the testicles, straighten all this out, reregulate, create a healthcare system, etc. etc. essentially undo all the damage done over the past buncha years.
Putting the sword down, that’s the tricky part.
Just thinking ‘French Revolution’ here. (Not that the ‘head on a pike’ thing isn’t really viscerally satisfying to me.)
Mutant that was a clear, cogent, well illustrated comment based on the solid experiance you obviously have. And wish I knew what the hell you were talking about. *grabs ‘Economics for Dummies’*
posted by Smedleyman at 1:10 PM on September 19, 2008
“...but I'm quite sure the American taxpayer will be royally screwed in the end.”
Been thinking about that myself. It’s entirely possible that all the misgivings I have about Obama (and this in the context of the utter lack of complexity in my concern for McCain, in that, I anticipate a complete disaster were he elected) are exactly the kind of thing the country needs.
I mean, if he does consolidate power within the Dems, work with outsiders, build the kinds of coalitions he would - in short - if he’s allowed to be as effective in getting things done as I’m aware he can be - I’d expect radical changes (which I have problems with).
But which might be what we need. Someone to grab the country by the testicles, straighten all this out, reregulate, create a healthcare system, etc. etc. essentially undo all the damage done over the past buncha years.
Putting the sword down, that’s the tricky part.
Just thinking ‘French Revolution’ here. (Not that the ‘head on a pike’ thing isn’t really viscerally satisfying to me.)
Mutant that was a clear, cogent, well illustrated comment based on the solid experiance you obviously have. And wish I knew what the hell you were talking about. *grabs ‘Economics for Dummies’*
posted by Smedleyman at 1:10 PM on September 19, 2008
Stan O'Neal walked with $161M in his pockets after Merrill lost $1B while he was CEO. It's not too hard to see where the money went.
posted by clevershark at 1:11 PM on September 19, 2008
posted by clevershark at 1:11 PM on September 19, 2008
Commodities Future Modernization Act which started this ... I tried to look into its legislative history, and as best I can tell it was rolled into the budget during conference on H.R.4577 by Sen. Gramm. He's the only one who said a word about it in debate (Page S11856). It was never actually voted on, since the senate approved the conference report by unanimous consent. So rarely is there just one person to blame.
At that conference committee, Sen Byrd is precient:
He also proposed "Rule 28 would be modified, blocking Conferees to a general appropriations bill from inserting in their Report any matter not committed to them by either House." A little late, I'd say.
posted by a robot made out of meat at 1:31 PM on September 19, 2008 [2 favorites]
At that conference committee, Sen Byrd is precient:
Mr. BYRD. Mr. President, as has been the case on far too many occasions in the past number of years, the Senate finds itself today in the position of having to deal with a massive omnibus appropriations bill. ... This is a practice that should never have been started and which, if not discontinued, I fear will gravely diminish the Senate as an institution. Senators are being denied the right to debate and amend appropriations bills, all of which contain billions of taxpayer dollars, and literally thousands of funding issues affecting their constituents. Instead, we are being presented with unamendable omnibus appropriations packages, which contain many, many matters that have not had any Senate consideration at all.At that conference McCain chooses to single out some earmarks, including "the $176,000 for the Reindeer Herders Association? ...$1 million for winter pollack survey in Alaska."
He also proposed "Rule 28 would be modified, blocking Conferees to a general appropriations bill from inserting in their Report any matter not committed to them by either House." A little late, I'd say.
posted by a robot made out of meat at 1:31 PM on September 19, 2008 [2 favorites]
If the government ends up owning a lot of bad mortgages, what happens to the houses those mortgages are for? Does the government end up owning a ton of foreclosed houses?
posted by Justinian at 1:35 PM on September 19, 2008
posted by Justinian at 1:35 PM on September 19, 2008
yarrow -- "Mutant: what were the arguments against creating a clearinghouse for CDSs?"
Ah, great question - I'll touch upon a few of the larger issues and maybe someone who is currently working with Credit Derivatives can chime in (I've mailed a heads up on this thread, so we'll see).
First of all, we have to keep in mind that the evolution of almost every derivative market to date has followed a similar path; as the instruments are initially developed they're traded counterpary to counterparty, off exchange as it were, and largely unstandardised.
As part of the scaling up of the market, to improve liquidity and guarantee performance of counterparties (a key concern in current markets) exchanges are developed that sit in between the two counterparties.
So instead of the current situation:
CNTPY A dealing with CNTPY B
We end up with:
CNTPY A dealing with EXCHANGE dealing with CNTPY B
Now the Exchange has a global view of the business, and not only can insure that counterparties perform, it can also monitor and control the market. And it's that point that brings us to the first objection some folks in industry raised: control.
They were used to this free wheeling market, where pretty much anything goes. So getting them on board to accept a central exchange, with it's power of control, is very, very difficult. It's changing the way they do business and it wasn't going to happen without a good reason. Now we've got it.
Secondly, cost. The regulatory reporting burden would be higher for banks dealing with an exchange. The exchange keeps track of trades, and requires regular reporting in a proscribed manner. This is something that isn't easily done - you need 1) people with business knowledge to 2) specify systems and 3) IT people to build said systems and 4) Back Office staff to operate this system and 5) Compliance & Risk Management people to insure the bank's systems / processes / people operate as required.
So lots of resistance from folks in the industry to this idea.
We've seen other derivative markets collapse, definitely not as large a break down but it's happened. Those events gave impetus and drive to the argument for exchanges and the necessary regulation.
I'm pretty hopeful we'll see new regulatory powers and the formation of an exchange or clearing house.
But one things for certain: Credit Derivatives are here to stay. They've rapidly grown to be essential financial engineering tools and we can't easily put the genie back in the bottle.
I say easily, as looking back at the history of finance, we've seen attempts to outlaw certain derivative instruments many times in the past. Derivatives trading was banned several times in both Europe and Japan. At one point in Feudal Japan (can't cite source as I'm not on my primary machine now) trading in rice forwards was outlawed "on pain of death". They tried to put the genie back in the bottle and guess what? Couldn't. Agricultural commodity futures are very widely used today, huge market.
And even the United States has banned derivatives from time to time. For example, trading in commodity futures was temporarily banned in 1867, however the law was repealed about one year later. In 1936 trading in Options on Futures was banned in the United States at the Federal level.
Almost all of theses bans were as a result of losses. Losses incurred because the models or the business processes involved failed. With each failure we learn lessons, and improve the markets.
So outlawing credit derivatives as a class? Probably not gonna happen. Hasn't worked before and won't work now.
posted by Mutant at 1:41 PM on September 19, 2008 [4 favorites]
Ah, great question - I'll touch upon a few of the larger issues and maybe someone who is currently working with Credit Derivatives can chime in (I've mailed a heads up on this thread, so we'll see).
First of all, we have to keep in mind that the evolution of almost every derivative market to date has followed a similar path; as the instruments are initially developed they're traded counterpary to counterparty, off exchange as it were, and largely unstandardised.
As part of the scaling up of the market, to improve liquidity and guarantee performance of counterparties (a key concern in current markets) exchanges are developed that sit in between the two counterparties.
So instead of the current situation:
CNTPY A dealing with CNTPY B
We end up with:
CNTPY A dealing with EXCHANGE dealing with CNTPY B
Now the Exchange has a global view of the business, and not only can insure that counterparties perform, it can also monitor and control the market. And it's that point that brings us to the first objection some folks in industry raised: control.
They were used to this free wheeling market, where pretty much anything goes. So getting them on board to accept a central exchange, with it's power of control, is very, very difficult. It's changing the way they do business and it wasn't going to happen without a good reason. Now we've got it.
Secondly, cost. The regulatory reporting burden would be higher for banks dealing with an exchange. The exchange keeps track of trades, and requires regular reporting in a proscribed manner. This is something that isn't easily done - you need 1) people with business knowledge to 2) specify systems and 3) IT people to build said systems and 4) Back Office staff to operate this system and 5) Compliance & Risk Management people to insure the bank's systems / processes / people operate as required.
So lots of resistance from folks in the industry to this idea.
We've seen other derivative markets collapse, definitely not as large a break down but it's happened. Those events gave impetus and drive to the argument for exchanges and the necessary regulation.
I'm pretty hopeful we'll see new regulatory powers and the formation of an exchange or clearing house.
But one things for certain: Credit Derivatives are here to stay. They've rapidly grown to be essential financial engineering tools and we can't easily put the genie back in the bottle.
I say easily, as looking back at the history of finance, we've seen attempts to outlaw certain derivative instruments many times in the past. Derivatives trading was banned several times in both Europe and Japan. At one point in Feudal Japan (can't cite source as I'm not on my primary machine now) trading in rice forwards was outlawed "on pain of death". They tried to put the genie back in the bottle and guess what? Couldn't. Agricultural commodity futures are very widely used today, huge market.
And even the United States has banned derivatives from time to time. For example, trading in commodity futures was temporarily banned in 1867, however the law was repealed about one year later. In 1936 trading in Options on Futures was banned in the United States at the Federal level.
Almost all of theses bans were as a result of losses. Losses incurred because the models or the business processes involved failed. With each failure we learn lessons, and improve the markets.
So outlawing credit derivatives as a class? Probably not gonna happen. Hasn't worked before and won't work now.
posted by Mutant at 1:41 PM on September 19, 2008 [4 favorites]
Congressional Leaders Were Stunned by Warnings:
As Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee, put it Friday morning on the ABC program “Good Morning America,” the congressional leaders were told “that we’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.”
Mr. Schumer added, “History was sort of hanging over it, like this was a moment.”
When Mr. Schumer described the meeting as “somber,” Mr. Dodd cut in. “Somber doesn’t begin to justify the words,” he said. “We have never heard language like this.”
(snip)
“You have the credit lines in America, which are the lifeblood of the economy, frozen.” Mr. Schumer said. “That hasn’t happened before. It’s a brave new world. You are in uncharted territory, but the one thing you do know is you can’t leave them frozen or the economy will just head south at a rapid rate.”
As he spoke, Mr. Schumer swooped his hand, to make the gesture of a plummeting bird. “You know we’d be lucky ...” he said as his voice trailed off. “Well, I’ll leave it at that.”
As officials at the Treasury Department raced on Friday to draft legislative language for an ambitious plan for the government to buy billions of dollars of illiquid debt from ailing American financial institutions, legislators on Capitol Hill said they planned to work through the weekend reviewing the proposal and making efforts to bring a package of measures to the floor of the House and Senate by the end of next week.
posted by ornate insect at 1:45 PM on September 19, 2008
As Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee, put it Friday morning on the ABC program “Good Morning America,” the congressional leaders were told “that we’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.”
Mr. Schumer added, “History was sort of hanging over it, like this was a moment.”
When Mr. Schumer described the meeting as “somber,” Mr. Dodd cut in. “Somber doesn’t begin to justify the words,” he said. “We have never heard language like this.”
(snip)
“You have the credit lines in America, which are the lifeblood of the economy, frozen.” Mr. Schumer said. “That hasn’t happened before. It’s a brave new world. You are in uncharted territory, but the one thing you do know is you can’t leave them frozen or the economy will just head south at a rapid rate.”
As he spoke, Mr. Schumer swooped his hand, to make the gesture of a plummeting bird. “You know we’d be lucky ...” he said as his voice trailed off. “Well, I’ll leave it at that.”
As officials at the Treasury Department raced on Friday to draft legislative language for an ambitious plan for the government to buy billions of dollars of illiquid debt from ailing American financial institutions, legislators on Capitol Hill said they planned to work through the weekend reviewing the proposal and making efforts to bring a package of measures to the floor of the House and Senate by the end of next week.
posted by ornate insect at 1:45 PM on September 19, 2008
Why do I have to pay my bills when Citibank doesn't have to pay theirs?
Because the suits have nerve that other people don't.
It's like this announced bailout -- here you have all these institutions that preached all sorts of things that lead to people losing their jobs and their homes -- and then taxpayers are forced to bailout these same people.
It's like being forced to make bail for the guy you mugged you.
So why does Citibank not have to pay their bills? Because no one is screaming to the right people, making outrageous demands. People think if they make waves, they will make things worse, but these institutions are on a shaky house of cards -- it will get worse whether you keep quiet or make a fuss -- so it's better to make a fuss -- you are paying for it, after all, one way or another...
posted by Alexandra Kitty at 1:45 PM on September 19, 2008
Because the suits have nerve that other people don't.
It's like this announced bailout -- here you have all these institutions that preached all sorts of things that lead to people losing their jobs and their homes -- and then taxpayers are forced to bailout these same people.
It's like being forced to make bail for the guy you mugged you.
So why does Citibank not have to pay their bills? Because no one is screaming to the right people, making outrageous demands. People think if they make waves, they will make things worse, but these institutions are on a shaky house of cards -- it will get worse whether you keep quiet or make a fuss -- so it's better to make a fuss -- you are paying for it, after all, one way or another...
posted by Alexandra Kitty at 1:45 PM on September 19, 2008
Okay, I've read all the threads, followed all the news stories, shorted all the banks, and drank all my liquor, but I'm still confused about one thing.
When Jim Cramer said over a year ago "They know nothing!" was he actually right?
Also, hey Mutant, when the NY Fed forced you to do that hotel room reconciliation thing, did you guys get to order room service? Because that would have made it okay. I would have ordered an awesome sandwich and said "I'm a big shot!" Then I would have ordered a big ice cream sundae, put it on top of the TV, and watched it melt.
Expense accounts rule.
posted by Pastabagel at 1:52 PM on September 19, 2008 [5 favorites]
When Jim Cramer said over a year ago "They know nothing!" was he actually right?
Also, hey Mutant, when the NY Fed forced you to do that hotel room reconciliation thing, did you guys get to order room service? Because that would have made it okay. I would have ordered an awesome sandwich and said "I'm a big shot!" Then I would have ordered a big ice cream sundae, put it on top of the TV, and watched it melt.
Expense accounts rule.
posted by Pastabagel at 1:52 PM on September 19, 2008 [5 favorites]
As Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee, put it Friday morning on the ABC program “Good Morning America,” the congressional leaders were told “that we’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.”
Mr. Schumer added, “History was sort of hanging over it, like this was a moment.”
When Mr. Schumer described the meeting as “somber,” Mr. Dodd cut in. “Somber doesn’t begin to justify the words,” he said. “We have never heard language like this.”
We should get these two some rubber pants. They could make a museum of Democratic suits that have been ruined by Republican propaganda. You can have the mushroom cloud wing dedicated to the Iraq WMD evidence, the FISA wing and now the financial Armageddon wing. With three months to go I'm sure it will certainly double in size. Way to stand strong Democrats!
posted by any major dude at 2:08 PM on September 19, 2008 [4 favorites]
Mr. Schumer added, “History was sort of hanging over it, like this was a moment.”
When Mr. Schumer described the meeting as “somber,” Mr. Dodd cut in. “Somber doesn’t begin to justify the words,” he said. “We have never heard language like this.”
We should get these two some rubber pants. They could make a museum of Democratic suits that have been ruined by Republican propaganda. You can have the mushroom cloud wing dedicated to the Iraq WMD evidence, the FISA wing and now the financial Armageddon wing. With three months to go I'm sure it will certainly double in size. Way to stand strong Democrats!
posted by any major dude at 2:08 PM on September 19, 2008 [4 favorites]
So, yeh, one thing that will shake out of this is we'll finally get our central clearing function for Credit Derivatives. Some of them at least. Remember, markets are global now, and just because the SEC compels US banks to trade through an exchange doesn't mean this will happen in Europe, Asia or even with the big hedge funds.
1. It is questionable under current precedent (i.e., Howey and progeny) whether credit derivatives as a class are directly subject to SEC authority, especially the more exotic species of financial instruments.
2. It is questionable how this regulation would be achieved; the SEC has no direct authority to regulate OTC exchanges, merely the ability to require registration. At its base, NASD is a self-regulating authority; as a practical matter, I am not certain that its behavior/function could be mandated out of thin air.
3. As Mutant suggests, there is a collateral question (ha!) of how one would standardize reporting of financial instruments that are almost by definition non-standard; presumably, if investors wanted to use a standard contract, they would already be doing so.
4. It seems to me that there's also a question of how to enforce the regulations; the SEA prohibits misleading trades, but (a) in addition to generally exempting OTC trades, (b) I think there's a question of what constitutes "misleading" in the first place. If a security is too complex to be confidently liquidated, is it "misleading" or just not-cognizable? I think the latter, but it's not clear that this is illegal.
posted by spiderwire at 2:10 PM on September 19, 2008 [1 favorite]
1. It is questionable under current precedent (i.e., Howey and progeny) whether credit derivatives as a class are directly subject to SEC authority, especially the more exotic species of financial instruments.
2. It is questionable how this regulation would be achieved; the SEC has no direct authority to regulate OTC exchanges, merely the ability to require registration. At its base, NASD is a self-regulating authority; as a practical matter, I am not certain that its behavior/function could be mandated out of thin air.
3. As Mutant suggests, there is a collateral question (ha!) of how one would standardize reporting of financial instruments that are almost by definition non-standard; presumably, if investors wanted to use a standard contract, they would already be doing so.
4. It seems to me that there's also a question of how to enforce the regulations; the SEA prohibits misleading trades, but (a) in addition to generally exempting OTC trades, (b) I think there's a question of what constitutes "misleading" in the first place. If a security is too complex to be confidently liquidated, is it "misleading" or just not-cognizable? I think the latter, but it's not clear that this is illegal.
posted by spiderwire at 2:10 PM on September 19, 2008 [1 favorite]
My dad just sent me this:
Hmmmm, something from AIG. Maybe they are sending me part of the [$85B] bail-out funds from our government!
posted by Korou at 2:11 PM on September 19, 2008
Hmmmm, something from AIG. Maybe they are sending me part of the [$85B] bail-out funds from our government!
posted by Korou at 2:11 PM on September 19, 2008
I love the comment above by Dodd! He is mySenatror and one of the big recipients of money from AIG...I am not knocking the Dems. Both parties got lots of money from AIG, and the lobby thing was also going on at the same time. of course payback time now to bail them out...Isn't that what makes the free market work?
posted by Postroad at 2:11 PM on September 19, 2008
posted by Postroad at 2:11 PM on September 19, 2008
When Jim Cramer said over a year ago "They know nothing!" was he actually right?
They know a great deal more than they understand.
posted by spiderwire at 2:11 PM on September 19, 2008
They know a great deal more than they understand.
posted by spiderwire at 2:11 PM on September 19, 2008
I guess I really don't care about the companies or their stockholders. I would like to see this sort of assistance go to individuals struggling with their mortgages, healthcare, or education.
posted by Mental Wimp at 2:14 PM on September 19, 2008
posted by Mental Wimp at 2:14 PM on September 19, 2008
BTW, one alternative to regulation would be to re-localize risk to the appropriate vehicles. The fact of the matter is that Goldman, Merrill, Lehman, Bear, and Morgan's assets were not amenable to being leveraged at 3 times the historical norm. Too much money, too few parties, not nearly enough investments.
40:1 leverage of that kind of money is even beyond Long-Term Capital Management territory; it doesn't matter whether you make good trades -- it's way past that. It can't be done in a noncontinuous market. Period. There's just no way to manage that kind of volatility at that kind of volume, and granting the exemptions to do it was just plain stupid.
posted by spiderwire at 2:22 PM on September 19, 2008
40:1 leverage of that kind of money is even beyond Long-Term Capital Management territory; it doesn't matter whether you make good trades -- it's way past that. It can't be done in a noncontinuous market. Period. There's just no way to manage that kind of volatility at that kind of volume, and granting the exemptions to do it was just plain stupid.
posted by spiderwire at 2:22 PM on September 19, 2008
NOW, perhaps, you start to understand what I meant when I said we were headed for Zimbabwe. I remember lots of scoffing, but I'm not hearing so much of that anymore.
For the thousanth time, we are NOT heading for Zimbabwe.
Continuing to say that just reinforces the low opinions of your so-called expertise many have about you.
We may be heading for Japan 1990-2000. We may be heading for Argentina 2001. But Zimbabwe is so far beyond either one that it's like screaming "WE ARE HEADING TO THE MOON!" while you're boarding a Southwest flight to Phoenix.
At its worst Argentina's inflation was running at over 100% monthly (for one month; rest of the time it was around 30% monthly). At its worst Zimbabwe's inflation was running at over 100,000% monthly.
Honestly, are you capable of anything other than hyperbole?
posted by dw at 2:26 PM on September 19, 2008 [10 favorites]
For the thousanth time, we are NOT heading for Zimbabwe.
Continuing to say that just reinforces the low opinions of your so-called expertise many have about you.
We may be heading for Japan 1990-2000. We may be heading for Argentina 2001. But Zimbabwe is so far beyond either one that it's like screaming "WE ARE HEADING TO THE MOON!" while you're boarding a Southwest flight to Phoenix.
At its worst Argentina's inflation was running at over 100% monthly (for one month; rest of the time it was around 30% monthly). At its worst Zimbabwe's inflation was running at over 100,000% monthly.
Honestly, are you capable of anything other than hyperbole?
posted by dw at 2:26 PM on September 19, 2008 [10 favorites]
Honestly, are you capable of anything other than hyperbole?
Our reality is highly leveraged for maximum return
posted by spiderwire at 2:30 PM on September 19, 2008 [7 favorites]
Our reality is highly leveraged for maximum return
posted by spiderwire at 2:30 PM on September 19, 2008 [7 favorites]
I am probably going to flamed for this post but here goes. I do not have time or energy to explain why I feel this way in great detail, and in some respects, it is more intuition than reasoned professional opinion such as Mutant's - and I will defer to his critique if he is of a mind. It is however, the intuition of someone who has been in and around 'the market' for some years, I'll not date myself though.
All of the outrage is sadly misplaced. I submit that a the actual losses arising from MBS defaults will be significantly less than what seems to be expected. The number of actual defaults compared to the size of the market is quite small, although not insignificant, and certainly large on a percentage basis versus historical norms. Obviously the human cost is the biggest thing.
The cause of the problem is simply that a financial engineering innovation went haywire. Should we stop all financial engineering because of this? I don't think so. Its generally an endeavor that unlocks possibilities that were previously impossible. For example, the creation of Fannie/Freddie and the rise of the CMO and securitization market and associated derivative instruments allowed many people that could not afford homes aford them and alloed them to realize their part of the 'American dream' and take advantage of increased cash flow from tax deductible home interest. The vast majority of households managed this appropriately.
The triggering fuck-up was two-fold - simplistically. First, people mistakenly thought that private ratings companies represented a workable marketplace assessor of risk - a severely flawed assumption - the level of their ability to assess such a fragmented underwriting process is prone to the system risk associated with the stupidest or most malign individual involved in a very long chain. Secondly, banks writing mortgages were allowed package them and decouple themselves from the underlying risk - pricing again based upon the ratings firms saying 'these are this quality, and these are that quality.'
It is also my opinion that the government will wind up making a great deal of money from this process - due to the proverbial buy low-sell high strategy. Taxpayers could wind up getting a big benefit - it seems to me - although I have to admit that my understanding of the terms of the Bear, Fran/Fred, and AIG deals is fairly superficial. If I can buy assets for cents on the dollar, a lot of the components can be non-performing and I can still make serious coin.
The changes proposed today were fairly sweeping - actualy deserving another 3 or so FPPs and amounted to changing the rules of the game with no notice and little communication. Without going too far afield, in particular the banning of short sales on 800 financial firms for a limited time is almost guaranteed to lead to an astonishing application of the 'law of unintended consequences.' Was today's market upswing real or just short covering? Should be fun to watch actually. The cynic in me wants to believe that this rule is changed to allow it to come off the week before the election which will lead to trillions of pent up short pressure to be released onto the market just prior to the election. Who knows what the effect will be.
Again, it should be interesting.
*pops corn, waits for mutant to arrive*
posted by sfts2 at 2:38 PM on September 19, 2008 [1 favorite]
All of the outrage is sadly misplaced. I submit that a the actual losses arising from MBS defaults will be significantly less than what seems to be expected. The number of actual defaults compared to the size of the market is quite small, although not insignificant, and certainly large on a percentage basis versus historical norms. Obviously the human cost is the biggest thing.
The cause of the problem is simply that a financial engineering innovation went haywire. Should we stop all financial engineering because of this? I don't think so. Its generally an endeavor that unlocks possibilities that were previously impossible. For example, the creation of Fannie/Freddie and the rise of the CMO and securitization market and associated derivative instruments allowed many people that could not afford homes aford them and alloed them to realize their part of the 'American dream' and take advantage of increased cash flow from tax deductible home interest. The vast majority of households managed this appropriately.
The triggering fuck-up was two-fold - simplistically. First, people mistakenly thought that private ratings companies represented a workable marketplace assessor of risk - a severely flawed assumption - the level of their ability to assess such a fragmented underwriting process is prone to the system risk associated with the stupidest or most malign individual involved in a very long chain. Secondly, banks writing mortgages were allowed package them and decouple themselves from the underlying risk - pricing again based upon the ratings firms saying 'these are this quality, and these are that quality.'
It is also my opinion that the government will wind up making a great deal of money from this process - due to the proverbial buy low-sell high strategy. Taxpayers could wind up getting a big benefit - it seems to me - although I have to admit that my understanding of the terms of the Bear, Fran/Fred, and AIG deals is fairly superficial. If I can buy assets for cents on the dollar, a lot of the components can be non-performing and I can still make serious coin.
The changes proposed today were fairly sweeping - actualy deserving another 3 or so FPPs and amounted to changing the rules of the game with no notice and little communication. Without going too far afield, in particular the banning of short sales on 800 financial firms for a limited time is almost guaranteed to lead to an astonishing application of the 'law of unintended consequences.' Was today's market upswing real or just short covering? Should be fun to watch actually. The cynic in me wants to believe that this rule is changed to allow it to come off the week before the election which will lead to trillions of pent up short pressure to be released onto the market just prior to the election. Who knows what the effect will be.
Again, it should be interesting.
*pops corn, waits for mutant to arrive*
posted by sfts2 at 2:38 PM on September 19, 2008 [1 favorite]
It's really, really, really bad out there. I was talking to a couple of financial people, and the thing that came out to me is that no one is really sure what anything is worth anymore.
And that's a very dangerous place to be.
The US sopping up the bad debt may not be a bad thing, if it means that the financial companies and banks are going to be kowtowed into firmer regulation -- oversight over derivatives, firmer controls on naked short selling, restoring the Glass-Steagall firewalls.
The other thing, too, is that the federal government now controls three financial companies it could use to turn loose on all this bad mortgage debt. They could do haircuts, cramdowns, short sales, whatever it takes to get the non-payers back in a position where they can pay. Then the government rolls up the good mortgages into transparent mortgage-backed securities, backed by Full Faith And Credit, and starts selling them. You can bet China will be first in line. They would make a killing off these bonds. Maybe even enough to offset the $1T it took to keep the economy from total meltdown.
But it's still very, very dangerous. The S&L crisis, after all, was an albatross around the neck of the US economy for years, even though the RTC recovered some money. Something this large, something that's as much as 10% of our annual GDP in expenses we may never get back... it's a huge problem.
The solution right now is looking more Sweden 1990 than Japan 1990. This is good. But Sweden had rigorous oversight when they nationalized the banks, and they were playing with a much smaller amount of money. Will Congress provide the oversight? Will the $1T end up being just too large a pill to swallow?
posted by dw at 2:42 PM on September 19, 2008 [1 favorite]
And that's a very dangerous place to be.
The US sopping up the bad debt may not be a bad thing, if it means that the financial companies and banks are going to be kowtowed into firmer regulation -- oversight over derivatives, firmer controls on naked short selling, restoring the Glass-Steagall firewalls.
The other thing, too, is that the federal government now controls three financial companies it could use to turn loose on all this bad mortgage debt. They could do haircuts, cramdowns, short sales, whatever it takes to get the non-payers back in a position where they can pay. Then the government rolls up the good mortgages into transparent mortgage-backed securities, backed by Full Faith And Credit, and starts selling them. You can bet China will be first in line. They would make a killing off these bonds. Maybe even enough to offset the $1T it took to keep the economy from total meltdown.
But it's still very, very dangerous. The S&L crisis, after all, was an albatross around the neck of the US economy for years, even though the RTC recovered some money. Something this large, something that's as much as 10% of our annual GDP in expenses we may never get back... it's a huge problem.
The solution right now is looking more Sweden 1990 than Japan 1990. This is good. But Sweden had rigorous oversight when they nationalized the banks, and they were playing with a much smaller amount of money. Will Congress provide the oversight? Will the $1T end up being just too large a pill to swallow?
posted by dw at 2:42 PM on September 19, 2008 [1 favorite]
Our reality is highly leveraged for maximum return
I've been throwing my life savings into shorting reality. If you'll excuse me, I need to talk to my realtor in Tuscany about the villa I'm buying with this week's earnings.
posted by dw at 2:46 PM on September 19, 2008 [1 favorite]
I've been throwing my life savings into shorting reality. If you'll excuse me, I need to talk to my realtor in Tuscany about the villa I'm buying with this week's earnings.
posted by dw at 2:46 PM on September 19, 2008 [1 favorite]
As to seeing it coming, I knew this was coming at least a year ago merely from reading blogs about the housing bubble and paying minimal attention to news sources such as NPR*. It's impossible to believe the federal government and Wall Street had no clue (although Greenspan admitted in an interview to underestimating the extent of the problem, again quite a while back).
The emergence of a global Ponzi scheme - and all that has gone on around it - has been riveting. As per what to do about it, the more you know, I suspect the less clear that becomes. Just hoping Bernanke and Paulson truly are protecting us from a global financial collapse, because we really could have used that money for things people actually need such as schools of equal high quality, universal health coverage, rapid public transport, alternative energy R&D, and yes, AFFORDABLE HOUSING! I hope there is serious political damage from this, and I hope all the idealistic "free market will take care of everything" people will finally give it up - this is what you get. We could have given eveyone a free house and paid them to stay home.
* I'm pretty sure I first hear of Collateralized Debt Obligations in a NPR piece. The tie-in with housing was made quite clear.
posted by AppleSeed at 2:46 PM on September 19, 2008
The emergence of a global Ponzi scheme - and all that has gone on around it - has been riveting. As per what to do about it, the more you know, I suspect the less clear that becomes. Just hoping Bernanke and Paulson truly are protecting us from a global financial collapse, because we really could have used that money for things people actually need such as schools of equal high quality, universal health coverage, rapid public transport, alternative energy R&D, and yes, AFFORDABLE HOUSING! I hope there is serious political damage from this, and I hope all the idealistic "free market will take care of everything" people will finally give it up - this is what you get. We could have given eveyone a free house and paid them to stay home.
* I'm pretty sure I first hear of Collateralized Debt Obligations in a NPR piece. The tie-in with housing was made quite clear.
posted by AppleSeed at 2:46 PM on September 19, 2008
*also waiting for mutant*
I've got a supplemental insurance piece of propaganda here, a plush toy duck dressed in an academic cap and gown that says: "Aflaaaaaaac!" in a really alarming way when you squeeze its butt. Anybody want it?
posted by woodway at 2:47 PM on September 19, 2008
I've got a supplemental insurance piece of propaganda here, a plush toy duck dressed in an academic cap and gown that says: "Aflaaaaaaac!" in a really alarming way when you squeeze its butt. Anybody want it?
posted by woodway at 2:47 PM on September 19, 2008
This is kind of unrelated, but will all the bailouts just get added to the US government debt? Does anyone actually know how much of it there is?
posted by dohmer at 2:52 PM on September 19, 2008
posted by dohmer at 2:52 PM on September 19, 2008
Wow. Great article. I've been trying to read up, and few pieces have put things so concisely for the layman.
posted by Durn Bronzefist at 2:57 PM on September 19, 2008
posted by Durn Bronzefist at 2:57 PM on September 19, 2008
“You have the credit lines in America, which are the lifeblood of the economy, frozen.” Mr. Schumer said.
There. Right there. In one sentence, the entire problem. We are dependent on credit instead of assets. We are hooked on debt, and the instant our supply dries up, we go into convulsions.
The solution to a debt problem is not more debt.
posted by Malor at 2:58 PM on September 19, 2008 [4 favorites]
There. Right there. In one sentence, the entire problem. We are dependent on credit instead of assets. We are hooked on debt, and the instant our supply dries up, we go into convulsions.
The solution to a debt problem is not more debt.
posted by Malor at 2:58 PM on September 19, 2008 [4 favorites]
Krugman's op-ed is pretty mind-blowing. Total credit freeze, huh? Like everyone suddenly waking up and saying, 'Wait, we don't actually have any money, and neither does anyone else. Except maybe the government...'
posted by kaibutsu at 3:08 PM on September 19, 2008
posted by kaibutsu at 3:08 PM on September 19, 2008
The other thing, too, is that the federal government now controls three financial companies it could use to turn loose on all this bad mortgage debt. They could do haircuts, cramdowns, short sales, whatever it takes to get the non-payers back in a position where they can pay.
1. There's the rub: if interested counterparties aren't protecting themselves adequately, why are we expecting that the government will? Would you rather have someone from Goldman or the government on the other side of the table when negotiating for a lower haircut? (On the other hand, haircuts interact with liquidity, but I don't think that's what you meant.)
2. The governments' interests are weirdly aligned; they're not going to aggressively compete to maximize returns. On one hand, maybe that sort of maverick pricing behavior is what we need. On one hand, I don't think it's plausible to think that the government is going to actively discipline the market -- the institutional players will complain about their margins and eventually the government will give in. Politically, terrorizing the market just won't play well.
3. None of this will do much if the government-owned securities can still be infinitely repurchased and repackaged. It'll just inflating the illiquid asset base. $1T of liquidity would be good; $1T of assets that just gets releveraged would be very bad.
4. I think that the best we can hope for is that the government will be a more risk-averse / less profit-maximizing investor, and that its presence will at least restrain market overreach by pure inertia. I'm not certain whether this is a better route than pure regulation, but in the short term I'm inclined to think it's the right choice.
In the long term, the question is whether the government can exercise enough self-discipline to act as a brake on systemic risk; however, its record so far (in the housing market especially) indicates that rent-seeking wins in the end.
posted by spiderwire at 3:09 PM on September 19, 2008 [1 favorite]
1. There's the rub: if interested counterparties aren't protecting themselves adequately, why are we expecting that the government will? Would you rather have someone from Goldman or the government on the other side of the table when negotiating for a lower haircut? (On the other hand, haircuts interact with liquidity, but I don't think that's what you meant.)
2. The governments' interests are weirdly aligned; they're not going to aggressively compete to maximize returns. On one hand, maybe that sort of maverick pricing behavior is what we need. On one hand, I don't think it's plausible to think that the government is going to actively discipline the market -- the institutional players will complain about their margins and eventually the government will give in. Politically, terrorizing the market just won't play well.
3. None of this will do much if the government-owned securities can still be infinitely repurchased and repackaged. It'll just inflating the illiquid asset base. $1T of liquidity would be good; $1T of assets that just gets releveraged would be very bad.
4. I think that the best we can hope for is that the government will be a more risk-averse / less profit-maximizing investor, and that its presence will at least restrain market overreach by pure inertia. I'm not certain whether this is a better route than pure regulation, but in the short term I'm inclined to think it's the right choice.
In the long term, the question is whether the government can exercise enough self-discipline to act as a brake on systemic risk; however, its record so far (in the housing market especially) indicates that rent-seeking wins in the end.
posted by spiderwire at 3:09 PM on September 19, 2008 [1 favorite]
Pastabagel, that Jim Cramer link was amazing. I've never really paid attention to the guy before but now I have, and he's my hero. Not that I have a clue what he's on about. But sometimes passion must trump comprehension.
posted by philip-random at 3:13 PM on September 19, 2008
posted by philip-random at 3:13 PM on September 19, 2008
So AIG and Lehman and Merrill and Fannie Mae and Freddie Mac all lobbied heavily to get things done in ways that they would like. And I'm sure many other big financial institutions currently in trouble have done likewise.
Assuming the already failed / taken-over companies are no longer lobbying, absent the failures or political firestorm, I wonder whether this alone would be enough to improve the US financial system. Would the politicians who voted to exempt firms from SEC regulation and real mortgage oversight have done so in the absence of the lobbying of these companies?
I also wonder whether major bank lobbying firms are going to collapse, following that of their customers.
posted by zippy at 3:21 PM on September 19, 2008
Assuming the already failed / taken-over companies are no longer lobbying, absent the failures or political firestorm, I wonder whether this alone would be enough to improve the US financial system. Would the politicians who voted to exempt firms from SEC regulation and real mortgage oversight have done so in the absence of the lobbying of these companies?
I also wonder whether major bank lobbying firms are going to collapse, following that of their customers.
posted by zippy at 3:21 PM on September 19, 2008
Malor: There. Right there. In one sentence, the entire problem.
Indeed. Here is a problem in two sentences:
We are dependent on credit instead of assets. We are hooked on debt, and the instant our supply dries up, we go into convulsions.
Not understanding the difference between "credit" and "debt" is a problem.
posted by spiderwire at 3:22 PM on September 19, 2008 [1 favorite]
Indeed. Here is a problem in two sentences:
We are dependent on credit instead of assets. We are hooked on debt, and the instant our supply dries up, we go into convulsions.
Not understanding the difference between "credit" and "debt" is a problem.
posted by spiderwire at 3:22 PM on September 19, 2008 [1 favorite]
“He also proposed "Rule 28 would be modified, blocking Conferees to a general appropriations bill from inserting in their Report any matter not committed to them by either House." A little late, I'd say.”
Well, at least it’s not Rule 34, I’d rather not imagine congress... ew...*shudders*
“ ‘Senators are being denied the right to debate and amend appropriations bills, all of which contain billions of taxpayer dollars,’ ”
Astonishing. Really. That seems like a pretty big Magilla to me.
Well, at least I’ve got this nifty Hubert doll.
posted by Smedleyman at 3:26 PM on September 19, 2008
Well, at least it’s not Rule 34, I’d rather not imagine congress... ew...*shudders*
“ ‘Senators are being denied the right to debate and amend appropriations bills, all of which contain billions of taxpayer dollars,’ ”
Astonishing. Really. That seems like a pretty big Magilla to me.
Well, at least I’ve got this nifty Hubert doll.
posted by Smedleyman at 3:26 PM on September 19, 2008
"the banning of short sales on 800 financial firms for a limited time is almost guaranteed to lead to an astonishing application of the 'law of unintended consequences.'"
This. This this this. See also: "Ban on Short-Selling Will Hurt Rather Than Help Broker-Dealers"
"will all the bailouts just get added to the US government debt? Does anyone actually know how much of it there is?"
According to a little something I read online today that tried to add it all up, we've got...
posted by Asparagirl at 3:27 PM on September 19, 2008
This. This this this. See also: "Ban on Short-Selling Will Hurt Rather Than Help Broker-Dealers"
"will all the bailouts just get added to the US government debt? Does anyone actually know how much of it there is?"
According to a little something I read online today that tried to add it all up, we've got...
- Housing "bailout" bill, $300 billion
- "Stimulus checks", $160 billion
- "Back door" bailouts done without Congressional authorization, including "hidden" loans that may never be repaid, such as Bear Stearns and "temporary" clearing loans to Lehman Brothers, about $100 billion (in total)
- Treasury's plan to back money market funds, $50 billion
- This new "bailout", $500 billion
posted by Asparagirl at 3:27 PM on September 19, 2008
All of the outrage is sadly misplaced. I submit that a the actual losses arising from MBS defaults will be significantly less than what seems to be expected. The number of actual defaults compared to the size of the market is quite small, although not insignificant, and certainly large on a percentage basis versus historical norms. Obviously the human cost is the biggest thing.
Well yeah, if we can freeze-dry the mortgages for 10-15 years we'll be OK most like.
But do you have a number for this bad debt? We know $5T or so of new lending went out 2003-2006 (most of it was refis IIRC).
It's my SWAG that at least 10% of this amount is bad, 20% is probable and 30% is possible. This correlates with the optimistic estimates I've seen and Roubini's (Dr Doom) estimate of $2.5T.
USG buys the debt at some discount, does a principal reset for the borrower so they can avoid FC, problem solved, sorta.
Other problems appear, though. Like $150 oil. USG borrowing rates moving up to 6%.
So instead of the borrowers paying ~7% on the inflated value of their house, the taxpayers will be paying ~6% on the debt issues to "retire" the bad loans.
We've already got a structural deficit thanks to the 2001-2003 tax cuts. We've added the WOT ($200B/yr) a doubled DOD budget ($600B+), rising medicare (also $600B+ IIRC), and now the interest on a trillion dollars of refinance bills ($50B or so).
Aren't we going to have to raise taxes to pay for this eventually?
If we raise taxes, that will drive real estate lower since new buyers will have less income to make their bids (and rents will also fall in response).
I think one real solution to our problems is the mercantilist approach of increasing the wealth production of our society and decreasing the wealth consumption, but that's tough since China has surplus capacity and we can't compete with China any more.
posted by troy at 3:32 PM on September 19, 2008
Well yeah, if we can freeze-dry the mortgages for 10-15 years we'll be OK most like.
But do you have a number for this bad debt? We know $5T or so of new lending went out 2003-2006 (most of it was refis IIRC).
It's my SWAG that at least 10% of this amount is bad, 20% is probable and 30% is possible. This correlates with the optimistic estimates I've seen and Roubini's (Dr Doom) estimate of $2.5T.
USG buys the debt at some discount, does a principal reset for the borrower so they can avoid FC, problem solved, sorta.
Other problems appear, though. Like $150 oil. USG borrowing rates moving up to 6%.
So instead of the borrowers paying ~7% on the inflated value of their house, the taxpayers will be paying ~6% on the debt issues to "retire" the bad loans.
We've already got a structural deficit thanks to the 2001-2003 tax cuts. We've added the WOT ($200B/yr) a doubled DOD budget ($600B+), rising medicare (also $600B+ IIRC), and now the interest on a trillion dollars of refinance bills ($50B or so).
Aren't we going to have to raise taxes to pay for this eventually?
If we raise taxes, that will drive real estate lower since new buyers will have less income to make their bids (and rents will also fall in response).
I think one real solution to our problems is the mercantilist approach of increasing the wealth production of our society and decreasing the wealth consumption, but that's tough since China has surplus capacity and we can't compete with China any more.
posted by troy at 3:32 PM on September 19, 2008
philip-random wrote:
Pastabagel, that Jim Cramer link was amazing. I've never really paid attention to the guy before but now I have, and he's my hero. Not that I have a clue what he's on about. But sometimes passion must trump comprehension.
Here's more from your hero a couple months later
posted by any major dude at 3:33 PM on September 19, 2008 [3 favorites]
Pastabagel, that Jim Cramer link was amazing. I've never really paid attention to the guy before but now I have, and he's my hero. Not that I have a clue what he's on about. But sometimes passion must trump comprehension.
Here's more from your hero a couple months later
posted by any major dude at 3:33 PM on September 19, 2008 [3 favorites]
the banning of short sales on 800 financial firms for a limited time is almost guaranteed to lead to an astonishing application of the 'law of unintended consequences.'
If someone could explain the function of short sellers in relation to the actions of regular stock buyers and sellers, I would appreciate it.
My naive understanding is that, by eliminating short sellers, you impede the flow of stocks in regular transactions as well. This does not sound like a good thing. Would this mean that market makers for stocks would have to hold a greater inventory than normal in order to ensure that stocks are liquid?
posted by zippy at 3:33 PM on September 19, 2008
If someone could explain the function of short sellers in relation to the actions of regular stock buyers and sellers, I would appreciate it.
My naive understanding is that, by eliminating short sellers, you impede the flow of stocks in regular transactions as well. This does not sound like a good thing. Would this mean that market makers for stocks would have to hold a greater inventory than normal in order to ensure that stocks are liquid?
posted by zippy at 3:33 PM on September 19, 2008
Instead of Talk Like A Pirate Day, today should really be known as Bart Simpson Day -- as in his famous catchphrase "Eat my shorts". Minyanville has a good explanatory article about what the SEC did today, with their new "banning financial short sellers" thing, and why it's a stupid quick-fix that will actually fuck things over so much worse in the end.
Meat in the sandwich: "With short sellers absent, shares will initially rise. But once demand is satisfied, there will be no softening any declines. This could potentially create a vacuum below market prices and exacerbate a decline."
So if the market goes kablooey, there will now be no shorts around to cover (that is, people buying stock just for the purpose of closing out a short position) on the way down, and thus the speed of the freefall will be even more rapid because there will be nothing standing in its way.
posted by Asparagirl at 3:40 PM on September 19, 2008
Meat in the sandwich: "With short sellers absent, shares will initially rise. But once demand is satisfied, there will be no softening any declines. This could potentially create a vacuum below market prices and exacerbate a decline."
So if the market goes kablooey, there will now be no shorts around to cover (that is, people buying stock just for the purpose of closing out a short position) on the way down, and thus the speed of the freefall will be even more rapid because there will be nothing standing in its way.
posted by Asparagirl at 3:40 PM on September 19, 2008
I've been under the longstanding assumption that the GOP strategy is to actually gut the government with the tax cuts, etc, and really turn the country into a laissez faire capitalist dreamland. We see it in the deregulation of the markets (helped along by McCain's economic advisers) leading into this mess. The outsourcing of military functions is another example; cut away every government function possible and outsource them to n00bish greed-motivated corporate entities. I'm pretty certain also that No Child Left Behind has the long term goal of destroying the public school system (even further than it already is) with the objective of replacing it with chartered private schools and voucher programs. (Until, of course, funding for the vouchers gets cut and we just give up on educating the poor.)
Government, for many of these asshats, is a way of getting richer faster. cf, the pile of Alaskan politicians under indictment. Oh, and something to run to when the roller-coaster goes off the tracks.
posted by kaibutsu at 3:56 PM on September 19, 2008 [4 favorites]
Government, for many of these asshats, is a way of getting richer faster. cf, the pile of Alaskan politicians under indictment. Oh, and something to run to when the roller-coaster goes off the tracks.
posted by kaibutsu at 3:56 PM on September 19, 2008 [4 favorites]
It is also my opinion that the government will wind up making a great deal of money from this process - due to the proverbial buy low-sell high strategy. Taxpayers could wind up getting a big benefit - it seems to me
No way. There's just no way. We're taking on bad debt that months and months of federal bailing could not relieve: not even the Treasury, the Federal Reserve Bank, or the poobahs on the Senate Finance committee are even spinning it otherwise.
I was very, very doubtful the Fed was buying anything other than a lemon when it bailed out Bear Stearns last spring, but I'm beyond certain that the emergency measures taken this week were taken simply to plug a gaping market hole--and that these debts are never going to suddenly or even gradually turn into a big windfall for the tax payer. Let's stop the charade and at least admit what the Wall Street Journal, the heads of the firms themselves, the Fed, the Treasury, and our political class is all now admitting: that this was an 11th hour attempt to prevent economic catastrophe, and it's not going to morph into some magical great deal for future taxpayers. The most we can hope for now is that the situation has been stabilized enough to prevent another major round of imploding banks, since the Fed will have run out of viable options at that point.
posted by ornate insect at 3:58 PM on September 19, 2008
No way. There's just no way. We're taking on bad debt that months and months of federal bailing could not relieve: not even the Treasury, the Federal Reserve Bank, or the poobahs on the Senate Finance committee are even spinning it otherwise.
I was very, very doubtful the Fed was buying anything other than a lemon when it bailed out Bear Stearns last spring, but I'm beyond certain that the emergency measures taken this week were taken simply to plug a gaping market hole--and that these debts are never going to suddenly or even gradually turn into a big windfall for the tax payer. Let's stop the charade and at least admit what the Wall Street Journal, the heads of the firms themselves, the Fed, the Treasury, and our political class is all now admitting: that this was an 11th hour attempt to prevent economic catastrophe, and it's not going to morph into some magical great deal for future taxpayers. The most we can hope for now is that the situation has been stabilized enough to prevent another major round of imploding banks, since the Fed will have run out of viable options at that point.
posted by ornate insect at 3:58 PM on September 19, 2008
(And thanks, Smedlyman; your mention of Rule 34 with regards to congressional voyeurism oversight put that image of the naked SCOTUS in America: The Book into my head...)
posted by kaibutsu at 4:00 PM on September 19, 2008
posted by kaibutsu at 4:00 PM on September 19, 2008
Great comment spiderwire; I'm by no means a regulatory or compliance person so I think I'm just expressing the unease that many of us feltl at the explosive growth of this market. That being said, I do think something like a clearing house or (even better) exchange is needed, not sure about the details regarding how this function would be structured or executed or even have legaly / regulatory powers, but I think everyone in this thread would agree that AIG illustrates the need for some solution.
sfts2 -- "The cause of the problem is simply that a financial engineering innovation went haywire."
Now that statement is the crux of the problem, concise and to the point.
This market grew explosively year on year, and like any other market that underwent such rapid growth (the history of finance shows us lots of examples), many of the pesky details fell to the wayside while pursuing the all mighty profit - for example regulatory oversight and the oh so important disclosure requirements, which can't happen until a proper regulatory framework is in place. And I only linked to The Deutsche Bundesbank / Basel II documentation as I'm current on European banking regulatory requirements, not US.
But - and I'm not excusing mind you, just looking back over a long horizon - we've seen this many times before, almost every time a new derivative market is opened there are problems.
These problems are (note I didn't say were) huge.
And as you pointed out, this isn't the time for a Luddite like reaction, largely based on ignorance, fear of the unknown. We've got to begin to reign in this reckless behaviour because Credit Default Swaps - like many other classes of derivatives - serve critical market driven needs.
I think for myself the moment when I "lost the faith" is when we noted large numbers of new Credit Default Swaps were being written for speculative purpose, not for hedging.
A big difference in use. One is a legitimate use of derivatives. The purpose they were financially engineered for. The other is - well, speculative.
Not only a big difference but also something we've observed every time we've seen an asset bubble. I previously commented about Hyman Minsky an economist who is best known for the phrase "stability is unstable" . Minsky had some intriquing ideas.
Specifically, Minsky viewed capitalist economies as inherently unstable (as did Kondatrieff but that's for another comment), and specified three components to the bubble building / business cycle.
First, investment as normal but, over time, hedging is introduced to reduce risk (i.e., losses). Credit Derivative are the topic we're discussing, and they serve a clear need and role in phase one.
Next speculation takes off, as the "normal" corrective mechanisms (i.e., losses) are suppressed by the aforementioned hedging activities. This is the part of the process where many became concerned about what was really going on with these products. Why was Delphi "hedged out" to a factor of six, maybe eight times it's nominal value? That aint' hedging!!
Finally, what is called "The Ponzi phase" in which investments can only be justified by the (always faulty in hindsight) assumption that prices will continue to rise.
As I mentioned before, we've seen this behaviour in every documented bubble, going back some four centuries.
We see asset bubbles on average every ten years or so (we've just gotten our fair share folks), and it doesn't matter who is in charge, what currency we're using or what the current mania is focused on (e.g., dot com stocks, California real estate, tulips), Minsky's three steps is a key test we apply to see if it "smells" like a bubble.
So, Credit Derivatives? Bubble. And that bubble? Burst.
Now's the time for regulating and reigning that business in (somewhat).
posted by Mutant at 4:04 PM on September 19, 2008 [7 favorites]
As I mentioned before, we've seen this behaviour in every documented bubble, going back some four centuries.
Exactly.
One of my professors put it to me this way:
There will always be arbitrage opportunities where there are information asymmetries, so you can make money by hedging deltas -- but once the difference has been arbitraged out the well dries up.
At that point you can still make more money via more leveraged positions, but you can then easily be put in a position where you don't have the liquidity or even the capital to unwind or even cover your position. Until that happens it's just a game of musical chairs.
Long-Term Capital's investments made money in the end, but they weren't around to see it.
posted by spiderwire at 4:12 PM on September 19, 2008 [2 favorites]
Exactly.
One of my professors put it to me this way:
There will always be arbitrage opportunities where there are information asymmetries, so you can make money by hedging deltas -- but once the difference has been arbitraged out the well dries up.
At that point you can still make more money via more leveraged positions, but you can then easily be put in a position where you don't have the liquidity or even the capital to unwind or even cover your position. Until that happens it's just a game of musical chairs.
Long-Term Capital's investments made money in the end, but they weren't around to see it.
posted by spiderwire at 4:12 PM on September 19, 2008 [2 favorites]
Does anyone think this is still just a liquidity crisis?
posted by ryoshu at 4:35 PM on September 19, 2008
posted by ryoshu at 4:35 PM on September 19, 2008
Re: regulation, have you seen Glenn Hubbard's op ed in WP, Mutant? I've been out of industry a while, but he was a respected economist in the day. Granted, such op eds are frequently the work of ghost writers, but if he put his name on it, that's still a commitment of intellectual currency.
I also thought this piece by Harold Meyerson about infrastructure investment was interesting, as someone more interested in historical / academic work now, but here too it was probably written with political point-scoring in mind.
What timing. I wonder if financial advisers to the respective campaigns have any hair they haven't pulled out, or fingernails they haven't bitten down to the quick? Most of us, i.e. the voters, don't understand the basics much less the nuances of the problem. We might want straight-talk, and hope, but this isn't a straight-forward problem. Economic well-being will be a major issue in voters' minds. It'll be interesting to see who inherits the mess, and how decisions now will (or won't) be carried forward come January. Wonder if regulatory instability has been priced into market considerations.
posted by woodway at 5:05 PM on September 19, 2008
I also thought this piece by Harold Meyerson about infrastructure investment was interesting, as someone more interested in historical / academic work now, but here too it was probably written with political point-scoring in mind.
What timing. I wonder if financial advisers to the respective campaigns have any hair they haven't pulled out, or fingernails they haven't bitten down to the quick? Most of us, i.e. the voters, don't understand the basics much less the nuances of the problem. We might want straight-talk, and hope, but this isn't a straight-forward problem. Economic well-being will be a major issue in voters' minds. It'll be interesting to see who inherits the mess, and how decisions now will (or won't) be carried forward come January. Wonder if regulatory instability has been priced into market considerations.
posted by woodway at 5:05 PM on September 19, 2008
For example, the creation of Fannie/Freddie and the rise of the CMO and securitization market and associated derivative instruments allowed many people that could not afford homes aford them and alloed them to realize their part of the 'American dream' and take advantage of increased cash flow from tax deductible home interest.
Or maybe this helped drive real estate prices up, leading to the current problems.
posted by exogenous at 5:06 PM on September 19, 2008
Or maybe this helped drive real estate prices up, leading to the current problems.
posted by exogenous at 5:06 PM on September 19, 2008
Does anyone think this is still just a liquidity crisis?
Nah,I thought it was a musical chairs crisis with the extra flavor of everyones pants being down
posted by uandt at 5:08 PM on September 19, 2008
Nah,I thought it was a musical chairs crisis with the extra flavor of everyones pants being down
posted by uandt at 5:08 PM on September 19, 2008
So if the market goes kablooey, there will now be no shorts around to cover (that is, people buying stock just for the purpose of closing out a short position) on the way down, and thus the speed of the freefall will be even more rapid because there will be nothing standing in its way.
Wait, weren't you shorting WM? Or dumping money in SKF? Hmm?
It may come back to bite us, but there are two problems right now with shorting financials -- too much of it will tip struggling companies over, and there's almost a speculative bubble forming around naked shorting. The last thing we need right now is WM or WB getting pushed into the arms of the FDIC, even if that's what JPMC or WFC want (so they can pick up their retail end for pennies on the dollar while the FDIC deals with the $100B in debt).
And honestly, the shorts won't save us from a meltdown. They may see their need to buy as some redemptive phase, but when every dollar down is another dollar in their pocket, there's no real push to hit the button until we're too far gone. Maybe the shorts would save us a percent on the decline, what's 23% down compared to 22%?
posted by dw at 5:08 PM on September 19, 2008
Wait, weren't you shorting WM? Or dumping money in SKF? Hmm?
It may come back to bite us, but there are two problems right now with shorting financials -- too much of it will tip struggling companies over, and there's almost a speculative bubble forming around naked shorting. The last thing we need right now is WM or WB getting pushed into the arms of the FDIC, even if that's what JPMC or WFC want (so they can pick up their retail end for pennies on the dollar while the FDIC deals with the $100B in debt).
And honestly, the shorts won't save us from a meltdown. They may see their need to buy as some redemptive phase, but when every dollar down is another dollar in their pocket, there's no real push to hit the button until we're too far gone. Maybe the shorts would save us a percent on the decline, what's 23% down compared to 22%?
posted by dw at 5:08 PM on September 19, 2008
I am certainly not going to start arguing that the government somehow is going to make a killing over time, but I do think its clear that:
a) People representing that...
* Housing "bailout" bill, $300 billion
* "Stimulus checks", $160 billion
* "Back door" bailouts done without Congressional authorization, including "hidden" loans that may never be repaid, such as Bear Stearns and "temporary" clearing loans to Lehman Brothers, about $100 billion (in total)
* Treasury's plan to back money market funds, $50 billion
* This new "bailout", $500 billion
...are all essentially the same (or even similar) thing are overly simplistic and in some respects completely inaccurate. Bear <> AIG <> money market fund guarantees <> tax rebates
b) If you think that up to now everyone has been irrational, but now everyone is thinking rationally and altruistically, well, I have a bridge to nowhere in Brooklyn to sell you. In my view, everyone is panicking - traders (less than most), money managers, CEOs, and regulators.
Over-leverage is a bad thing.
Thoughtful government regulation is not a bad thing.
The defining driver of this 'bubble burst' - like every other one is panic. Panic is a bad thing.
posted by sfts2 at 5:21 PM on September 19, 2008
a) People representing that...
* Housing "bailout" bill, $300 billion
* "Stimulus checks", $160 billion
* "Back door" bailouts done without Congressional authorization, including "hidden" loans that may never be repaid, such as Bear Stearns and "temporary" clearing loans to Lehman Brothers, about $100 billion (in total)
* Treasury's plan to back money market funds, $50 billion
* This new "bailout", $500 billion
...are all essentially the same (or even similar) thing are overly simplistic and in some respects completely inaccurate. Bear <> AIG <> money market fund guarantees <> tax rebates
b) If you think that up to now everyone has been irrational, but now everyone is thinking rationally and altruistically, well, I have a bridge to nowhere in Brooklyn to sell you. In my view, everyone is panicking - traders (less than most), money managers, CEOs, and regulators.
Over-leverage is a bad thing.
Thoughtful government regulation is not a bad thing.
The defining driver of this 'bubble burst' - like every other one is panic. Panic is a bad thing.
posted by sfts2 at 5:21 PM on September 19, 2008
Hmm. Upon investigation, it seems that there is little consensus as to whether exotic instruments can be regulated as securities.
Some courts hold that synthetic options are securities because of language in the Exchange Act (Caiola v. Citibank), but others hold that they aren't covered because there's no right to the underlying asset (P&G v. Bankers Trust Co.).
More confusingly, CDS agreements are specifically exempted from the definition of "securities" under the CFMA, but the Act also amends 10b-5's antifraud provisions to cover them, which makes no sense to me.
Seems pretty clear that the SEC doesn't have regulatory control here, and my understanding is that they generally don't want to get involved with more complex instruments anyway. But I don't think that'll continue. My prediction is that by the end of all this, the SEC will have more regulatory authority than God. Whether that'll be sufficient power to do anything remains to be seen.
posted by spiderwire at 5:44 PM on September 19, 2008 [2 favorites]
Some courts hold that synthetic options are securities because of language in the Exchange Act (Caiola v. Citibank), but others hold that they aren't covered because there's no right to the underlying asset (P&G v. Bankers Trust Co.).
More confusingly, CDS agreements are specifically exempted from the definition of "securities" under the CFMA, but the Act also amends 10b-5's antifraud provisions to cover them, which makes no sense to me.
Seems pretty clear that the SEC doesn't have regulatory control here, and my understanding is that they generally don't want to get involved with more complex instruments anyway. But I don't think that'll continue. My prediction is that by the end of all this, the SEC will have more regulatory authority than God. Whether that'll be sufficient power to do anything remains to be seen.
posted by spiderwire at 5:44 PM on September 19, 2008 [2 favorites]
what were the arguments against creating a clearinghouse for CDSs?
Central clearinghouses make it harder for the seller to dump the policy on a mysterious third party who cannot be located to pay the claim. Burying everything in a broken, antiquated, paper system makes it a lot easier to sell the policy and then get out of Dodge.
Open markets are easier to measure and regulate. Broker Dealers spend much money, time, and effort to avoid measurement and regulation.
"I've been wondering this since the Frannie/Freddie mess: if companies like AIG keep getting bailed out because they are "too big to fail," would putting regulations in place to keep companies from getting too big to fail be a possiblity? And what would that look like?"
Regulations are already in place that would have prevented this. The problem is not their size per se, but the healthiness of their balance sheet. FNM flouted SEC reporting requirements for years and nothing was done about it. If reporting rules were enforced, it would have done a lot to uncover the problem activity. In general, the SEC is underfunded and kept on a tight leash.
Governments require central banks and modern financial markets in order to fund their operations. Their operations cannot be funded merely by taxes alone, they need a market willing to lend them money - a very large market. This is why the finance sector is being bailed out. If they were not bailed out, the US Government would immediately be unable to pay salaries and expenses without brutally raising taxes and cutting spending. The real answer is to reduce government expenses, but I doubt that will happen.
The current system does not benefit most people. It benefits an elite few who get all the advantage. When they screw you over, regulators are nowhere to be found, and you are told to "man up". When it is your turn to screw them back, they whine to the government for protection. The Government, "by the people and for the people", gives them loans at rates unavailable to you (discount window), with generous terms (pay us back whenever), changes the rules (no shorting financial stocks) and sticks you with the bill (future inflation, future tax increases, capital controls, loss of US economic primacy, etc.).
Looking only at the markets for what they are supposed to be, there is no reason to prop up these financial stocks. It would not kill the economy. It would kill the status quo, but that is going to happen no matter what the government tries to do. It is only when the markets are viewed as a money pump to feed the US Government that it becomes expedient to try to protect the current order. They are futilely trying to keep things the way they are and not worrying about the horrible costs to current and future generations of Americans.
posted by b1ff at 6:04 PM on September 19, 2008 [5 favorites]
Central clearinghouses make it harder for the seller to dump the policy on a mysterious third party who cannot be located to pay the claim. Burying everything in a broken, antiquated, paper system makes it a lot easier to sell the policy and then get out of Dodge.
Open markets are easier to measure and regulate. Broker Dealers spend much money, time, and effort to avoid measurement and regulation.
"I've been wondering this since the Frannie/Freddie mess: if companies like AIG keep getting bailed out because they are "too big to fail," would putting regulations in place to keep companies from getting too big to fail be a possiblity? And what would that look like?"
Regulations are already in place that would have prevented this. The problem is not their size per se, but the healthiness of their balance sheet. FNM flouted SEC reporting requirements for years and nothing was done about it. If reporting rules were enforced, it would have done a lot to uncover the problem activity. In general, the SEC is underfunded and kept on a tight leash.
Governments require central banks and modern financial markets in order to fund their operations. Their operations cannot be funded merely by taxes alone, they need a market willing to lend them money - a very large market. This is why the finance sector is being bailed out. If they were not bailed out, the US Government would immediately be unable to pay salaries and expenses without brutally raising taxes and cutting spending. The real answer is to reduce government expenses, but I doubt that will happen.
The current system does not benefit most people. It benefits an elite few who get all the advantage. When they screw you over, regulators are nowhere to be found, and you are told to "man up". When it is your turn to screw them back, they whine to the government for protection. The Government, "by the people and for the people", gives them loans at rates unavailable to you (discount window), with generous terms (pay us back whenever), changes the rules (no shorting financial stocks) and sticks you with the bill (future inflation, future tax increases, capital controls, loss of US economic primacy, etc.).
Looking only at the markets for what they are supposed to be, there is no reason to prop up these financial stocks. It would not kill the economy. It would kill the status quo, but that is going to happen no matter what the government tries to do. It is only when the markets are viewed as a money pump to feed the US Government that it becomes expedient to try to protect the current order. They are futilely trying to keep things the way they are and not worrying about the horrible costs to current and future generations of Americans.
posted by b1ff at 6:04 PM on September 19, 2008 [5 favorites]
goddamn another thread I need to think up something halfway cogent to say just to get it into my Recent Activity?
Yep. Regarding the banning of short sales, perhaps it is useful to look how well it worked for Parkistan. The US markets being (I assume) larger and more sophisticated, perhaps the short-covering will take longer to wear off, and who knows what new tricks they'll come up with before then.
Personally, I plan to wait until the US loses its AAA sovereign debt AAA rating before I panic.
posted by sfenders at 6:25 PM on September 19, 2008
Yep. Regarding the banning of short sales, perhaps it is useful to look how well it worked for Parkistan. The US markets being (I assume) larger and more sophisticated, perhaps the short-covering will take longer to wear off, and who knows what new tricks they'll come up with before then.
Personally, I plan to wait until the US loses its AAA sovereign debt AAA rating before I panic.
posted by sfenders at 6:25 PM on September 19, 2008
Yeh, because the ratings have worked out so well up till now.
posted by bonaldi at 6:27 PM on September 19, 2008
posted by bonaldi at 6:27 PM on September 19, 2008
US debt to GDP is half what Canada's and Japan's were before they got their rating downgraded.
And what bonaldi said.
posted by sfts2 at 6:32 PM on September 19, 2008
And what bonaldi said.
posted by sfts2 at 6:32 PM on September 19, 2008
Wait, weren't you shorting WM? Or dumping money in SKF? Hmm?
Nope, I sold my last three WM puts a while ago, and have never shorted them. I do have a little money in SKF in my IRA - but again, that's an inverse ETF (as I think you know), and also not a short of any one stock, exactly. It's just not my thing. But speaking just on principle, there is nothing wrong with shorting a stock -- despite comments I heard were actually made on TV today that shorting is "unpatriotic" (!!!), which seems to be the new party line on the matter.
The fact is that all the shorting and rumors in the world can't kill a stock or a company that has intrinsic value -- it would be wasting your money. I think we can all agree that naked shorting should be curtailed, absolutely -- but the thing is, isn't it already illegal? And isn't that tactic only used by hedge funds, and inaccessible to small individual traders? The SEC's new actions today banned all shorting of certain favored stocks, by everyone, big or little, rather than just enforcing the existing laws. That's using an elephant gun to kill a mosquito. And that's also setting off all sorts of unintended effects, the funniest of which is watching other companies (i.e. GE, etc.) suddenly clamoring to get access to the government's special new guest list.
I get that many Wall Street CEO's would like to lead a witch hunt here -- which now-failed investment bank head was it who said publicly (just a little while ago) that he would crush the shorts for being so mean to his noble company? -- but that doesn't mean the government should become grand inquisitor.
posted by Asparagirl at 6:33 PM on September 19, 2008
Nope, I sold my last three WM puts a while ago, and have never shorted them. I do have a little money in SKF in my IRA - but again, that's an inverse ETF (as I think you know), and also not a short of any one stock, exactly. It's just not my thing. But speaking just on principle, there is nothing wrong with shorting a stock -- despite comments I heard were actually made on TV today that shorting is "unpatriotic" (!!!), which seems to be the new party line on the matter.
The fact is that all the shorting and rumors in the world can't kill a stock or a company that has intrinsic value -- it would be wasting your money. I think we can all agree that naked shorting should be curtailed, absolutely -- but the thing is, isn't it already illegal? And isn't that tactic only used by hedge funds, and inaccessible to small individual traders? The SEC's new actions today banned all shorting of certain favored stocks, by everyone, big or little, rather than just enforcing the existing laws. That's using an elephant gun to kill a mosquito. And that's also setting off all sorts of unintended effects, the funniest of which is watching other companies (i.e. GE, etc.) suddenly clamoring to get access to the government's special new guest list.
I get that many Wall Street CEO's would like to lead a witch hunt here -- which now-failed investment bank head was it who said publicly (just a little while ago) that he would crush the shorts for being so mean to his noble company? -- but that doesn't mean the government should become grand inquisitor.
posted by Asparagirl at 6:33 PM on September 19, 2008
US debt to GDP is half what Canada's and Japan's were before they got their rating downgraded.
And it'll be twice that before it happens, but I read somewhere that the best thing to do is DON'T PANIC.
posted by sfenders at 6:47 PM on September 19, 2008
And it'll be twice that before it happens, but I read somewhere that the best thing to do is DON'T PANIC.
posted by sfenders at 6:47 PM on September 19, 2008
> The cause of the problem is simply that a financial engineering innovation went haywire. Should we stop all financial engineering because of this? I don't think so. Its generally an endeavor that unlocks possibilities that were previously impossible.
Huh?
Here's what I think I saw the last few years:
- the creation of absolutely insane mortgage products. No money down! Teaser introductory rates! any grade 10 math student with a calculator could figure out how dangerous a deal these are, yet it was legal, and widely promoted.
- the granting of the above insane product to borderline-qualifying buyers
- many mortgage applications accepted without even the pretense of a credit or info check
- "laundering" these risky loans and selling to the wider investment market, in financial instruments that somehow got rated highly
Calling this financial "engineering" is an insult to engineers. This was greed, abetted by willful regulatory neglect. This was one "possibility" that should have never been unlocked... we just learned how impossible it was.
I don't share your high opinion of "financial engineering". To me it seems that such developments are just ways to drive a wedge into the economy to create a new "information asymmetry" that allows a small group of clever fellows to extract more money out of the system. These opportunities only benefit the ones who are in on the con.
Heads on pikes...
posted by Artful Codger at 6:47 PM on September 19, 2008 [9 favorites]
Huh?
Here's what I think I saw the last few years:
- the creation of absolutely insane mortgage products. No money down! Teaser introductory rates! any grade 10 math student with a calculator could figure out how dangerous a deal these are, yet it was legal, and widely promoted.
- the granting of the above insane product to borderline-qualifying buyers
- many mortgage applications accepted without even the pretense of a credit or info check
- "laundering" these risky loans and selling to the wider investment market, in financial instruments that somehow got rated highly
Calling this financial "engineering" is an insult to engineers. This was greed, abetted by willful regulatory neglect. This was one "possibility" that should have never been unlocked... we just learned how impossible it was.
I don't share your high opinion of "financial engineering". To me it seems that such developments are just ways to drive a wedge into the economy to create a new "information asymmetry" that allows a small group of clever fellows to extract more money out of the system. These opportunities only benefit the ones who are in on the con.
Heads on pikes...
posted by Artful Codger at 6:47 PM on September 19, 2008 [9 favorites]
I bugged out of my LEH puts late last month when they moved 10% against me. Two weeks later they had a $30,000 payday. d'oh!
I sold the last of my BAC calls yesterday at the close, at the open they were worth another $8,000. d'oh!
I cashed out $1000 on SDS this week but gave $1600 back today. d'oh!
I used to be up $2000 with SRS but last month's chop cut that down to $500. d'oh!
I've lost $600 on SKF over the months but today my newly-bought 30 shares are up $200.
Sure beats warcraft!
posted by troy at 6:49 PM on September 19, 2008
I sold the last of my BAC calls yesterday at the close, at the open they were worth another $8,000. d'oh!
I cashed out $1000 on SDS this week but gave $1600 back today. d'oh!
I used to be up $2000 with SRS but last month's chop cut that down to $500. d'oh!
I've lost $600 on SKF over the months but today my newly-bought 30 shares are up $200.
Sure beats warcraft!
posted by troy at 6:49 PM on September 19, 2008
You thought these Investment Banks were protecting themselves from default risk with Credit Default Swaps? I hope it's obvious now they were protecting themselves from default risk with campaign finance bribes to the U.S. Congress. Man, that shit has paid off big!
posted by sdodd at 6:56 PM on September 19, 2008
posted by sdodd at 6:56 PM on September 19, 2008
kaibutsu: I've been under the longstanding assumption that the GOP strategy is to actually gut the government with the tax cuts, etc, and really turn the country into a laissez faire capitalist dreamland.
(Hi everyone! 1st post from a N. European long-time lurker and ignoramus in most things financial.)
I've been reading these fascinating brokergeddon et al. threads, way over my head, but I keep seeing sentiments like "we/they knew where this was headed [long timeperiod] ago."
Is a totally free market the "planned" goal of this crisis, like kaibutsu imagines? Is this standard fare "Shock Doctrine" or something?
As stated, I'm too ignorant to grasp the intricacies of this, but the entire system is on the verge of collapsing under its own complexity, interconnectedness, and penchant for cutting corners ...right?
So how can all of these complicated ways of buying and selling even be controlled and regulated meaningfully?
Mutant wrote (I think?!) about the need for a standardized and regulated derivatives market, and how difficult and costly it would be. But then what? Won't financial eggheads immediately cook up something even more fiendishly clever and elusive to regulation? And then how to regulate that: wait for another one of these catastrophes and wash-rinse-repeat?
posted by Glee at 6:57 PM on September 19, 2008
(Hi everyone! 1st post from a N. European long-time lurker and ignoramus in most things financial.)
I've been reading these fascinating brokergeddon et al. threads, way over my head, but I keep seeing sentiments like "we/they knew where this was headed [long timeperiod] ago."
Is a totally free market the "planned" goal of this crisis, like kaibutsu imagines? Is this standard fare "Shock Doctrine" or something?
As stated, I'm too ignorant to grasp the intricacies of this, but the entire system is on the verge of collapsing under its own complexity, interconnectedness, and penchant for cutting corners ...right?
So how can all of these complicated ways of buying and selling even be controlled and regulated meaningfully?
Mutant wrote (I think?!) about the need for a standardized and regulated derivatives market, and how difficult and costly it would be. But then what? Won't financial eggheads immediately cook up something even more fiendishly clever and elusive to regulation? And then how to regulate that: wait for another one of these catastrophes and wash-rinse-repeat?
posted by Glee at 6:57 PM on September 19, 2008
The most we can hope for now is that the situation has been stabilized enough to prevent another major round of imploding banks, since the Fed will have run out of viable options at that point.
Wamu and Wachovia would take out the FDIC as we know it, and I guess nobody wanted to step up and save them this week.
The Feds need to change some rules, establish some new cash buffers, to keep Wamu and Wachovia in business.
Which is good, because
a) their signs have nice fonts
and
b) who wants to bank in a world with just Wells and BofA?
posted by troy at 6:58 PM on September 19, 2008
Wamu and Wachovia would take out the FDIC as we know it, and I guess nobody wanted to step up and save them this week.
The Feds need to change some rules, establish some new cash buffers, to keep Wamu and Wachovia in business.
Which is good, because
a) their signs have nice fonts
and
b) who wants to bank in a world with just Wells and BofA?
posted by troy at 6:58 PM on September 19, 2008
Glee, I think it was blind ideology and lack of reality-based reasoning (the same decision-making process that got us into Iraq as we did), the opportunity to apply good ol' Republican business oversight (ie lack thereof) of the banking sector 2002-2004.
John Snow, who replaced the first guy in 2003 IIRC, was obviously a horrible Treasury Secretary.
By 2005 they had created a ravenous monster (home appreciation rates + household debt growth) but knew not how to put it back in its cage, nor particularly wanted to given the immense economic vitality it was lending (!) to the otherwise rather limpid Bush Economy.
The Dems didn't cover themselves in glory during this timeperiod. Difficult, politically, to be the sober negative-nelly party-pooper when everyone is a raving drunk at the party.
Actuallly this entire situation parallels Iraq quite closely. Get ready for The Surge!
posted by troy at 7:05 PM on September 19, 2008
John Snow, who replaced the first guy in 2003 IIRC, was obviously a horrible Treasury Secretary.
By 2005 they had created a ravenous monster (home appreciation rates + household debt growth) but knew not how to put it back in its cage, nor particularly wanted to given the immense economic vitality it was lending (!) to the otherwise rather limpid Bush Economy.
The Dems didn't cover themselves in glory during this timeperiod. Difficult, politically, to be the sober negative-nelly party-pooper when everyone is a raving drunk at the party.
Actuallly this entire situation parallels Iraq quite closely. Get ready for The Surge!
posted by troy at 7:05 PM on September 19, 2008
I so hope David Simon, Ed Burns, et al. return to Wire form in their upcoming "Derivative Nation" mini.
posted by Glee at 7:26 PM on September 19, 2008
posted by Glee at 7:26 PM on September 19, 2008
You know, there's all this focus on CDSs, and how they're related to the current mess. To my mind they're just one part of the larger picture. A major problem, but certainly not the lone cause. If that was the fact that CDSs were "going haywire" was the only thing wrong, then we'd still be happily going along oblivious, and the big shot investment banks etc. would happily continue minting money with little effort.
I'm not a big fan of business books, or the "tools" that they espouse. DMAIC, Fishbone, 6 Sigma, etc. I'm a maintenance guy, and all that stuff is fine for white collar types to sit in meetings and get jolly about, but for doing actual work, it's not really helpful. I'm also not a big fan of Root Cause Failure Analysis since it is too simplistic in looking for one cause. It's the overly focused manner of this that has people all looking at CDSs.
What I have found helpful is something called cause mapping where you look at ALL the causes of an incident or failure, and map them out to their origins, or at least as far as you can research. The current crisis has many causes. One that readily comes to mind is mortgage practices. What a cause map does for you besides giving you a bigger picture of an issue, it also gives you many more avenues to attack the problem, and helps find the best avenues to improve the situation. CDSs might never have been an issue without the mortgage situation, and yet everyone is focusing on this like it's the whole reason for the current crisis. Maybe it would be easier to fix the problems in the already regulated mortgage industry. I don't know, and have no idea since I know very little about economics and finance.
Of course, the really obvious cause for all this is greed, but I don't see an easy cure for this coming any time soon...
posted by Eekacat at 7:57 PM on September 19, 2008 [2 favorites]
I'm not a big fan of business books, or the "tools" that they espouse. DMAIC, Fishbone, 6 Sigma, etc. I'm a maintenance guy, and all that stuff is fine for white collar types to sit in meetings and get jolly about, but for doing actual work, it's not really helpful. I'm also not a big fan of Root Cause Failure Analysis since it is too simplistic in looking for one cause. It's the overly focused manner of this that has people all looking at CDSs.
What I have found helpful is something called cause mapping where you look at ALL the causes of an incident or failure, and map them out to their origins, or at least as far as you can research. The current crisis has many causes. One that readily comes to mind is mortgage practices. What a cause map does for you besides giving you a bigger picture of an issue, it also gives you many more avenues to attack the problem, and helps find the best avenues to improve the situation. CDSs might never have been an issue without the mortgage situation, and yet everyone is focusing on this like it's the whole reason for the current crisis. Maybe it would be easier to fix the problems in the already regulated mortgage industry. I don't know, and have no idea since I know very little about economics and finance.
Of course, the really obvious cause for all this is greed, but I don't see an easy cure for this coming any time soon...
posted by Eekacat at 7:57 PM on September 19, 2008 [2 favorites]
just sayin' :P more here!
and if you're curious about origins...
oh and a diagnosis, cf.
cheers!
posted by kliuless at 8:10 PM on September 19, 2008 [1 favorite]
and if you're curious about origins...
oh and a diagnosis, cf.
At its core, the current crisis stems from two problems. Regulators, starting with Alan Greenspan, assumed that a real estate bubble couldn’t happen and that Wall Street could largely police itself. And households, struggling with incomes that haven’t kept up with inflation in recent years, said yes when those lightly regulated banks offered them wishful-thinking loans. No bailout can solve either problem.possible solution(s), underlying principals & costs, including: "as an aside - when the banks make their assets transparent (should be a requirement for participation), we will discover if any executives misrepresented their assets and filed false reports with the SEC. That could be prosecuted under Sarbanes-Oxley, and perhaps a few executives spending time in jail might help with the moral hazard issues" :P
cheers!
posted by kliuless at 8:10 PM on September 19, 2008 [1 favorite]
I've been under the longstanding assumption that the GOP strategy is to actually gut the government with the tax cuts, etc, and really turn the country into a laissez faire capitalist dreamland.
Are you also assuming that Republicans REALLY ever believed in laissez faire capitalism?
posted by ZenMasterThis at 8:34 PM on September 19, 2008
Are you also assuming that Republicans REALLY ever believed in laissez faire capitalism?
posted by ZenMasterThis at 8:34 PM on September 19, 2008
b) who wants to bank in a world with just Wells and BofA?
Credits unions, my friend.
Credit unions.
My reaction when I moved out of Boston and the cold iron grip of Fleet was something to the effect of: "Whoa, you mean that not only are you going to help fund little Jimmy's baseball team and otherwise enrich the local community, but you're also not going to charge me two dollars every time I talk to a teller? Fuck yeah!"
posted by kaibutsu at 8:35 PM on September 19, 2008
Credits unions, my friend.
Credit unions.
My reaction when I moved out of Boston and the cold iron grip of Fleet was something to the effect of: "Whoa, you mean that not only are you going to help fund little Jimmy's baseball team and otherwise enrich the local community, but you're also not going to charge me two dollars every time I talk to a teller? Fuck yeah!"
posted by kaibutsu at 8:35 PM on September 19, 2008
mutant and malor get shout out on calculated risk another place to read up on/discuss this clusterfuck.
posted by snofoam at 8:39 PM on September 19, 2008
posted by snofoam at 8:39 PM on September 19, 2008
eekacat, Mr Mortgage in this piece has something resembling a fault diagram, in that he graphically illustrates when & how prices were driven up.
posted by troy at 8:44 PM on September 19, 2008
posted by troy at 8:44 PM on September 19, 2008
I'm stilling hoping someone will explain to me what happens to the houses if the government buys up a whole bunch of CDOs or other debt instruments full of bad mortgages. Do we end up with the government owning a million houses or what?
posted by Justinian at 8:55 PM on September 19, 2008
posted by Justinian at 8:55 PM on September 19, 2008
Troy, that's interesting, and data that could be used with a cause map. If I was more motivated, I'd actually build one on this clusterfuck. It would be interesting to see how a cause map looks as compared to the cures the government puts forth.
posted by Eekacat at 8:59 PM on September 19, 2008
posted by Eekacat at 8:59 PM on September 19, 2008
mutant and malor get shout out on calculated risk
Mutant will be less than thrilled to see that.
posted by gsteff at 9:18 PM on September 19, 2008
Mutant will be less than thrilled to see that.
posted by gsteff at 9:18 PM on September 19, 2008
eeka, IMO he missed one the initial movers of price appreciation, the 2001-2003 tax cuts.
Some of that extra monthly income went right into bidding up rents and land values.
posted by troy at 9:25 PM on September 19, 2008
Some of that extra monthly income went right into bidding up rents and land values.
posted by troy at 9:25 PM on September 19, 2008
Bill Moyers interviews NYTimes business and financial columnists Gretchen Morgenson and Floyd Norris, and author Kevin Phillips (previously).
posted by homunculus at 10:25 PM on September 19, 2008
posted by homunculus at 10:25 PM on September 19, 2008
Hey neat. Malor and Mutant are listed as "educated normal people" over on Calculated risk.
posted by Lord_Pall at 10:45 PM on September 19, 2008
posted by Lord_Pall at 10:45 PM on September 19, 2008
Seems like the republicans have nationalized the banking system! lol!
posted by jeffburdges at 10:53 PM on September 19, 2008
posted by jeffburdges at 10:53 PM on September 19, 2008
Not nationalized, they just proved that the best way to solve any financial hiccups in the market is with a little hard work, some elbow grease and 1.2 trillion dollars.
posted by Lord_Pall at 11:08 PM on September 19, 2008 [2 favorites]
posted by Lord_Pall at 11:08 PM on September 19, 2008 [2 favorites]
Why do I have to pay my bills when Evil_Corporate_Institution_263 doesn't have to pay theirs?
I've heard this sentiment a lot this week. The primary difference is that when you can't pay your bills, nobody really cares. When a multinational insurance company or the largest mortgage lender in the United States fails, the entire developed world faces economic catastrophe. Secondly, the government is not paying back this debt from taxpayers. AIG is still under obligation to pay back their bills. They are not yet owned by the US government, we merely loaned them $65B in exchange for warrants which guarantee we can buy them should they fail to pay back the loans. Not saying we won't be cashing in those warrants, but the government does not own them yet as far as I understand. Fannie/Freddie were always understood to be implicitly backed by the US government, so we had to cover that either way. Lehman will be paying back its creditors what it can from the assets after they are liquidated, which is standard practice in bankruptcy as far as I know. Bankruptcy is an option that is available to any private citizen, and a common way for people who cannot pay their bills to handle that exact situation. I am not saying this situation isn't dire, because it is. But this "Hey I want a bailout too!" and "Now US = Socialism!" nonsense is uninformed and unhelpful.
posted by sophist at 11:50 PM on September 19, 2008 [1 favorite]
I've heard this sentiment a lot this week. The primary difference is that when you can't pay your bills, nobody really cares. When a multinational insurance company or the largest mortgage lender in the United States fails, the entire developed world faces economic catastrophe. Secondly, the government is not paying back this debt from taxpayers. AIG is still under obligation to pay back their bills. They are not yet owned by the US government, we merely loaned them $65B in exchange for warrants which guarantee we can buy them should they fail to pay back the loans. Not saying we won't be cashing in those warrants, but the government does not own them yet as far as I understand. Fannie/Freddie were always understood to be implicitly backed by the US government, so we had to cover that either way. Lehman will be paying back its creditors what it can from the assets after they are liquidated, which is standard practice in bankruptcy as far as I know. Bankruptcy is an option that is available to any private citizen, and a common way for people who cannot pay their bills to handle that exact situation. I am not saying this situation isn't dire, because it is. But this "Hey I want a bailout too!" and "Now US = Socialism!" nonsense is uninformed and unhelpful.
posted by sophist at 11:50 PM on September 19, 2008 [1 favorite]
When you owe the bank $1000, the bank owns you. When you owe the bank $1,000,000,000,000 you own the bank!
And now we do!
Hah hah!
Now I'm going to go drink some scotch and cry.
posted by Justinian at 12:21 AM on September 20, 2008 [3 favorites]
And now we do!
Hah hah!
Now I'm going to go drink some scotch and cry.
posted by Justinian at 12:21 AM on September 20, 2008 [3 favorites]
Sadly, I think this might be the most plausible scenario for what's in store over the next few years:
posted by Sonny Jim at 1:10 AM on September 20, 2008 [2 favorites]
Nobody should believe the overblown claims that "free market" ideology is now dead. During boom times it is profitable to preach laissez-faire, because an absentee government allows speculative bubbles to inflate. When those bubbles burst, the ideology becomes a hindrance, and it goes dormant while government rides to the rescue. But rest assured: the ideology will come roaring back when the bailouts are done. The massive debt the public is accumulating to bail out the speculators will then become part of a global budget crisis that will be the rationalisation for deep cuts to social programmes, and for a renewed push to privatise what is left of the public sector. We will also be told that our hopes for a green future are too costly.My thirties are going to be awesome.
posted by Sonny Jim at 1:10 AM on September 20, 2008 [2 favorites]
So, two things I don't understand.
As I understand it, part of the justification for a federal bailout program is that the alternative would be more expensive to the country than 500 billion dollars. Buying all these securities will restart the MBS market, allowing banks to get the liquidity they need to start investing again. All this investment restart the economy, giving people jobs so they can all get back to spending like mad.
Only, what investment exactly is going to create all those jobs? With our current trade policy, what service or manufacturing can be performed here that can't be done cheaper elsewhere? This liquidity isn't going to go towards opening new factories or starting new businesses - it'll just go towards more financial engineering and the law firms to sustain it. Basically I don't see any good investment that would create jobs in the US until the dollar drops in value enough to make exporting from the US feasible.
So, given that, could someone explain why unrestricted free trade still makes sense? And if you can do that, why do our current trade policies make sense, where China charges a 25% import tariff on cars and we charge 2.5%? (you can verify this at www.export.gov and dataweb.usitc.gov ).
Also, what's the downside of national debt? I keep hearing that the national debt is actually small compared to other countries as a percentage of GDP. If that's the case, why can't we just have universal health care and college tuition? They couldn't cost more than a couple trillion. As long as those programs grow in cost less than GDP, why not just float them on the national debt? If the debt gets too large, how will we know? What'll happen?
posted by heathkit at 3:47 AM on September 20, 2008
As I understand it, part of the justification for a federal bailout program is that the alternative would be more expensive to the country than 500 billion dollars. Buying all these securities will restart the MBS market, allowing banks to get the liquidity they need to start investing again. All this investment restart the economy, giving people jobs so they can all get back to spending like mad.
Only, what investment exactly is going to create all those jobs? With our current trade policy, what service or manufacturing can be performed here that can't be done cheaper elsewhere? This liquidity isn't going to go towards opening new factories or starting new businesses - it'll just go towards more financial engineering and the law firms to sustain it. Basically I don't see any good investment that would create jobs in the US until the dollar drops in value enough to make exporting from the US feasible.
So, given that, could someone explain why unrestricted free trade still makes sense? And if you can do that, why do our current trade policies make sense, where China charges a 25% import tariff on cars and we charge 2.5%? (you can verify this at www.export.gov and dataweb.usitc.gov ).
Also, what's the downside of national debt? I keep hearing that the national debt is actually small compared to other countries as a percentage of GDP. If that's the case, why can't we just have universal health care and college tuition? They couldn't cost more than a couple trillion. As long as those programs grow in cost less than GDP, why not just float them on the national debt? If the debt gets too large, how will we know? What'll happen?
posted by heathkit at 3:47 AM on September 20, 2008
Glee -- "Mutant wrote (I think?!) about the need for a standardized and regulated derivatives market, and how difficult and costly it would be. But then what? Won't financial eggheads immediately cook up something even more fiendishly clever and elusive to regulation? And then how to regulate that: wait for another one of these catastrophes and wash-rinse-repeat?"
You're absolutely correct glee, its a particularly intractable problem, as there will always be new derivative products. As a field, finance has just witnessed the birth of Credit Derivatives, products that are still very much in their embryonic stage of development.
And at the same time new derivatives have been created to target other aspects of finance, for example, volatility or correlation. These qualities are indeed traded now, and can be approached via structured derivatives.
A relatively simple example could be someone taking a view on equity market volatility via two listed options, a Call and a Put. Combine the two and you've created something called "a straddle", and it's a play on volatility. Buy a straddle if you think the markets will be volatile, and sell if if you think they won't be volatile. Two way to profit.
The problem? Well, straddles are (relatively) expensive as there are two sets of transaction fees involved (four total per option pair and keep in mind a pro won't be doing this small scale, maybe hundreds of thousands of options contracts will be deployed with the attendant cost implications), so we saw the development of derivatives that with all the convenience of one stop shopping, offer pure plays on volatility.
Financial innovation. It never ends. And would be difficult to control, in my view. But I'm not really a Regulatory person (as some folks in thread and lurkers but whom have emailed are), and I'll defer to their expertise here.
Actually valuing, using or structuring a derivative, I know that side of the business very well (disclaimer: not for all derivatives, its a very, very broad field).
But a perceptive comment on your part that captures the essence of the problem rather well.
posted by Mutant at 4:58 AM on September 20, 2008
Crap. That sentence should have read:
Actually valuing, using or structuring a derivative, I know that side of the business fairly well (disclaimer: not for all derivatives, its a very, very broad field).
posted by Mutant at 5:02 AM on September 20, 2008
Actually valuing, using or structuring a derivative, I know that side of the business fairly well (disclaimer: not for all derivatives, its a very, very broad field).
posted by Mutant at 5:02 AM on September 20, 2008
woodway -- "Re: regulation, have you seen Glenn Hubbard's op ed in WP, Mutant? "
Ah no I hadn't - many thanks for the link. Its a good read. He's got some solid points about regulatory capital, especially on the liquidity side which we now know (and previously suspected) is a key problem.
I'd also like to see someone address the well known problem of regulatory arbitrage; back when I was working I sat in meetings where we were deciding where to park assets to minimise balance sheet impact.
Hardly in the spirit of the law.
posted by Mutant at 5:09 AM on September 20, 2008
we merely loaned them $65B in exchange for warrants which guarantee we can buy them should they fail to pay back the loans.
Uh huh. Isn't that the kind of thing that got us into this mess in the first place?
posted by dirigibleman at 5:14 AM on September 20, 2008
Uh huh. Isn't that the kind of thing that got us into this mess in the first place?
posted by dirigibleman at 5:14 AM on September 20, 2008
A relatively simple example could be someone taking a view on equity market volatility via two listed options, a Call and a Put. Combine the two and you've created something called "a straddle", and it's a play on volatility. Buy a straddle if you think the markets will be volatile, and sell if if you think they won't be volatile. Two way to profit.
OK, so here's something I don't understand about vol arbitrage.
My understanding is that the options pricing models used generally assume a continuous market (the old B-S model does anyway), but, as you say, the model makes money off volatility.
However, the two (continuity and volatility) seem at least loosely inverse: volatile markets are generally noncontinuous -- if not for those inefficiencies (the very inefficiencies being hedged), they wouldn't be volatile in the first place. (If third world markets were more efficient, they'd be first world markets...)
It seems to me that much of the expected return is from the features of the markets that bork the models' foundational assumptions. If the market were perfectly continuous, it'd be highly efficient, and there'd be nothing to hedge.
I'm sure I'm missing something, but I don't know what.
posted by spiderwire at 8:10 AM on September 20, 2008
OK, so here's something I don't understand about vol arbitrage.
My understanding is that the options pricing models used generally assume a continuous market (the old B-S model does anyway), but, as you say, the model makes money off volatility.
However, the two (continuity and volatility) seem at least loosely inverse: volatile markets are generally noncontinuous -- if not for those inefficiencies (the very inefficiencies being hedged), they wouldn't be volatile in the first place. (If third world markets were more efficient, they'd be first world markets...)
It seems to me that much of the expected return is from the features of the markets that bork the models' foundational assumptions. If the market were perfectly continuous, it'd be highly efficient, and there'd be nothing to hedge.
I'm sure I'm missing something, but I don't know what.
posted by spiderwire at 8:10 AM on September 20, 2008
My understanding is that the options pricing models used generally assume a continuous market (the old B-S model does anyway)
Maybe as some kind of mathematical abstraction it does, but in practice the market is never continuous in that sense; every trade (and every change in bid/ask) is a discrete event. So exactly what do you mean by "continuous" here?
posted by sfenders at 9:19 AM on September 20, 2008
Maybe as some kind of mathematical abstraction it does, but in practice the market is never continuous in that sense; every trade (and every change in bid/ask) is a discrete event. So exactly what do you mean by "continuous" here?
posted by sfenders at 9:19 AM on September 20, 2008
Maybe as some kind of mathematical abstraction it does, but in practice the market is never continuous in that sense; every trade (and every change in bid/ask) is a discrete event. So exactly what do you mean by "continuous" here?
That may be one part of the question: i.e., I know that the basic Black-Scholes-Merton model assumes (as you say, implausibly) a continuous market, but I don't know how well more complex models account for discrete price movements. Maybe my naive understanding of options pricing isn't up to date.
The question may make more sense if we just focus general efficiency instead of specific aspects like continuity. That is, the markets that are most volatile are generally not information-efficient, not liquid, and highly discontinuous: i.e. the factors that indicate the vol-arbitrage opportunity all seem to prevent effective use of the models you'd need to capitalize on it.
posted by spiderwire at 9:39 AM on September 20, 2008
That may be one part of the question: i.e., I know that the basic Black-Scholes-Merton model assumes (as you say, implausibly) a continuous market, but I don't know how well more complex models account for discrete price movements. Maybe my naive understanding of options pricing isn't up to date.
The question may make more sense if we just focus general efficiency instead of specific aspects like continuity. That is, the markets that are most volatile are generally not information-efficient, not liquid, and highly discontinuous: i.e. the factors that indicate the vol-arbitrage opportunity all seem to prevent effective use of the models you'd need to capitalize on it.
posted by spiderwire at 9:39 AM on September 20, 2008
From Saturday's New York Times -- Rescue Plan Seeks $700 Billion to Buy Bad Mortgages:
posted by cenoxo at 9:51 AM on September 20, 2008
The Bush administration on Saturday formally proposed to Congress the largest financial bailout in United States history, requesting virtually unfettered sweeping authority for the Treasury to purchase up to $700 billion in mortgage-related assets from financial institutions headquartered in the United States.Garbage in, garbage out.
The proposal was stunning for its stark simplicity: less than three pages, it would raise the national debt ceiling to $11.3 trillion. And it would place no restrictions on the administration other than requiring semi-annual reports to Congress, allowing the Treasury to buy and resell mortgage debt as it sees fit.
posted by cenoxo at 9:51 AM on September 20, 2008
the factors that indicate the vol-arbitrage opportunity all seem to prevent effective use of the models you'd need to capitalize on it.
Oh, I didn't read carefully enough to see that you are really talking about models of volatility itself, not just general options pricing models. Black-Scholes by itself could only give you a signal for some kind of arbitrage play on volatility rather indirectly I imagine, like if you find implied volatility for a particular strike price is out of line based on how you think it should look. It will tell you implied volatility for a given price, or it will tell you a price for a given degree of volatility, but it does nothing to model changes in volatility itself. There are some models that do, but I've no idea how they work. I think mostly they just look for abnormally high or low volatility, and predict some probability of a return to the mean.
Anyway, models of pretty much everything, not just volatility, probably have a hard time with weeks like this one.
posted by sfenders at 10:39 AM on September 20, 2008
Oh, I didn't read carefully enough to see that you are really talking about models of volatility itself, not just general options pricing models. Black-Scholes by itself could only give you a signal for some kind of arbitrage play on volatility rather indirectly I imagine, like if you find implied volatility for a particular strike price is out of line based on how you think it should look. It will tell you implied volatility for a given price, or it will tell you a price for a given degree of volatility, but it does nothing to model changes in volatility itself. There are some models that do, but I've no idea how they work. I think mostly they just look for abnormally high or low volatility, and predict some probability of a return to the mean.
Anyway, models of pretty much everything, not just volatility, probably have a hard time with weeks like this one.
posted by sfenders at 10:39 AM on September 20, 2008
New Investment Strategies Compound a Fiscal Crisis:
Essentially insurance on debt, the market for credit-default swaps has ballooned to a nearly unimaginable $45.5 trillion, from $900 billion in 2001....
(snip)
James Cawley, a veteran player in the credit default swap market, doubts the full understanding of the older chiefs of the firms who profited from these products and the young traders who specialized in them.
“Had they understood the implications, we wouldn’t be where we are today,” said Mr. Cawley, founder and chief executive of IDX Capital. The overriding feeling on Wall Street, he said, was, “Let’s make money while the sun shines and worry about the details later.”
(snip)
“If you’re approving things you don’t understand, that’s not doing your job,” said Jonathan GS Koppell, director of the Millstein Center for Corporate Governance and Performance at the Yale School of Management. “What are these guys compensated for, if they’re checking off things they don’t understand?”
(snip)
“Twenty years ago, it was hard to accurately price a corporate bond, let alone calculate credit spreads,” said David Munves, a managing director in the capital markets research group of Moody’s, who spent 10 years at Lehman. Even in the mid-1990s, he said, bond traders would use oversize calculators at their desks to figure out yields down to one-sixteenth and one thirty-second.
Now, he said, traders can call up databases that feature 400 fields for a single bond. Once-straightforward features like duration and yield are sliced a multitude of ways. “As you build more complex products, you get further away from real-world events, like actually having to sell these bonds,” he said.
posted by ornate insect at 10:54 AM on September 20, 2008
Essentially insurance on debt, the market for credit-default swaps has ballooned to a nearly unimaginable $45.5 trillion, from $900 billion in 2001....
(snip)
James Cawley, a veteran player in the credit default swap market, doubts the full understanding of the older chiefs of the firms who profited from these products and the young traders who specialized in them.
“Had they understood the implications, we wouldn’t be where we are today,” said Mr. Cawley, founder and chief executive of IDX Capital. The overriding feeling on Wall Street, he said, was, “Let’s make money while the sun shines and worry about the details later.”
(snip)
“If you’re approving things you don’t understand, that’s not doing your job,” said Jonathan GS Koppell, director of the Millstein Center for Corporate Governance and Performance at the Yale School of Management. “What are these guys compensated for, if they’re checking off things they don’t understand?”
(snip)
“Twenty years ago, it was hard to accurately price a corporate bond, let alone calculate credit spreads,” said David Munves, a managing director in the capital markets research group of Moody’s, who spent 10 years at Lehman. Even in the mid-1990s, he said, bond traders would use oversize calculators at their desks to figure out yields down to one-sixteenth and one thirty-second.
Now, he said, traders can call up databases that feature 400 fields for a single bond. Once-straightforward features like duration and yield are sliced a multitude of ways. “As you build more complex products, you get further away from real-world events, like actually having to sell these bonds,” he said.
posted by ornate insect at 10:54 AM on September 20, 2008
I've been thinking about what it means to have the government own the mortgage debt. I'm not sure, but I think it gives them an incentive to make housing prices go up (yes?). This is great -- it could give the federal government an incentive to care more about cities. Perhaps they would quit underfunding some of the HUD programs like Community Development Block Grants (cite [only first few paragraphs, but you get the gist]). Perhaps it gives Obama political leverage in starting his Office of Urban Policy ("open a national bank...to finance road, bridge, airport and other public-works projects in metropolitan areas.....shift urban-policy making to so-called smart-growth strategies that synchronize transportation, commercial and housing needs for entire regions"- WSJ). While I didn't like the government absorbing bad debt, I do think this could be an upside.
posted by salvia at 11:07 AM on September 20, 2008
posted by salvia at 11:07 AM on September 20, 2008
Also can I ask a really simple question? The way I understand loans (this came to me second-hand but originated with some professor) is that I start with $10. I loan you $9. Now, there are $19 in the world, or there have to eventually be, for me to be made whole without you going back to ground zero. Where that money comes from in a very fundamental sense is still a bit beyond me ... inflation? resource extraction? ... but I understand that over time, economies "grow" and new money comes into being. But how long will it take for the amount that got loaned as part of these CDOs and bailouts to trickle into being? Is this a totally wrong way to look at the question?
posted by salvia at 11:12 AM on September 20, 2008
posted by salvia at 11:12 AM on September 20, 2008
AP says the plan would give the government power to designate financial institutions as "financial agents of the government" and require them to carry out any "reasonable duties" that entails.
?!
posted by LobsterMitten at 11:23 AM on September 20, 2008
?!
posted by LobsterMitten at 11:23 AM on September 20, 2008
AP says the plan would give the government power to designate financial institutions as "financial agents of the government" and require them to carry out any "reasonable duties" that entails.
Someone once said something about the merging of the government and corporations...
As for the bailout plan, they are flat out looting the treasury and they are going to get away with it.
posted by ryoshu at 12:01 PM on September 20, 2008
Someone once said something about the merging of the government and corporations...
As for the bailout plan, they are flat out looting the treasury and they are going to get away with it.
posted by ryoshu at 12:01 PM on September 20, 2008
Maybe the Banks Are Just Counting Wrong
SEC Plans to Probe Credit-Default Swaps
Regulators shut down Ameribank in W. Va.; 12th bank failure this year
posted by ornate insect at 12:17 PM on September 20, 2008
SEC Plans to Probe Credit-Default Swaps
Regulators shut down Ameribank in W. Va.; 12th bank failure this year
posted by ornate insect at 12:17 PM on September 20, 2008
Relax, everybody. W understands the problem and is on the case.
Bush Administration Seeks $700B for Economic Bailout
Washington Post Online, 20 Sep 08, 11:52 am:
Bush, who campaigned for office as the nation's first MBA president and a free-market advocate, also appeared to address complaints from conservatives that the plan is too costly and inserts the government too heavily into the economy...
"I'm sure there are some of my friends out there that are saying, 'I thought this guy was a market guy, what happened to him?' '' Bush said. "My first instinct was to let the market work, until I realized, while being briefed by the experts, how significant this problem became.''
Bush acknowledged that the plans would put "hundreds of billions of dollars at risk," but said he was confident [?] would get most of their money back in the end.
Who gets their money is questionable -- the WP article seems to be missing something. But Bush has it figured out, and he's well qualified in strategery.
posted by woodway at 12:31 PM on September 20, 2008
Bush Administration Seeks $700B for Economic Bailout
Washington Post Online, 20 Sep 08, 11:52 am:
Bush, who campaigned for office as the nation's first MBA president and a free-market advocate, also appeared to address complaints from conservatives that the plan is too costly and inserts the government too heavily into the economy...
"I'm sure there are some of my friends out there that are saying, 'I thought this guy was a market guy, what happened to him?' '' Bush said. "My first instinct was to let the market work, until I realized, while being briefed by the experts, how significant this problem became.''
Bush acknowledged that the plans would put "hundreds of billions of dollars at risk," but said he was confident [?] would get most of their money back in the end.
Who gets their money is questionable -- the WP article seems to be missing something. But Bush has it figured out, and he's well qualified in strategery.
posted by woodway at 12:31 PM on September 20, 2008
As for the bailout plan, they are flat out looting the treasury and they are going to get away with it.
I think it's satisfying to think so, but I'm not sure that's really what's happening. The multitude of causes leading up to this point were rife with excess and bad risk, and definitely people acted opportunistically, but the bailouts are to keep catastrophic events contained. There is little choice but to act when the economy teeters on the brink of meltdown. Nobody really anticipated what's recently happened, btw. I'm sure there were some people who figured the government would come to the rescue if things came back around, if those high risk mortgages revealed their true worth, but nobody really wants these sorts of events, not on this scale. And the loan to AIG, as has been repeatedly mentioned, is borrowed money.
posted by krinklyfig at 12:37 PM on September 20, 2008
I think it's satisfying to think so, but I'm not sure that's really what's happening. The multitude of causes leading up to this point were rife with excess and bad risk, and definitely people acted opportunistically, but the bailouts are to keep catastrophic events contained. There is little choice but to act when the economy teeters on the brink of meltdown. Nobody really anticipated what's recently happened, btw. I'm sure there were some people who figured the government would come to the rescue if things came back around, if those high risk mortgages revealed their true worth, but nobody really wants these sorts of events, not on this scale. And the loan to AIG, as has been repeatedly mentioned, is borrowed money.
posted by krinklyfig at 12:37 PM on September 20, 2008
Speaking of bailout plans - I think the danger is that the government is going after the symptom, not the cause. So $700 bn to buy up MBS won't do much unless you deal with the underlying instruments. From what I can see folks are focusing on the wrong paradigm - its not the RTC - from the S&L crisis - (where the government got the assets for free) but the HOLC - from the Great Depression - where the government bought up home loans and restructured them. An RTC vehicle funded by the government could then recapitalize the banks. Typically, Roubini summarizes the crisis beautifully and lays out the best bailout plan I've heard.
posted by zia at 1:00 PM on September 20, 2008
posted by zia at 1:00 PM on September 20, 2008
Mutant: "Credit Derivatives" as we currently build them, is more than just the creation of a new financial market, it's frankly, utter stupidity. Asset derivatives are easy because you're creating a financial instrument of homogeneous assets. No one is stupid enough to buy securitized derivatives of heterogeneous assets ("I'm buying a different ratio of S&P500 components for every option I buy!"). Credit derivatives being sold today, are, by its nature (and it's primary supposed benefit), a means to smooth out heterogeneous liabilities. By doing this, they create an intractable dilemma: packaging more together creates smoother and more equal returns between different packages, but increases the likelihood of systemic risk as well as lower value of the insurance itself (I would assume that the purpose of the derivative is to insure against a specific liability, it's unsystematic risk).
The only credit derivatives I can see that seem to work these days are ones that operate similarly to asset-based derivatives: have one single type (of liability). Of course, futures contracts are a little bit more boring, but I really don't see it working out otherwise.
posted by amuseDetachment at 1:41 PM on September 20, 2008 [1 favorite]
The only credit derivatives I can see that seem to work these days are ones that operate similarly to asset-based derivatives: have one single type (of liability). Of course, futures contracts are a little bit more boring, but I really don't see it working out otherwise.
posted by amuseDetachment at 1:41 PM on September 20, 2008 [1 favorite]
spiderwire --- "That may be one part of the question: i.e., I know that the basic Black-Scholes-Merton model assumes (as you say, implausibly) a continuous market, but I don't know how well more complex models account for discrete price movements. Maybe my naive understanding of options pricing isn't up to date."
Ah great stuff! There seem to be a couple of questions rolled up into this, and I'm not totally certain if I understand the overall query, but let me take a pass at it as is.
But before I do, sfenders is absolutely correct -- "Maybe as some kind of mathematical abstraction it does, but in practice the market is never continuous in that sense; every trade (and every change in bid/ask) is a discrete event. "
We introduce continuous time frameworks into (some) derivative pricing models as they allow us to price options as if investors were risk neutral. But, as attractive as this theoretical construct is, as sfenders points out, the markets are hardly so accommodative.
Even for well developed derivative markets like options trading, these assumptions built into our models introduce pricing inaccuracies when comparing forecasted prices to observed prices. Continuous time in Black-Scholes is but one of the assumptions underlying that model, at least in its simplest form (there are more advanced BS models in use). We find other assumptions as well, specifically
Binomial Option Pricing Models substitute a discrete price process<>continuous price process Black-Scholes assumes. This model is not only very easy to understand, it brings other attractive properties to the table, specifically
So binomial option pricing models substitute discrete time for the continuous time assumption in Black-Scholes, and deliver fairly decent results. Both have their pluses and minuses, and its not uncommon to find both (heavily customised; the basics are presented here) deployed by a desk, sometimes even in the same market.
In terms of the Volatility Arbitrage query - straddle really are just a way to either buy or sell volatility. There isn't really any arbitrage going on as all trades are taking place in the same market (options), and we're really hoping for a large change in the price of the underlying security. Or no change in price - depending if we're long or short volatility.
Long volatility - we don't know / can't predict which way the underlying security will move. But we suspect it will, so we buy a straddle and wait for the underlying to change value - drastically.
Short volatility - we're taking the opposite view, see a period of time with little change in value and we sell a set of options, collecting two sets of option premium as income, and hope that the underlying doesn't change in value.
So by employing a straddle we're able to profit no matter how the price of the underlying security changes.
This isn't really a retail strategy - too risky, too expensive. But trading desks who employ such strategies will be neutralising their exposure by hedging someplace else, perhaps even across asset classes and into different markets, locking in profits almost no matter what happens (events of last week excluded, of course).
All of us are familiar with straddles, of course, as Nick Leeson brought down Barings Bank by means of selling volatility, a strategy that in quiet markets can generate some nice coin. Leeson was down several million dollars after a series of sharp losses on Nikkei 225 Futures (caused by the Kobe earthquake). He then tried to correct his mistake by selling volatility, eventually ending up with losses of in excess of $1.5B.
Barings, a venerable 233 year old institution which had financed the Napoleonic wars, the Louisiana purchase and the Erie Canal was sold to ING bank for what Economist Magazine at the time described as "the decidedly nominal sum of one pound Sterling" (ah those English have such a way with words ... I swear I am in absolute awe sometimes - its great).
Finally, just to touch upon Volatility Arbitrage.
This trading strategy look across two markets - cash equities and options - and profits from differences in volatility between the two.
Each option has, as we saw above, as assumed volatility priced into it. This is called implied volatility, and for the price of the option to reflect fair value this assumption must hold.
If a trader has reason to believe that the volatility of the underlying will be different from that embedded in the price of the option they can execute strategies to profit off this difference, between the two markets.
I've recently become interested in Volatility Arbitrage as I've heard rumours that some big funds are now targeting Volatility as an asset class, and trying to profit. Well, not just rumours, as the Volatility guys are making absolute buckets of money in this environment, so maybe it is indeed true.
In fact we know that "Many fund managers have been strengthening their capabilities to trade this previously ignored asset class.", the quote in question referred explicitly to volatility.
I've got links to a few free papes that folks might find interesting. Pretty accessible as well, so I hope you enjoy them.
A Volatility Arbitrage [.pdf] factsheet by Standard and Poors
A July 2008 paper by Standard and Poors [.pdf]
An interesting article [.pdf] from Hedge Fund World, 2003.
As always, questions via email or in-thread are not a problem.
posted by Mutant at 1:46 PM on September 20, 2008 [5 favorites]
Ah great stuff! There seem to be a couple of questions rolled up into this, and I'm not totally certain if I understand the overall query, but let me take a pass at it as is.
But before I do, sfenders is absolutely correct -- "Maybe as some kind of mathematical abstraction it does, but in practice the market is never continuous in that sense; every trade (and every change in bid/ask) is a discrete event. "
We introduce continuous time frameworks into (some) derivative pricing models as they allow us to price options as if investors were risk neutral. But, as attractive as this theoretical construct is, as sfenders points out, the markets are hardly so accommodative.
Even for well developed derivative markets like options trading, these assumptions built into our models introduce pricing inaccuracies when comparing forecasted prices to observed prices. Continuous time in Black-Scholes is but one of the assumptions underlying that model, at least in its simplest form (there are more advanced BS models in use). We find other assumptions as well, specifically
- The underlying security doesn't pay dividends
- Early exercise before expiration is not possible (i.e. we can model European, not American option)
- The pricing generation process of the underlying approximates a random walk
- All trades take place in a frictionless environment (i.e., no commissions on buy / sell)
- Constant interest rates across the term
- Constant volatility of the underlying across the term
Binomial Option Pricing Models substitute a discrete price process<>continuous price process Black-Scholes assumes. This model is not only very easy to understand, it brings other attractive properties to the table, specifically
- We can model early exercise (aka American)
- We can also model Bermudian options, which allow for exercise at discrete times
- We can model dividend paying securities
- The price converges to the output of a Black Scholes model if the number of steps simulated is appropriately large
- In practice we get fairly good approximations after as few as 30 simulation steps
So binomial option pricing models substitute discrete time for the continuous time assumption in Black-Scholes, and deliver fairly decent results. Both have their pluses and minuses, and its not uncommon to find both (heavily customised; the basics are presented here) deployed by a desk, sometimes even in the same market.
In terms of the Volatility Arbitrage query - straddle really are just a way to either buy or sell volatility. There isn't really any arbitrage going on as all trades are taking place in the same market (options), and we're really hoping for a large change in the price of the underlying security. Or no change in price - depending if we're long or short volatility.
Long volatility - we don't know / can't predict which way the underlying security will move. But we suspect it will, so we buy a straddle and wait for the underlying to change value - drastically.
Short volatility - we're taking the opposite view, see a period of time with little change in value and we sell a set of options, collecting two sets of option premium as income, and hope that the underlying doesn't change in value.
So by employing a straddle we're able to profit no matter how the price of the underlying security changes.
This isn't really a retail strategy - too risky, too expensive. But trading desks who employ such strategies will be neutralising their exposure by hedging someplace else, perhaps even across asset classes and into different markets, locking in profits almost no matter what happens (events of last week excluded, of course).
All of us are familiar with straddles, of course, as Nick Leeson brought down Barings Bank by means of selling volatility, a strategy that in quiet markets can generate some nice coin. Leeson was down several million dollars after a series of sharp losses on Nikkei 225 Futures (caused by the Kobe earthquake). He then tried to correct his mistake by selling volatility, eventually ending up with losses of in excess of $1.5B.
Barings, a venerable 233 year old institution which had financed the Napoleonic wars, the Louisiana purchase and the Erie Canal was sold to ING bank for what Economist Magazine at the time described as "the decidedly nominal sum of one pound Sterling" (ah those English have such a way with words ... I swear I am in absolute awe sometimes - its great).
Finally, just to touch upon Volatility Arbitrage.
This trading strategy look across two markets - cash equities and options - and profits from differences in volatility between the two.
Each option has, as we saw above, as assumed volatility priced into it. This is called implied volatility, and for the price of the option to reflect fair value this assumption must hold.
If a trader has reason to believe that the volatility of the underlying will be different from that embedded in the price of the option they can execute strategies to profit off this difference, between the two markets.
I've recently become interested in Volatility Arbitrage as I've heard rumours that some big funds are now targeting Volatility as an asset class, and trying to profit. Well, not just rumours, as the Volatility guys are making absolute buckets of money in this environment, so maybe it is indeed true.
In fact we know that "Many fund managers have been strengthening their capabilities to trade this previously ignored asset class.", the quote in question referred explicitly to volatility.
I've got links to a few free papes that folks might find interesting. Pretty accessible as well, so I hope you enjoy them.
A Volatility Arbitrage [.pdf] factsheet by Standard and Poors
A July 2008 paper by Standard and Poors [.pdf]
An interesting article [.pdf] from Hedge Fund World, 2003.
As always, questions via email or in-thread are not a problem.
posted by Mutant at 1:46 PM on September 20, 2008 [5 favorites]
but the bailouts are to keep catastrophic events contained
Charlie Brown, don't you ever learn? Lucy is always going to pull the football away.
So the same administration that said we had to invade Iraq because of the WMDs that they knew Sadaam had is now telling us that we have to do something RIGHT NOW, no time for review, no time for oversight[0], no time to negotiate any provisions that help the regular guy? Yeah. Call me incredulous.
There is little choice but to act when the economy teeters on the brink of meltdown.
Sez the people that got us into this mess. And they've done such a great job so far so we should surely listen to what they have to say.
Nobody really anticipated what's recently happened, btw.
Well, yes, umm, no, not really. Plenty of people have been predicting this. There have been multiple threads in the blue about how bad things are going to get. I'll even go as far as to say, again, we haven't seen the worst of it yet.
And the loan to AIG, as has been repeatedly mentioned, is borrowed money.
The loan to AIG will be paid back if they manage to stay solvent. Didn't they blow through $25 billion in the first 24 hours after the bridge loan?
This is not a liquidity crisis. This is a solvency crisis.
[0] - from the administration's proposal for the bailout:
Charlie Brown, don't you ever learn? Lucy is always going to pull the football away.
So the same administration that said we had to invade Iraq because of the WMDs that they knew Sadaam had is now telling us that we have to do something RIGHT NOW, no time for review, no time for oversight[0], no time to negotiate any provisions that help the regular guy? Yeah. Call me incredulous.
There is little choice but to act when the economy teeters on the brink of meltdown.
Sez the people that got us into this mess. And they've done such a great job so far so we should surely listen to what they have to say.
Nobody really anticipated what's recently happened, btw.
Well, yes, umm, no, not really. Plenty of people have been predicting this. There have been multiple threads in the blue about how bad things are going to get. I'll even go as far as to say, again, we haven't seen the worst of it yet.
And the loan to AIG, as has been repeatedly mentioned, is borrowed money.
The loan to AIG will be paid back if they manage to stay solvent. Didn't they blow through $25 billion in the first 24 hours after the bridge loan?
This is not a liquidity crisis. This is a solvency crisis.
[0] - from the administration's proposal for the bailout:
Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.posted by ryoshu at 2:40 PM on September 20, 2008
Do you guys think China would pay 10 trillion dollars for Taiwan? 'Cause it's starting to look like not that bad a deal to me, and now I feel bad.
posted by Justinian at 3:10 PM on September 20, 2008
posted by Justinian at 3:10 PM on September 20, 2008
So the same administration that said we had to invade Iraq because of the WMDs that they knew Sadaam had is now telling us that we have to do something RIGHT NOW, no time for review, no time for oversight[0], no time to negotiate any provisions that help the regular guy? Yeah. Call me incredulous.
I think we are talking about somewhat separate things. The AIG bailout wasn't a Bush proposal, specifically, it was the Fed's, although Bush supported it. A lot of his party did not, however.
Anyway, I dislike Bush a great deal, but I really do think it's simplistic to see these sorts of measures as purely self-serving, although many of the events which lead up to this point were. I'm not sure if Bush's $700 billion proposal will endure intact. Congress has to approve it.
posted by krinklyfig at 3:19 PM on September 20, 2008
I think we are talking about somewhat separate things. The AIG bailout wasn't a Bush proposal, specifically, it was the Fed's, although Bush supported it. A lot of his party did not, however.
Anyway, I dislike Bush a great deal, but I really do think it's simplistic to see these sorts of measures as purely self-serving, although many of the events which lead up to this point were. I'm not sure if Bush's $700 billion proposal will endure intact. Congress has to approve it.
posted by krinklyfig at 3:19 PM on September 20, 2008
Hank Paulson To Dems: Not Allowing CEO’s to Keep Multi-Million Dollar Salaries Is A “Poison Pill”
posted by homunculus at 3:59 PM on September 20, 2008 [1 favorite]
posted by homunculus at 3:59 PM on September 20, 2008 [1 favorite]
The AIG bailout wasn't a Bush proposal, specifically, it was the Fed's, although Bush supported it.
I'm talking about the administration's proposal to make $700 billion in tax payer dollars available with no oversight and no recourse.
I'm not sure if Bush's $700 billion proposal will endure intact. Congress has to approve it.
You overestimate the spine of congress.
posted by ryoshu at 4:05 PM on September 20, 2008
I'm talking about the administration's proposal to make $700 billion in tax payer dollars available with no oversight and no recourse.
I'm not sure if Bush's $700 billion proposal will endure intact. Congress has to approve it.
You overestimate the spine of congress.
posted by ryoshu at 4:05 PM on September 20, 2008
Hank Paulson To Dems: Not Allowing CEO’s to Keep Multi-Million Dollar Salaries Is A “Poison Pill”
See. This shit. This is what I'm talking about. If this is such a crisis, something we have to do RIGHT NOW, no one would have a problem holding the CEOs accountable for the actions of their companies other than the CEOs. This is flat out looting.
posted by ryoshu at 4:08 PM on September 20, 2008
See. This shit. This is what I'm talking about. If this is such a crisis, something we have to do RIGHT NOW, no one would have a problem holding the CEOs accountable for the actions of their companies other than the CEOs. This is flat out looting.
posted by ryoshu at 4:08 PM on September 20, 2008
This is flat out looting.
Check this link out. Money quotes:
``Bankruptcy law allows recovery of compensation paid to insiders if the company didn't receive reasonably equivalent value,'' said Lynn LoPucki, a bankruptcy law professor who teaches at Harvard University and the University of California. ``The value of the services of a CEO who runs a company into bankruptcy is less than $34 million.''
A 2005 change in U.S. bankruptcy laws made it easier for creditors to recover past compensation. The amendment came after Enron Corp. creditors failed to recoup more than $120 million paid to executives in the month before the energy trader's 2001 bankruptcy, LoPucki said.
Creditors may try to recover payments based on the theory that the company fraudulently transferred assets before the bankruptcy to evade creditors or because the company didn't get full value for its money. The 2005 amendment to U.S. bankruptcy law allows creditors to reclaim bonuses or compensation paid to insiders in the previous two years even if the company wasn't insolvent when the transfer was made, LoPucki said.
Succeed or fail, no matter how much money Fuld made over the past few years, I'd hate to be in his shoes right now. There are some very, very angry people out there, who deserve to be mad, and they got him in the crosshairs.
posted by SeizeTheDay at 4:17 PM on September 20, 2008
Check this link out. Money quotes:
``Bankruptcy law allows recovery of compensation paid to insiders if the company didn't receive reasonably equivalent value,'' said Lynn LoPucki, a bankruptcy law professor who teaches at Harvard University and the University of California. ``The value of the services of a CEO who runs a company into bankruptcy is less than $34 million.''
A 2005 change in U.S. bankruptcy laws made it easier for creditors to recover past compensation. The amendment came after Enron Corp. creditors failed to recoup more than $120 million paid to executives in the month before the energy trader's 2001 bankruptcy, LoPucki said.
Creditors may try to recover payments based on the theory that the company fraudulently transferred assets before the bankruptcy to evade creditors or because the company didn't get full value for its money. The 2005 amendment to U.S. bankruptcy law allows creditors to reclaim bonuses or compensation paid to insiders in the previous two years even if the company wasn't insolvent when the transfer was made, LoPucki said.
Succeed or fail, no matter how much money Fuld made over the past few years, I'd hate to be in his shoes right now. There are some very, very angry people out there, who deserve to be mad, and they got him in the crosshairs.
posted by SeizeTheDay at 4:17 PM on September 20, 2008
So are you US taxpayers at least going to get a couple hundred truckloads of share certificates in exchange for taking bad debt of every major bank's books? At least then the stock price would go down as the shares are diluted and there would be some moral hazard in play right?
posted by PenDevil at 4:18 PM on September 20, 2008
posted by PenDevil at 4:18 PM on September 20, 2008
The primary difference is that when you can't pay your bills, nobody really cares.
For one person. When they become millions, it does become a problem. If you start selling thousand of houses, don't you think the "market" will notice and offer you a pittance, because you need money right here right now ? A single person may not notice, but people monitoring those transactions do and act accordingly.
AIG is still under obligation to pay back their bills. They are not yet owned by the US government, we merely loaned them $65B in exchange for warrants which guarantee we can buy them should they fail to pay back the loans.
And what assets does AIG hold or its debtors and how much are they worth? Who are they? What are they going to pay with, exactly? Let's assume we don't want them to default and let them pay slowly and at relatively low interest rates ; even so, they'll have to pay for years to come, which generates a steady cash flow that will be government property. How will it be spent, maybe on more tax cuts for those who don't need one? I surely don't know. And notice the following:
The 2005 amendment to U.S. bankruptcy law allows creditors to reclaim bonuses or compensation paid to insiders in the previous two years even if the company wasn't insolvent when the transfer was made, LoPucki said.
Which may net some money, assuming this wasn't already transfered into some safe heaven or locked into some other scheme.
Lehman will be paying back its creditors what it can from the assets after they are liquidated, which is standard practice in bankruptcy as far as I know.
Usually a fraction of what they have invested. Depending on the laws and level of protection , which vary depending on the type of credit you own, some will see absolutely zero return and complete loss of ther invested capital.
posted by elpapacito at 5:17 PM on September 20, 2008
For one person. When they become millions, it does become a problem. If you start selling thousand of houses, don't you think the "market" will notice and offer you a pittance, because you need money right here right now ? A single person may not notice, but people monitoring those transactions do and act accordingly.
AIG is still under obligation to pay back their bills. They are not yet owned by the US government, we merely loaned them $65B in exchange for warrants which guarantee we can buy them should they fail to pay back the loans.
And what assets does AIG hold or its debtors and how much are they worth? Who are they? What are they going to pay with, exactly? Let's assume we don't want them to default and let them pay slowly and at relatively low interest rates ; even so, they'll have to pay for years to come, which generates a steady cash flow that will be government property. How will it be spent, maybe on more tax cuts for those who don't need one? I surely don't know. And notice the following:
The 2005 amendment to U.S. bankruptcy law allows creditors to reclaim bonuses or compensation paid to insiders in the previous two years even if the company wasn't insolvent when the transfer was made, LoPucki said.
Which may net some money, assuming this wasn't already transfered into some safe heaven or locked into some other scheme.
Lehman will be paying back its creditors what it can from the assets after they are liquidated, which is standard practice in bankruptcy as far as I know.
Usually a fraction of what they have invested. Depending on the laws and level of protection , which vary depending on the type of credit you own, some will see absolutely zero return and complete loss of ther invested capital.
posted by elpapacito at 5:17 PM on September 20, 2008
Krugman's take is completely correct, IMHO. Interestingly, Krugman is just as qualified to run the Fed as Bernanke, as Krugman has a profound intuition and intellect when it comes to financial crises.
There are so many, many problems with the existing plan that if passed, would only slow the crisis, not stop or reverse it, and end up costing the US its AAA status and put us on par with Japan in terms of national debt/GDP.
I kept waiting, and waiting, for someone to write that the US would take equity stakes in all the troubled banks in exchange for their bad assets. In this type of event, current shareholders would take a huge hit, but the US government could eventually get its money back in 10-20 years as these banks got back on their feet and began to perform normally. I'm shocked that the US would take an equity stake in Fannie, Freddie, and AIG, but not even hint at that in exchange for this "bad bank" worth $700 billion. It's absurd, and incredibly disheartening, to see that only when Goldman fucking Sachs was about to lost 60-80% of its value did the Treasury step up. Morgan and Goldman deserved to go down; they are only the hook for hundreds of billions right now, and were key players in creating this gigantic mess.
We just have too many banks, and bankers, in America right now. We ended up with more and more banks pushing paper around, and now that that paper is disappearing, the revenue streams associated are gone, and the banks are too big for their own good. And nothing the Fed can do at this point will stop "failures". The larger banks simply need to pick off the weak and keep laying people off until we hit some sort of equilibrium. But there's no political will for that.
Man, if I didn't do this for a living, I'd be a willfully ignorant, and blissfully happy, man right now.
posted by SeizeTheDay at 5:46 PM on September 20, 2008
There are so many, many problems with the existing plan that if passed, would only slow the crisis, not stop or reverse it, and end up costing the US its AAA status and put us on par with Japan in terms of national debt/GDP.
I kept waiting, and waiting, for someone to write that the US would take equity stakes in all the troubled banks in exchange for their bad assets. In this type of event, current shareholders would take a huge hit, but the US government could eventually get its money back in 10-20 years as these banks got back on their feet and began to perform normally. I'm shocked that the US would take an equity stake in Fannie, Freddie, and AIG, but not even hint at that in exchange for this "bad bank" worth $700 billion. It's absurd, and incredibly disheartening, to see that only when Goldman fucking Sachs was about to lost 60-80% of its value did the Treasury step up. Morgan and Goldman deserved to go down; they are only the hook for hundreds of billions right now, and were key players in creating this gigantic mess.
We just have too many banks, and bankers, in America right now. We ended up with more and more banks pushing paper around, and now that that paper is disappearing, the revenue streams associated are gone, and the banks are too big for their own good. And nothing the Fed can do at this point will stop "failures". The larger banks simply need to pick off the weak and keep laying people off until we hit some sort of equilibrium. But there's no political will for that.
Man, if I didn't do this for a living, I'd be a willfully ignorant, and blissfully happy, man right now.
posted by SeizeTheDay at 5:46 PM on September 20, 2008
So is this the "October Surprise"? Just let Obama win so he can be president of whatever charred hellscape the Republicans leave behind?
posted by fungible at 6:44 PM on September 20, 2008
posted by fungible at 6:44 PM on September 20, 2008
In all seriousness, I just can't comprehend how Congress can go along with this, if how the bailout is presented is accurate. I had thought that the government would be buying up the debts at moderate prices in exchange for partial ownership in the institutions which then could be sold off at a later date when things were more stable, at least partially offsetting the cost of the initial bailout.
But it sounds to me like we're just throwing hundreds of billions of dollars at these companies in exchange for basically nothing. Just handing money to them and taking the bad debts wthout getting anything in return. Along with language allowing the fed chairman to do whatever he wants in times of "emergency" without any sort of review or oversight.
Can this possibly be correct? Isn't allowing this to happen an even worse disaster than letting the banks fail?
posted by Justinian at 6:51 PM on September 20, 2008
But it sounds to me like we're just throwing hundreds of billions of dollars at these companies in exchange for basically nothing. Just handing money to them and taking the bad debts wthout getting anything in return. Along with language allowing the fed chairman to do whatever he wants in times of "emergency" without any sort of review or oversight.
Can this possibly be correct? Isn't allowing this to happen an even worse disaster than letting the banks fail?
posted by Justinian at 6:51 PM on September 20, 2008
oops I meant treasury secretary not fed chairman.
posted by Justinian at 6:54 PM on September 20, 2008
posted by Justinian at 6:54 PM on September 20, 2008
"nobody really wants these sorts of events"
How can that possibly be true? Let's not just look at the few CEOs who might conceivably be called to task. There are clearly billions of dollars of compensation to thousands of people that has been pocketed. There are many people who got out in time, just like any pyramid scheme.
I mean, realistically, here in Seattle there are thousands of people alone who bought and sold houses who are fine with this. If you're a bartender and you made $50,000 selling your condo after owning it a year or three, you're coming out ahead even with whatever consequences or horrors are coming.
posted by Wood at 6:58 PM on September 20, 2008
How can that possibly be true? Let's not just look at the few CEOs who might conceivably be called to task. There are clearly billions of dollars of compensation to thousands of people that has been pocketed. There are many people who got out in time, just like any pyramid scheme.
I mean, realistically, here in Seattle there are thousands of people alone who bought and sold houses who are fine with this. If you're a bartender and you made $50,000 selling your condo after owning it a year or three, you're coming out ahead even with whatever consequences or horrors are coming.
posted by Wood at 6:58 PM on September 20, 2008
I had thought that the government would be buying up the debts at moderate prices in exchange for partial ownership in the institutions which then could be sold off at a later date when things were more stable, at least partially offsetting the cost of the initial bailout. But it sounds to me like we're just throwing hundreds of billions of dollars at these companies in exchange for basically nothing. Just handing money to them and taking the bad debts wthout getting anything in return.
Whether or not that's the case depends entirely on what price the sludge is sold at. If the Fed buys it at 99 cents on the dollar, then yeah, they're subsidizing the investment banks and hedge funds at taxpayer expense. If they're somehow able buy it at 1 cent on the dollar, they'll make a profit while saving the economy. But even though that's the most important part of this deal, the draft legislation that has been published provides no hint at what auction mechanism would be used. Which greatly worries me. As near as I can tell, all parties in this decision have an incentive to err on the side of generosity when pricing this stuff.
posted by gsteff at 7:30 PM on September 20, 2008
Whether or not that's the case depends entirely on what price the sludge is sold at. If the Fed buys it at 99 cents on the dollar, then yeah, they're subsidizing the investment banks and hedge funds at taxpayer expense. If they're somehow able buy it at 1 cent on the dollar, they'll make a profit while saving the economy. But even though that's the most important part of this deal, the draft legislation that has been published provides no hint at what auction mechanism would be used. Which greatly worries me. As near as I can tell, all parties in this decision have an incentive to err on the side of generosity when pricing this stuff.
posted by gsteff at 7:30 PM on September 20, 2008
Oops, I said that the Fed would buy the sludge. I think it would actually be Treasury.
posted by gsteff at 7:32 PM on September 20, 2008
posted by gsteff at 7:32 PM on September 20, 2008
But isn't the price at which we buy the debt the single most important point of the whole deal? Shouldn't that be the first thing hammered out?
posted by Justinian at 7:33 PM on September 20, 2008
posted by Justinian at 7:33 PM on September 20, 2008
The Mind-Boggling Trillion Dollar Bailout: A Q&A With Finance Writer Max Wolff
posted by ornate insect at 7:48 PM on September 20, 2008
posted by ornate insect at 7:48 PM on September 20, 2008
> I kept waiting, and waiting, for someone to write that the US would take equity stakes in all the troubled banks in exchange for their bad assets.
Me too. And Krugman makes perfect sense.
Here's a question-
The issue is liquidity - capital being available to the market, yes? Wall St wet their briefs with joy and the markets all shot up Friday when the US government announced that they were stepping up to take on some of the bad debt.
Why can't the US government just provide this market liquidity from a new government corporation AND also let the bastards who made the mess choke and die on their own shit, and the government corporation and surviving banks pick the carcasses for assets?
posted by Artful Codger at 7:54 PM on September 20, 2008
Me too. And Krugman makes perfect sense.
Here's a question-
The issue is liquidity - capital being available to the market, yes? Wall St wet their briefs with joy and the markets all shot up Friday when the US government announced that they were stepping up to take on some of the bad debt.
Why can't the US government just provide this market liquidity from a new government corporation AND also let the bastards who made the mess choke and die on their own shit, and the government corporation and surviving banks pick the carcasses for assets?
posted by Artful Codger at 7:54 PM on September 20, 2008
If they're somehow able buy it at 1 cent on the dollar, they'll make a profit while saving the economy.
Simple banking 101:
The banks are afraid to sell it, because if/when they do, they eat the loss. If they eat the loss, that means negative income, which comes out of shareholders' equity, which would make the banks inadequately capitalized (and in some cases completely insolvent). So if the Fed buys this paper at 100%, then the banks won't need additional capital raises. But if the Fed buys at a discount, there is a real risk at many institutions being insolvent. So they can't buy it at a steep discount without somehow recapitalizing the banks.
My crude solution: Buy the paper at 50 cents on the dollar and the other 50 cents will represent warrants on bank stock. Why won't this work? Because no one knows the real value of these assets, and banks don't want to take a gigantic hit (talk to Lehman Brothers, who waited so long that it cost them the business). But the Fed, in good faith, can't pay 100%, because that is tantamount to a complete and utter bailout, with taxpayers effectively giving bank shareholders' all the money for free.
It's extremely complicated right now, made moreso because the market has run out of patience and wants to bring every major bank in America to zero, effectively destroying our financial system.
posted by SeizeTheDay at 7:59 PM on September 20, 2008
Simple banking 101:
The banks are afraid to sell it, because if/when they do, they eat the loss. If they eat the loss, that means negative income, which comes out of shareholders' equity, which would make the banks inadequately capitalized (and in some cases completely insolvent). So if the Fed buys this paper at 100%, then the banks won't need additional capital raises. But if the Fed buys at a discount, there is a real risk at many institutions being insolvent. So they can't buy it at a steep discount without somehow recapitalizing the banks.
My crude solution: Buy the paper at 50 cents on the dollar and the other 50 cents will represent warrants on bank stock. Why won't this work? Because no one knows the real value of these assets, and banks don't want to take a gigantic hit (talk to Lehman Brothers, who waited so long that it cost them the business). But the Fed, in good faith, can't pay 100%, because that is tantamount to a complete and utter bailout, with taxpayers effectively giving bank shareholders' all the money for free.
It's extremely complicated right now, made moreso because the market has run out of patience and wants to bring every major bank in America to zero, effectively destroying our financial system.
posted by SeizeTheDay at 7:59 PM on September 20, 2008
The issue is liquidity - capital being available to the market, yes?
The issue was liquidity. That's what credit crunch means: ultimately people stopped trusting each other, so the market seized up as no one was lending to each other, so the central banks teamed up to lube the system.
The problem now is that banks (THE providers of liquidity to the market) hold assets that aren't worth what people thought they were. Remember last year when Bernanke said the downside was contained to subprime? People didn't think that housing prices were going to fall 20-50% on a nationwide basis. But now that they are, and there is no end in sight, the market has realized that not only is there a liquidity problem, there's a problem with inflated asset prices (in many classes, not just CDOs, or mortgages).
So now not only do people not trust each other (liquidity), but there is systemic asset price deflation, and systemic deleveraging, which any economist will tell you is the death knell of a properly functioning financial market.
IF the price of houses stops falling, banks can reassess their positions, and investors would put money in banks, knowing that the problems were behind them. But since that hasn't happened, no one is willing to step up to the plate and offer banks a reasonable amount of money to buy their distressed assets. And banks can't function as banks (lending money and churning the money supply) until they can stem the losses from these distressed assets (chicken and egg, basically: no one buys these assets, but until they do, banks can't function).
Then you throw into this a $60 trillion off balance sheet market of credit default swaps, and suddenly the ball game becomes so large that even the government may not be able to solve this problem by itself. (Luckily $60 trillion is only the notional amount, and not the amount of money that actually exchanged hands, but CDS are based on companies defaulting, and guess what? Economists are suggesting that the next couple of years should yield record defaults.)
posted by SeizeTheDay at 8:11 PM on September 20, 2008
The issue was liquidity. That's what credit crunch means: ultimately people stopped trusting each other, so the market seized up as no one was lending to each other, so the central banks teamed up to lube the system.
The problem now is that banks (THE providers of liquidity to the market) hold assets that aren't worth what people thought they were. Remember last year when Bernanke said the downside was contained to subprime? People didn't think that housing prices were going to fall 20-50% on a nationwide basis. But now that they are, and there is no end in sight, the market has realized that not only is there a liquidity problem, there's a problem with inflated asset prices (in many classes, not just CDOs, or mortgages).
So now not only do people not trust each other (liquidity), but there is systemic asset price deflation, and systemic deleveraging, which any economist will tell you is the death knell of a properly functioning financial market.
IF the price of houses stops falling, banks can reassess their positions, and investors would put money in banks, knowing that the problems were behind them. But since that hasn't happened, no one is willing to step up to the plate and offer banks a reasonable amount of money to buy their distressed assets. And banks can't function as banks (lending money and churning the money supply) until they can stem the losses from these distressed assets (chicken and egg, basically: no one buys these assets, but until they do, banks can't function).
Then you throw into this a $60 trillion off balance sheet market of credit default swaps, and suddenly the ball game becomes so large that even the government may not be able to solve this problem by itself. (Luckily $60 trillion is only the notional amount, and not the amount of money that actually exchanged hands, but CDS are based on companies defaulting, and guess what? Economists are suggesting that the next couple of years should yield record defaults.)
posted by SeizeTheDay at 8:11 PM on September 20, 2008
You guys are depressing me. I am reminded of the end of the movie version of FIGHT CLUB, and wonder if perhaps Tyler Durden hadn't figured something out after all.
posted by Justinian at 8:46 PM on September 20, 2008 [1 favorite]
posted by Justinian at 8:46 PM on September 20, 2008 [1 favorite]
Tyler Durden did a shit job blowing up banks in that movie. Any decent financial institution has multiple redundant data centers.
posted by benzenedream at 10:38 PM on September 20, 2008
posted by benzenedream at 10:38 PM on September 20, 2008
Vermont Senator Bernie Sanders is stating a bailout should: be funded by taxing the rich, not pay full price for the banks' assets, provide company shares to the taxpayers, be accompanied by an economic stimulus and jobs program, re-regulate markets, and not allow companies to grow "too big to fail." (via dkos)
posted by salvia at 12:13 AM on September 21, 2008
posted by salvia at 12:13 AM on September 21, 2008
I'm terrified right now by the thought that it's the Bush administration getting together this bailout. Has there been one major project that they haven't fucked up?
posted by afu at 1:37 AM on September 21, 2008
posted by afu at 1:37 AM on September 21, 2008
CDS issues are a crisis that quite a few saw coming just a few months ago and one that was discussed here then
Warren Buffett described the current problem concisely, eloquently, and with perfect precision in his 2002 Berkshire shareholder letter. Scroll down to page 13. There's nothing happening now that wasn't in those few paragraphs.
posted by ikkyu2 at 1:48 AM on September 21, 2008 [4 favorites]
Warren Buffett described the current problem concisely, eloquently, and with perfect precision in his 2002 Berkshire shareholder letter. Scroll down to page 13. There's nothing happening now that wasn't in those few paragraphs.
posted by ikkyu2 at 1:48 AM on September 21, 2008 [4 favorites]
> So now not only do people not trust each other (liquidity), but there is systemic asset price deflation, and systemic deleveraging, which any economist will tell you is the death knell of a properly functioning financial market.
I think I understand that. But isn't it evident that the market hasn't been properly functioning, in the sense that this imbalance happened and was allowed to fester to this level?
I still think (wish) that there's a way that the crisis could be managed without rewarding the bastards who brought it about. Such as some way for financial institution to temporarily transfer or "park" the problem debt with the government or in some kind of shelter, so that the banks can operate more safely for a few years til the assets recover. Or more emphasis on ways to keep people in their houses and working. Maybe forgiving 25% of a mortgage where it would keep someone from defaulting or bankruptcy - availability limited to their principal residence, and who genuinely qualified (did not lie) on their mortgage application. Speculators can go fish.
Rewarding Wall st with a bailout AND leaving people stuck with oversized mortgages is a double-whammy on the taxpayer.
If I happened to have a mortgage for more than the value of my house, and I heard that the government was doing a straight bailout of the banks (essentially rewarding the crooks at my expense), I wouldn't hesitate for a moment to walk away from the debt, if at all possible, in order to get my piece of the pie. Isn't this what's going to happen next?
posted by Artful Codger at 6:45 AM on September 21, 2008
I think I understand that. But isn't it evident that the market hasn't been properly functioning, in the sense that this imbalance happened and was allowed to fester to this level?
I still think (wish) that there's a way that the crisis could be managed without rewarding the bastards who brought it about. Such as some way for financial institution to temporarily transfer or "park" the problem debt with the government or in some kind of shelter, so that the banks can operate more safely for a few years til the assets recover. Or more emphasis on ways to keep people in their houses and working. Maybe forgiving 25% of a mortgage where it would keep someone from defaulting or bankruptcy - availability limited to their principal residence, and who genuinely qualified (did not lie) on their mortgage application. Speculators can go fish.
Rewarding Wall st with a bailout AND leaving people stuck with oversized mortgages is a double-whammy on the taxpayer.
If I happened to have a mortgage for more than the value of my house, and I heard that the government was doing a straight bailout of the banks (essentially rewarding the crooks at my expense), I wouldn't hesitate for a moment to walk away from the debt, if at all possible, in order to get my piece of the pie. Isn't this what's going to happen next?
posted by Artful Codger at 6:45 AM on September 21, 2008
It seems foreign banks will be allowed to offload their debt to the US gov as long as they have business operations in the US. Yeah... that won't be abused at all...
posted by PenDevil at 7:13 AM on September 21, 2008
posted by PenDevil at 7:13 AM on September 21, 2008
Washington Post, Campaigns Beef Up Economic Teams in Face of Crisis, 21 Sep 08:
As for the Hill, Congressional Quarterly reports that House & Senate staffers, from both parties, met with Adminsitration officials for 2 hrs Sat afternoon. CQ also offers a fact-checking article re: economic assertions of the two campaigns, and this about the nasty ads. Staffers are also reading The Hill, and Roll Call [subscription required]. The shot clock is ticking: leadership probably won't let the proposal get bogged down with too many changes, and I have a hard time believing that Congress will do anything to spook Wall Street. We'll see.
posted by woodway at 7:39 AM on September 21, 2008
Obama appears to have one clear advantage in the conversation: His campaign has been able to bulk up quickly, bringing in an array of major players from the Clinton administration who helped guide the nation through market upheavals, including the crises in Russia, Argentina and Southeast Asia and the collapse of the massive hedge fund Long-Term Capital Management. In the past few weeks, an eclectic and largely low-profile team of economic advisers at the Obama campaign headquarters has been practically taken over by the Clinton A-team...I would like a smart president, please, though to give McCain the benefit of the doubt, the top R people are probably busy working for the current administration +/or advising people on the Hill.
"He's terrific on this stuff," Rubin gushed Friday on the return trip from Florida, where he had joined Obama for his emergency economic session. "He starts every meeting the same way, 'Let's try to figure out what's right substantively, then figure out how to handle it.' He asks good questions, really understands these things, the nuance, the distinctions.
As for the Hill, Congressional Quarterly reports that House & Senate staffers, from both parties, met with Adminsitration officials for 2 hrs Sat afternoon. CQ also offers a fact-checking article re: economic assertions of the two campaigns, and this about the nasty ads. Staffers are also reading The Hill, and Roll Call [subscription required]. The shot clock is ticking: leadership probably won't let the proposal get bogged down with too many changes, and I have a hard time believing that Congress will do anything to spook Wall Street. We'll see.
posted by woodway at 7:39 AM on September 21, 2008
I have a hard time believing that Congress will do anything to spook Wall Street.
Wall Street needs more than spooked, though, it needs fucking shot in the head. (Don't forget that RTC I sacked all the bastards). The assets made from irresponsible lending and financial chicanery are now unsellable and worthless, and this makes many of these guys bankrupt. It's not the job of the US Govt to allow them to pretend they're still solvent. Nor to pretend that the houses are worth what they were are the height of the boom.
"The value of your home may go down as well as up" ring any bells? Bankers.
posted by bonaldi at 10:50 AM on September 21, 2008
Wall Street needs more than spooked, though, it needs fucking shot in the head. (Don't forget that RTC I sacked all the bastards). The assets made from irresponsible lending and financial chicanery are now unsellable and worthless, and this makes many of these guys bankrupt. It's not the job of the US Govt to allow them to pretend they're still solvent. Nor to pretend that the houses are worth what they were are the height of the boom.
"The value of your home may go down as well as up" ring any bells? Bankers.
posted by bonaldi at 10:50 AM on September 21, 2008
If you're a bartender and you made $50,000 selling your condo after owning it a year or three, you're coming out ahead even with whatever consequences or horrors are coming.
Come to find out it's triple that to buy back in. Stocks down, dollar down - the $50k less of a windfall with each passing day. On the up side, if the bailout doesn't work, a lot more people will take to drinking, so he's in a Depression-proof job!
posted by AppleSeed at 4:18 AM on September 22, 2008
Come to find out it's triple that to buy back in. Stocks down, dollar down - the $50k less of a windfall with each passing day. On the up side, if the bailout doesn't work, a lot more people will take to drinking, so he's in a Depression-proof job!
posted by AppleSeed at 4:18 AM on September 22, 2008
One of the earliest CDS deals came out of JP Morgan in December 1997. It essentially took 300 different loans, totaling $9.7 billion, that had been made to a variety of big companies like Ford, Wal-Mart and IBM, and cut them up into pieces known as "tranches" (that's French for "slices"). The bank then identified the riskiest 10 percent tranche and sold it to investors in what was called the Broad Index Securitized Trust Offering, or Bistro for short.
The Bistro was put together by Terri Duhon, at the time a 25-year-old MIT graduate working on JP Morgan's credit swaps desk in New York—a division that would eventually earn the name the Morgan Mafia for the number of former members who went on to senior positions at global banks and hedge funds. "We made it possible for banks to get their credit risk off their books and into non-financial institutions like insurance companies and pension funds," says Duhon, who now heads her own derivatives consulting business in London.
Given the CDSs' role in the bailout mess, it's likely that the federal government will start regulating them; New York state has already said it will begin doing so in January. "Sadly, they've been vilified," says Duhon, who helped get the whole thing started with that Bistro deal a decade ago. "It's like saying it's the gun's fault when someone gets shot."
But just as one might want to regulate street sales of AK-47s, there's an argument to be made that credit default swaps can be dangerous in the wrong hands. "It made it a lot easier for some people to get into trouble," says Darrell Duffie, an economist at Stanford. Although he believes credit default swaps have been "dramatically misused," Duffie says he still believes they're a very effective tool and shouldn't be done away with entirely. Besides, he says, "if you outlaw them, then the financial engineers will just come up with something else that gets around the regulation."
Lather. Rinse. Repeat.
posted by netbros at 1:20 PM on September 28, 2008 [1 favorite]
The Bistro was put together by Terri Duhon, at the time a 25-year-old MIT graduate working on JP Morgan's credit swaps desk in New York—a division that would eventually earn the name the Morgan Mafia for the number of former members who went on to senior positions at global banks and hedge funds. "We made it possible for banks to get their credit risk off their books and into non-financial institutions like insurance companies and pension funds," says Duhon, who now heads her own derivatives consulting business in London.
Given the CDSs' role in the bailout mess, it's likely that the federal government will start regulating them; New York state has already said it will begin doing so in January. "Sadly, they've been vilified," says Duhon, who helped get the whole thing started with that Bistro deal a decade ago. "It's like saying it's the gun's fault when someone gets shot."
But just as one might want to regulate street sales of AK-47s, there's an argument to be made that credit default swaps can be dangerous in the wrong hands. "It made it a lot easier for some people to get into trouble," says Darrell Duffie, an economist at Stanford. Although he believes credit default swaps have been "dramatically misused," Duffie says he still believes they're a very effective tool and shouldn't be done away with entirely. Besides, he says, "if you outlaw them, then the financial engineers will just come up with something else that gets around the regulation."
Lather. Rinse. Repeat.
posted by netbros at 1:20 PM on September 28, 2008 [1 favorite]
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