Somebody has to be getting rich...

One thing that confuses me about the current financial crisis is this: If the banks are the losers, then who are the winners?

In the case of the mortgage crisis, the answer is clear: if a house drops in value, that money is simply gone. Whoosh! Somebody who shouldn't have gotten a loan got one, bought a home for more than it's worth, and now can't repay. The house market declines (or corrects), and nobody really wins... except for the cash-rich speculator who buys the home for 1/2 its value... then rents it back to the person who bought it in the first place.

The banks lose... which rattles the economy. Clear enough...

But what about these credit default swaps that are taking down ACA Capital Holdings, Ambac, and other bond reinsurance people? These seem kind of funny to me... somebody "bought" the risk that these loans would not default... then they defaulted... and so ACACH has to pay.

Pay whom? Who was the wise speculator buying up all this risk, and cashing in as the system crumbles? Who are the creditors who are forcing ACACH to fold, causing panic across the board?

If I had a billion dollars, I would have bet against the US economy BIG TIME. Pretty much any Agonist reader (with flexible morals) would have done the same... so why don't we see their names in the news? Or is this similar to the mortgage crisis, where the money just evaporated? Is there a cash-rich speculator who's waiting for the bottom before buying? Or is this so screwed up, that nobody knows where the bottom will be?

Can anybody enlighten me?

Ed Note: This is a good question, one I would answer, but cannot due to a project I am working on taking my time. Perhaps one of our esteemed finance guys, Numerian, Ian or Stilring can do so?

bex January 21, 2008 - 7:10pm

bex's diary | printer friendly version |

( categories: Miscellany | Opinion )

There is an opportunity to make money through destruction

For example, currency speculation, put and call strategies, etc, can destroy many times the value that it returns. Its just that the value destroyed does not belong to the destroyer; it is someone else's value that is destroyed. Some people get rich on the woes of others.

Joaquin January 21, 2008 - 7:55pm

There may be some smart guys,

who make some money off this, but it's not zero sum. Money (or rather value) will disappear, so not only will there be more losers than winners, but the pie gets smaller, so the (total) losses are larger than any (total) gains.

From what I've seen, the stock market people desparately want an emergency drop in interest rates. That will boost inflation, but keep their losses less than anyone's else's losses, so be a relative gain.

Any econo-wonk is welcome to correct me if I've got it wrong.

Gordon January 21, 2008 - 11:57pm

This is spot on

Bex also points out how it is not a zero sum game in the housing market. If you bought a home for $200,000 and a year later you have five people offering $300,000 you have made a profit (provided you actually sell the home and move to something costing less than $300,000 - and leaving aside tax affects).

If however only one person shows up offering $100,000, and you are desperate to sell, you have lost money.

These examples involve cash losses. You will also have paper gains and losses just by owning a home. These are called marked to market gains or losses from market risk, and until last year the real estate industry insisted you could only get gains on your home based on historical experience (they were wrong).

Something that confuses a lot of people is the difference between market risk and credit risk. A lot of banks have bought credit default swaps, so that if an asset they own goes down in value, the default swap will go up in value in equal amount. They appear to be perfectly hedged. What's going on now is that the parties who sold the credit default swap are themselves defaulting, unable to perform (like the monoline insurance companies). The bank is no longer perfectly hedged. Credit risk, as represented by the default of the swap provider, has disrupted a perfect market risk hedge. The bank has to take a write-down because their market risk has suddenly exploded - they are not hedged at all and if they could find a new hedge it would be at much more expensive prices.

This explains a lot of the write-downs going on in banks. This also explains a third, much more serious risk - systemic risk. This is the contagion factor. The party who defaulted on the credit swap may have done so because they themselves had to take huge losses from suddenly being unhedged in their market risk. The bank in our example may find itself bankrupt as well, meaning all the credit protection and hedges it sold to other banks will cause losses. The whole daisy chain implodes. This is really what is going on now but the central banks seemed stunned, unable to figure out what to do despite years of talking about systemic risk.

This is a very volatile, nightmarish situation. It is exactly how paper value disappears. And because anything to do with derivatives gets marked to market accounting treatment - meaning the gains and losses are taken into income quarterly (this way traders get fabulous bonuses during boom times) - the losses now are taken into income. The financial industry doesn't get the luxury of waiting until maturity of these investments to see how they come out. The accounting practices therefore play a big role in destroying wealth, because they played a big role earlier in creating it. Banks may wish at the end of this that they could go back to old fashioned investment accounting - keeping their periodic gains and losses out of income. But then there would be no big bonuses.

Numerian January 22, 2008 - 12:45am

I recall saying some time

back that I didn't think that sharing credit risk had reduced it, but had rather made it likely the contagion would spread instead of being isolated. Think some folks thought I didn't understand the math well enough.

They were right, but I didn't need to beause what I understood was that the equations themselves only held under certain circumstances.

People are such fools, mostly because they want to be fools.

Ian Welsh January 22, 2008 - 2:22am

good way of putting it...

On wikipedia, this quote jumped out at me:

The market for credit derivatives is now so large, in many instances the amount of credit derivatives outstanding for an individual name are vastly greater than the bonds outstanding. For instance, company X may have $1 billion of outstanding debt and $10 billion of CDS contracts outstanding. If such a company were to default, and recovery is 40 cents on the dollar, then the loss to investors holding the bonds would be $600 million. However the loss to credit default swap sellers would be $6 billion. In addition to spreading risk, credit derivatives, in this case, also amplify it considerably.

huh... if you're spreading risk, and amplifying risk, then aren't you increasing risk? And then there's this:

Many people wonder why indices like the Dow Jones Industrial Average and S&P 500 seem to go up endlessly. Part of the reason is that big institutional investors no longer sell companies they feel are about to fail... investors can buy "insurance" in the form of derivatives and keep holding their investments. This distorts the value of traditional market indices because the decision to remove a failing company from the index can be made well before the paper value drops to zero. This ... creates the false impression that the index always rises. The underlying markets, for which the index was developed to reflect value, may be far more unstable than appearances indicate.

Ian is right... I never trust heads-down math formulas in a complex dynamic system. Academics almost never see the big picture: they're far too invested to their perfect formulas.

--
http://bexhuff.com
Of COURSE you can trust the US Government! Just ask the Indians.

bex January 22, 2008 - 11:47am

For years derivatives proponents

lectured everybody on what a great service they were providing by letting risk get sliced up and spread around. Therefore, so they said, there was less risk.

Yeah, that worked real good didn't it?

But to add insult to injury, while the cassandras who kept warning that this stuff was out of control got nothing while the asswipes who play these games have socked away millions of dollars. And they'll be able to keep those millions of dollars, while millions of working Americans who have no idea what a CDS or a CDO are, are going to be losing their jobs, their homes, and many of them, their lives.

How long, O Lord, how long, shall the wicked triumph?

Tony Wikrent January 23, 2008 - 12:50am

is punnishment even remotely possible?

how could we prevent this kind of short-term crap from happening? Only give bonuses based on long-term growth? Heavy taxes on financial services profits that do not actually create new wealth?

ideas?

--
http://bexhuff.com
Of COURSE you can trust the US Government! Just ask the Indians.

bex January 24, 2008 - 1:24pm

Well I know that

Warren Buffet's company was at 35% cash the last quarter, the greatest amount of cash horde he'd ever put together. I heard that today he'd said that these are the days he waits for (i.e. stock market down 600 points on the futures market). My understanding is that he will be in position to buy all these failing bond insurance companies and that some of these are going for $.32 on the dollar.

In many respects though the money does just vanish in the sense that there is debt secured against borrwings of debt and when the default cascade occurs it truly just vanishes. One dollar that circulates eight times is worth $8, but if it defaults along the way it collapses back to $1. Nobody wins.

Scotjen61 January 22, 2008 - 12:15am

In Jim Cramer's first book,

In Jim Cramer's first book, his wife had an interesting observation: the bottom hits when the biggest bulls panic and scream "get out!" When that happens, then the bears come out and look for deals amongst the panicky bulls.

Of course, I'd assume that the only way to prevent a global panic is if the bears have sufficient cash... Hopefully Buffet has friends. I heard something about private equity funds sitting on big wads of cash... but if China starts to invest in something besides treasury bills, you can bet that xenophobia will be next...

Side note: "confessions of a street addict" is an interesting look at how Cramer's hedge fund made money using questionably legal tactics... and how the average investor should forget about playing with the big boys. Frankly, the little guys lack the "not-quite insider information" that hedge funds acquire through "legal" bribes. At least, that's my take away... not a "good" book, but eye opening.

--
http://bexhuff.com
Of COURSE you can trust the US Government! Just ask the Indians.

bex January 22, 2008 - 12:14pm

Enter the lawyers........

Tide of lawsuits approaches troubled U.S. mortgage market
By Vikas Bajaj
Monday, January 21, 2008

NEW YORK: Everyone wants to know who is to blame for the losses paining Wall Street and homeowners. The answer, it seems, is someone else.

A wave of lawsuits is beginning to wash over the troubled U.S. mortgage market and the rest of the financial world. American homeowners are suing mortgage lenders. Mortgage lenders are suing Wall Street banks. Wall Street banks are suing loan specialists. And investors are suing everyone.

The legal and regulatory wrangles could dwarf the ones that followed the technology-stock bust and the Enron and WorldCom debacles. But the size and complexity of the modern mortgage market will make untangling the latest mess even trickier. Some cases stretch across continents. Others are likely to involve state and federal regulators.

"It will be a multi-ring circus," said Joseph Grundfest, a professor of law and business and co-director of the Rock Center of Corporate Governance at Stanford University. "This particular species of litigation will be manifest in many different types of lawsuits in many different jurisdictions."

The legal battles stretch from Main Street to Wall Street and beyond. Homeowners and subprime mortgage lenders are squaring off in dozens of cases that claim some lenders engaged in predatory lending practices and other wrongdoing. Cleveland and Baltimore are pursuing cases against Wall Street banks, saying local residents are suffering because the banks fostered the proliferation of high-risk home loans.

Two questions lie at the heart of many of the cases. The first is whether lenders and investment banks alerted borrowers and investors to the risks posed by subprime loans or securities backed by them. The second is how much they were legally obliged to disclose.

"Those are the two issues that are frequently raised," said Jayant Tambe, a partner at the law firm Jones Day.

As defaults and foreclosures rise, the various players in the housing market are all pointing fingers at each other. State prosecutors like Andrew Cuomo, the attorney general of New York, are investigating whether investment banks that packaged mortgages into securities disclosed the risks to investors and credit-rating agencies. Investment banks, in turn, are accusing lenders and mortgage brokers of shoddy business practices.

"What strikes me here is that this a tainted system from A to Z," said Tamar Frankel, a law professor at Boston University. "Everybody blames everybody else. If you look at what is being said, there isn't one who doesn't blame another and there is half-truth in everything."

Wall Street banks that sold mortgage investments around the world face legal complaints from as far away as Australia and Norway. Lehman Brothers, the Wall Street bank with the biggest mortgage business, is being sued by towns in Australia that say a division of the firm improperly sold them risky mortgage-linked investments. Lehman has denied the charges and has said the subsidiary, formerly known as Grange Securities, acted properly.

Closer to home, members of a New Jersey family have sued Lehman for $4.14 billion, saying the firm steered them into complex securities that have become difficult to sell, Bloomberg News reported Friday. Lehman denied the accusations.

In the United States, Lehman itself is suing at least half a dozen mortgage lenders and brokers like Fremont Investment and Loan and Fieldstone Investment, claiming they sold Lehman dubious loans. Lehman claims that borrowers' incomes were overstated, home appraisals were inflated and the homes were in poor condition. In most cases, the lenders are fighting the allegations and Lehman's demand that they buy back defaulted or otherwise problematic loans.

In another case, the PMI Group, a mortgage insurer, sued WMC Mortgage, a subprime lender that has stopped making loans, and its corporate parent in California Superior Court in Los Angeles. PMI is trying to force the companies to buy back or replace loans that the firm was hired to insure and that it says were made fraudulently or in violation of the standards that the lender said it was using.

According to the lawsuit, a review of loan files found "a systemic failure by WMC to apply sound underwriting standards and practices." Reviewing a sample of the nearly 5,000 loans in the pool, Clayton identified 120 "defective" loans for which borrowers' incomes and employment were incorrect or where the borrower's intention to live in the home was incorrect. WMC offered to buy back 14 loans, according to the lawsuit.

Some of the loans have already defaulted, and a trustee's report on the pool of loans that was packaged and underwritten by UBS, the Swiss investment bank, shows that losses on some defaulted mortgages are as high as 100 percent. As of November, about 27 percent of the loans in the pool were either delinquent 60 days or more, in foreclosure or had resulted in a repossessed home.

Tina January 22, 2008 - 1:42am

Why financial disaster is inevitable

As Numerian explains, the banks have two basic problems. The first is that many of the financial derivatives they hold have become worthless because the counter-party cannot perform as stipulated in the contract. The second boils down to accounting and whether or not certain paper losses or gains have to be included in financial statements, and if so, how. This second problem is discussed in an interesting post on The European Tribune: Can accounting standards be scapegoated for the turmoil? http://www.eurotrib.com/?op=displaystory;sid=2008/1/21/83137/7644

But there is a larger, more important point that needs to be understood. It is the point the demonstrates why the present system must ultimately collapse. The point is: all financial instruments represent a claim for payment that must ultimately be satisfied from what the actual goods and services produced by the economy.

Actual goods and services produced by the economy is measured by GDP – gross domestic product. There are debates among economists and others as to how accurate a measure GDP is, and if GDP as a concept adequately captures beneficial economic activity (for example, if there is an oil spill, the costs of cleaning up that oil spill will result in an increase in GDP; critics point out the absurdity of including in GDP an activity that clearly results a great harm done, or wrong committed). But let us leave these debates aside, and accept GDP as an adequate measure of real economic activity within a national economy.

On the Wikipedia page on financialization I created last November, there is a table that compares U.S. GDP with trading activity in the various financial markets. http://en.wikipedia.org/wiki/Financialization
In the 1950s and 1960s, financial trading was just slightly larger than GDP, a rough one to one parity. By 2000, however, the financial trading had become over fifty times larger. U.S. GDP of $9.817 trillion was supporting financial trading of $508.456 trillion.

The banks and brokers involved in all that financial trading probably capture some fraction of one or two percent as fees and commissions. Let us assume one fifth of one percent. That comes to almost exactly $1 trillion. But if the ratio of financial trading to GDP in the 1960s still held true, then the amount of fees and commissions captured by banks, brokers, speculators, arbitragers, and so on, would be about one fiftieth that amount, or around $20 billion.

Are these estimates outlandish, or do they accurately reflect reality? John Bogle, founder and retired CEO of The Vanguard Group of mutual funds, has publicly stated his estimate that the financial sector robs the economy of about $500 billion in value each year. Bogle would probably disagree with me on the claiming that all $1 trillion is value stolen from the economy, so his figure of $500 billion in my mind confirms my figure of $1 trillion is in the ball park.

So, year in and year out, the “players” in the financial markets and have been siphoning off $1 trillion in fees, commissions and so on, and enjoying multi-million dollar bonuses, while wages for everyone else have been collapsing. Collapsing wages should not be a surprise, once you understand the dynamic of increasing trading in ever more claims for payment being imposed on the back of the real economy.

But what happens when the total amount of financial instruments outstanding – not just trading turnover – exceeds GDP by multiple factors of ten? That’s the situation we are in today. For example, here is a graph showing just one type of financial derivative: the credit default swaps, which are the financial derivatives that AMBAC and other similar companies specialized in:

Yes, the scale on the left is in increments of $5,000 billion -- that is, in increments of $5 trillion.

By contrast, U.S. GDP in 2006 was $13.13 trillion.

So, the potential claims for payment vastly exceed what the economy itself can actually produce. In this situation, one the ugly specter of a daisy chain of defaults appears, it makes eminent sense for all parties involved to stampede for the doors. Because only the first ones out have any hope of actually getting paid. All the rest can present their claims for payment, but there simply ain’t that much in the economy to give up as payment.

This is why deregulated free markets in banking and finance always, ALWAYS collapse. From tulip bulbs in the 1600s, to gold and silver in the 1890s, to stocks bought on margin in the 1920s, to financial derivatives today, it is always in the interest of financial agents to sell and trade more potential claims for payment -- and skim off their one fifth of one percent -- than the economy has the ability to actually pay.

When, in August 1971, Richard Nixon announced that the US dollar would no longer be convertible into gold, but would be allowed to “float” against other currencies, economist James Tobin warned of the greedy behavior of unregulated financial markets and argued for imposing a transaction fee on all foreign-exchange transactions. Interestingly, Tobin proposed a tax rate of around one fifth of one percent. http://en.wikipedia.org/wiki/Tobin_tax
Tobin’s idea was to demolish the profitability of trading ever larger amounts of foreign exchange, and thus prevent the development of a speculative bubble that ended up generating paper claims for payment far in excess of what the real economy could actually pay.

Unfortunately, Tobin and his ideas were scoffed at by the radical free market ideologues, and a series of new financial instruments have been created and traded, until we get to where we are today, with financial transactions totaling more than fifty times more the goods and services produced in the real economy. How it all ends, as they say, is inevitable.

Tony Wikrent January 22, 2008 - 2:40am

Excellent Tony

Thanks for that. I nominate you for Fed chief right now. Can you take over today, looks like Gentle Ben is in over his head.

PS: Got any thoughts on how we work our way out of this madness?

Zman1527 January 22, 2008 - 11:18am

excellent analysis... but...

I can't tell if you're proposing going back onto the gold standard? I don't think so, but I'm curious how much "regulation" you think the economy needs.

Free market radicals need to chill out... as long as we have the Fed, the economy is regulated. Other than the Mises Institute, does anybody believe in abolishing the Fed? If not, then its hypocritical to scoff at a .2% Tobin tax on paper speculation.

I'm starting to believe that policy makers only listen to stupid economists, because stupid economists are more likely to tell you what you want to hear...

--
http://bexhuff.com
Of COURSE you can trust the US Government! Just ask the Indians.

bex January 22, 2008 - 12:00pm

We need managed exhange rates, not a gold standard.

No, I am not for a return to a gold standard, or to pegging a currency to any type of physical asset. At this point, the most sensible proposals I have found include Thomas Palley, who suggests a scheme of crawling band target zones in a paper entitled "The Fallacy of the Revised Bretton Woods Hypothesis: Why Today’s System is Unsustainable and Suggestions for a Replacement":

Such a system involves choice of a number of parameters that would need to be negotiated by participants. First, there is choice of the target exchange rate. Second, there is the choice of size of the band in which the exchange rate could fluctuate. Third, there is a choice whether the band would be hard or soft. A hard band is automatically and decisively defended; a soft band is one that allows for marginal temporary deviations outside the band, while retaining a commitment to bring the exchange rate back within the band when market conditions are most conducive. Fourth, there is the choice of the rate of crawl. This involves determining the rules governing the adjustment of the target and band. Issues here concern the periodicity of adjustment, and the rule governing adjustment of the nominal exchange rate. . . .
Finally, rules of intervention to protect the target exchange rate need to be agreed upon. Historically, the onus of defending the exchange rate has fallen on the country whose exchange rate is weakening. This requires the country to sell foreign exchange reserves to protect the exchange rate. Such a system is fundamentally flawed because countries have limited reserves, and the market knows it. This gives speculators an incentive to try and “break the bank” by shorting the weak currency, and they have a good shot at success given the scale of low cost leverage that financial markets can muster. Recognizing this, the onus of exchange rate intervention needs to be reversed so that the strong currency country (the central bank whose exchange rate is appreciating) is responsible for preventing appreciation, rather than the weak currency country being responsible for preventing depreciation. Since the strong currency bank has unlimited amounts of its own currency for sale, it can never be beaten by the market. Consequently, once this rule of intervention is credibly adopted, speculators will back off, making the target exchange rate viable. Such a procedure recognizes and addresses the fundamental asymmetry between defending weak and strong currencies.

The U.S. tax code as it now stands is outrageously tilted to favor unearned income. That has to be radically shifted. For example, capital gains tax has to go back to around 30% to 40% from the current level of 15%. Top marginal tax rates should go back to the 1940s to 1970s levels of 70% to 90%, which as Ian Walsh brilliantly wrote about two weeks ago would force much needed sanity back into CEO management of economic enterprises that absolutely require long-term planning and management horizons, rather than the current, very short-term "grab all you can" CEO mentality.

Simple justice needs to be restored. For example, if investors take over a hospital or a nursing home, and their cost cutting results in increased patient death rates, those investors should not be allowed to hide behind corporate shells and should be personally tried and executed for the capital crime of murder.

We should start funding massive infrastructure projects. A personal favorite of mine would be to build a high-speed rail line from Florida to Boston that, in the Northeast Corridor at least, was entirely underground. Similarly for Philly - Pitts - Columbus - Indianapolis - Chicago - St. Paul, and San Diego to Vancouver. We need massive water projects or we need to begin resettling a few million people from areas like Phoenix, Las Vegas, Los Angeles, and Atlanta. We must have a crash program to develop cars and trucks that run on something other than fossil fuels, with a goal of replacing all vehicles on the road within the next ten or fifteen years. That means huge tax breaks for the small firms that were recently profiled in WIRED magazine that are struggling to find financing for building vehicles like this - an Aptera, which gets 340 miles per gallon. That's right, ten time better fuel efficiency than what is available today.

Thanks for the offer of being Fed chairman, but I think someone like me would be assassinated within a matter of weeks. Welcome to my dark side - I doubt anything will be done because of the nexus of finance with intelligence with oil, that, for instance, Kevin Phillips revealed in his books on the Bush family. Simply put, they will outright kill anyone that seriously threatens to so radically change the rules on them. The problem of course, is that while they are going down because of the inevitable instability of the system they have created and maintain, they are going to take all the rest of us with them.

Tony Wikrent January 22, 2008 - 2:04pm

woah

Recognizing this, the onus of exchange rate intervention needs to be reversed so that the strong currency country (the central bank whose exchange rate is appreciating) is responsible for preventing appreciation, rather than the weak currency country being responsible for preventing depreciation.

That would be a radical change in the current system... getting winners to compensate losers? It works historically, but there's such a visceral desire to "punish" somebody who managed their assets poorly.

Simple justice needs to be restored. For example, if investors take over a hospital or a nursing home, and their cost cutting results in increased patient death rates, those investors should not be allowed to hide behind corporate shells and should be personally tried and executed for the capital crime of murder.

I think that they can be tried for murder already: "willful disregard for human life." Its just that its too difficult to prove "beyond a reasonable doubt" when corporate policies are designed to maximize reasonable doubt...

I'd argue what's needed is something like Sarbanes Oxley for the medical industry. Every cost-cutting decision needs to have an associated "risk" (such as death), and if the risk event occurs, then they have to alter the cost cutting decision... or face prosecution. They need to prove what they knew and when, otherwise they won't get any Medicaid funding ;-)

--
http://bexhuff.com
Of COURSE you can trust the US Government! Just ask the Indians.

bex January 22, 2008 - 5:43pm

Interesting that you should make that point

A few days ago, Stirling Newberry wrote in With Economists like these, who needs Alchemy?:
http://agonist.org/stirling_newberry/20080116/with_economists_like_these_who_needs_alchemy

"Winners should compensate losers because it prevents the greater expense of losers chosing a less than pareto solution in which their relative position is better…[versus the elites, who apparently believe that] they would be better off in a world where everyone is worse off.”

Tony Wikrent January 22, 2008 - 6:41pm

The crux of it

The point is: all financial instruments represent a claim for payment that must ultimately be satisfied from what the actual goods and services produced by the economy.

Basically, what happened is that the governments, the CB's, including the or especially the Fed, and the markets let paper wealth get too far removed from real wealth. It's called the "it can't happen here" syndrome.

Big Ben's move to "increase liquidity" will just exacerbate this syndrome by generating more paper; hence, it can only postpone but not prevent the impending death spiral that is unfolding.

To avoid disaster, the US needs a huge capital injection from the SWFs to the tune of a trillion or more, and then it needs to get refocused on real productivity instead of the financial industry as its economic foundation. Of course, getting this capital will mean selling prize ownership at fire sale prices.

Otherwise, expect huge deflation as paper wealth is wiped out wholesale, excess is painfully wrung out of the system, dislocations are addressed and resolved, and there is a restructuring along productive lines, with paper in line with production. By then, however, Americans may find themselves paying a lot more rent to foreign owners of US assets, as some of that paper for oil and trinkets gets exchanged for US ownership.

tjfxh January 22, 2008 - 12:29pm

china has 1.4 trillion...

as noted earlier... China has 1.4 trillion in federal reserve notes, and a directive to invest $200 billion in the US. Saudis could probably do an equivalent. Japan might be able to do the same. There's probably some bearish speculators in the US willing to pony up $150 billion...

So, that's about $750 billion... which might do the trick. Of course, this will certainly lead to another round of xenophobia about Sovereign Wealth Funds controlling the country...

Of course, getting rid of all this paper speculation in the financial industry -- which costs the economy 500-1000 billion per year -- would help as well. But, Wall Street would balk at that.

I wonder what Eliot Spitzer thinks?

--
http://bexhuff.com
Of COURSE you can trust the US Government! Just ask the Indians.

bex January 22, 2008 - 5:51pm

What is the nature of money

The problem is that we still operate under the assumption that money not only represents value, but is value. Since we are no longer trading in gold and silver, that's no longer the case. Modern monetary systems are a function of national governments and need to be understood as public utilities, not forms of private property. As an economic circulatory system, it is similar to roads. We own our houses, cars and businesses, but not the roads connecting them, which are public property. Money is very similar. If we viewed monetary wealth as a form of public property, it would change the entire psychology of society. For one thing, it wouldn't make any more sense to hoard paper wealth, then it would to be a road hog, since it opens one to public condemnation, rather then respect. Personal wealth and value would have to be accrued through physical means, such as improving one's environment and community. Profits from the monetary system would be viewed as community income, much like highway taxes are used to maintain public transportation, etc. It may well serve to slow down economic activity considerably, if people cannot accumulate massive amounts of wealth, but this would be a long term benefit for preserving resources. It's not like we are going to have much choice, when the paper bubble does burst, in reassembling a viable economic model. Think of it as reverse shock doctrine.

brodix January 22, 2008 - 2:37pm

credit markets and swaps

I've been involved in the credit markets for almost 20yrs now and have never seen anything like what we have today. The problem with CDS is not in the instruments themselves, but the massive use of them in the CDO (collateralized debt obligation)market. Until the late 90s CDO were constructed with cash bonds. Cash bonds transactions limited the market because you actually had to go out and buy the collateral, so the synthetic was born.These are constructed with only default swaps. Synthetic CDO could be rated like a cash bond(AAA!)and sold to market participants that did not understand what they were buying,but knew they could buy AAA rated securities. The flat/inverted yield curve pushed issuance up to fill these deals as managers reached for more yield.Remember in the credit markets you make money on taking risk, interest rate or credit. With the flat yield curve there was limited interest rate risk and these offered credit risk. It was a monster that had to be fed. It also pushed the issuance of mortgage related assets to new highs. The need for mortgages pushed all the pipeline lenders (Countrywide,etc.)to reach lower in the credit barrel for new borrowers.CDS were written(sold) against these and packaged as CDO. For some investors plain old CDOs did not offer enough risk, so the CDO^2(squared) was created by repackaging tranches of CDO. Then came the CDO^4(cubed) that repackaged tranches of CDO^2. Every transaction leverages the one previous. When the current problems started the pipelines were full. A lot of people, including the street and large banks were stuck with paper they never intended to hold. The monolines,(ACA,Ambac,Mbia,etc.) had also transformed their very profitable muni business into a toxic dump for the other side of this trade.

cbond January 22, 2008 - 8:13pm

Please write much, much more on this

we need to learn about these things, how to unwind them, and how to make them serve useful purposes again.

Tony Wikrent January 22, 2008 - 10:30pm

Here's a big winner -

John Paulson.

According to the Wall Street Journal, he personally made 3-4 Billion off of the collapse of the housing market. His hedge funds rose by roughly $15 billion in 2007.

http://online.wsj.com/public/article/SB120036645057290423.html

Either he's got a twisted sense of humor or he's feeling a little conflicted about his big score -

"Mr. Paulson has tried to keep a low profile, saying he's reluctant to celebrate while housing causes others pain. He has told friends he'll increase his charitable giving. In October, he gave $15 million to the Center for Responsible Lending to fund legal assistance to families facing foreclosure. The center lobbies for a law that would let bankruptcy judges restructure some mortgages."

In the same vein, there's a long story about the economy titled appropriately enough "The next bubble: Priming the markets for tomorrow's big crash" in the Feb issue of Harper's magazine.

Here's a link -

http://harpers.org/archive/2008/02/0081908

Bruce F January 23, 2008 - 2:43pm

Search

latest

User login

Navigation

Team Agonist

Thoughtful

Global

Timely

Who's online

Online users:

Syndicate

Somebody has to be getting rich...

Comment viewing options