More Anatomy: Credit Default Swaps and The Nation of Whiners
Sloshing aside still more credit meltdown guts, we come upon a small, glistening 262-page organ known as the Commodity Futures Modernization Act of 2000. Let's sponge it off and see if we can see what's oozing out of those ducts.
Introduced in the House by Thomas Ewing, the CFMA was largely written by and championed by Senator Phil "Mental Recession" Gramm, and it was his impetus which had the Senate companion version slipped into that year's omnibus reappropriations bill (H.R. 4577). Per usual GOP majority practice, it was never debated in either the House or the Senate.
So, what exactly does it do?
Well, for one it exempts certain over-the-counter derivatives (on OTC markets including electronic exchanges) from regulation by the Commodity Futures Trading Commission, the SEC, or, indeed, any federal regs at all aside from basic contract & fraud enforcement. Private electronic exchanges for new commodities derivatives (called “swaps”) sprang up overnight, mostly for energy futures.
Hardly surprising, since this section of the law was drafted by Enron lobbyists working cheek-by-jowl with Phil Gramm, and so was born the so-called "Enron loophole" (pdf). Through the miracle of laissez-faire policymaking, Enron was able to – more or less legally – manipulate wholesale energy supplies and reap the benefits on a derivatives market operating without any of the transaction rules for preventing price collusion and similar monkey business on a regular exchange.
It should surprise nobody that Phil’s Law, like the gift that keeps on giving, specifically exempts Credit Default Swaps from regulation. Creating two financial disasters with one law has to be some kind of record, but that is exactly, by letting OTC swaps go completely unregulated for the past 8 years, what the CFMA has done.
And Enron is small potatoes compared to the CDS market. With a nominal value around $62 trillion dollars, four times the size of the total US stock market, CDS is a monster, all of it unregulated, most of it uncollateralized (because unregulated), and it has been at the core of the credit market meltdown.
I’m not qualified to explain Credit Default Swaps, how they work, and how they are used by various institutional investors, except to say that they are generally used as a hedge, even a type of insurance, for CDO investors seeking to protect themselves against default of the mortgages underlying their securities. Thing is, up until the real estate market began its slow leak earlier this year, speculators had been running hogwild on the assumption real estate values would continue rising forever and ever hallelujah. Nobody wanted to get off the gravy train. And because of CFMA, none of them were required to collateralize their paper. $62 trillion is a lot of worthless paper, if it comes to that.
Imagine if you bought homeowner’s insurance on the off chance your house would burn down in a fire. Then your house burns down in a fire. Now imagine your insurance company is the next-door neighbor’s kid. An enterprising little sucker, he’s got about three thousand bucks stashed away in a savings account. In other words, he couldn’t afford to repaint your house, to say nothing of covering the market value. At the same time, you went out and got a second mortgage, partly on the strength of this fancy policy you bought yourself. Your mortgage lender just smiled and nodded, all of you blithely assuming the house was never, never going to catch fire. That’s the CDS market in a nutshell. And it’s legal thanks to Phil Gramm.
It’s important to remember what was happening in Congress on Dec. 15, 2000. Just three days earlier, the Supreme Court had handed down a decision on a little case called Bush v. Gore, and at the same time Republicans in Congress were threatening to bring the federal government to a standstill – by refusing to pass the same omnibus appropriations act CFMA is tacked on to. And of course it was GOP SOP to forestall any debate. To say that there may have been less than the usual scrutiny of the bill as written is a bit of an understatement.
So on a Friday evening in one of Washington’s craziest weeks in decades, Phil Gramm slipped the CFMA by reference into H.R. 4577, saying that it would “protect financial institutions from overregulation” and “position our financial services industries to be world leaders into the new century.”
At bottom, this is a story of deregulation gone terribly wrong, and laissez-faire philosophy misguided in the worst possible way. Or maybe it's a story of simple greed. Gramm and his wife made billions from Enron, and made millions in exchange. Gramm pushed for UBS to be allowed to take over US financial institutions, and now he sits on the board of UBS. Maybe it's a bit of both.
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Before you criticize someone, you should walk a mile in their shoes. That way when you criticize them, you're a mile away and you have their shoes. -JH
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Before you criticize someone, you should walk a mile in their shoes. That way when you criticize them, you're a mile away and you have their shoes. -JH
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"Those who can make you believe absurdities can make you commit atrocities."
–Voltaire
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References
Hillary Clinton would beg to differ.
--The proper balance between defense and welfare are the tectonic plates that lie beneath our political discourse.
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)"Running For President As Profile In Courage: The Barack Obama Story."
Unless you're buying stock in the "the Clintons whacked Vince Foster" meme family, of course.
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| parent )And the idea that McCain is a genuine GOP "Maverick" is utterly laughable.
--The proper balance between defense and welfare are the tectonic plates that lie beneath our political discourse.
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| parent ). . .the existing Republican leadership in 1964; of course, he waa also putting his money where his mouth was in the Senate, rather than voting "present."
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| parent )The above seems simple enough to me.
Using a life insurance analogy, I cannot purchase a policy of life insurance if I lack an "insurable interest" in the life being insured. For example, I could have legitimate reasons to pay for insurance on the life of a family member or business partners.
However, allowing me to buy a policy of life insurance on Timmy the Wonder Dog would be bad public policy and should be illegal.
By extension, credit default swaps do serve a legitimate purpose to hedge corporate bonds, bundled mortgages, government bonds or other debt IF the folks buying and selling have legitimate interests in the underlying instrument and IF the total CDS exposure is proportional to the actual "real life" obligation.
Otherwise, what we are bailing out is gambling analogous to Citibank (for example) taking a $100 billion position on InTrade, and losing the bet.
Where am I wrong, here?
--The proper balance between defense and welfare are the tectonic plates that lie beneath our political discourse.
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)I believe you are talking about investor owned insurance. I'm against it.
But let me expand the discussion. Should we require the European Option for all contracts; that is, once you have entered into a contract you have to take delivery. Net, net at the end of the day, you would end up with a less liquid market. The overall idea is to expand the mkt, er make it more liquid.
--"Perhaps we also ought to run off people who abuse our toleration of differing viewpoints."
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| parent )downside, or looking backwards for a second, how much did these highly liquid instruments contribute to the bubble and popping thereof?
--"Those who can make you believe absurdities can make you commit atrocities."
–Voltaire
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| parent )First a scenario from the wikipedia entry:
Let us suppose the CRA caused banks to make $1 billion in bad mortgage loans. (Highly disputable but lets us assume.)
Absent speculation in credit default swaps a bailout of $1 billion would entirely solve the problem AND there would be the real estate given as collateral worth some fraction of that one billion. Say $400 million as in the above example. Taxpayers chip in $600 million. Ouch! But hardly a bank buster.
But because of the derivatives contracts, the institutions that underwrote the CDS contracts now require $6 billion to be bailed out. Ten times the actual face value of the bad CRA induced loans.
Of note: FHA mortgage insurance serves a similar function.
Does anyone know the real numbers concerning actual bad mortgage debt and the actual exposure from CDS contracts coming due?
Or is that proprietary information such as drug patent profit margins? It seems to me that public disclosure of all such proprietary information should be a condition of receiving bail out money. At a minimum.
More wikipedia:
Going forward, a simple regulation would be to require that a purchaser of a credit default swap also own the underlying bond AND that no one can buy more in CDS contracts than the face value of the bonds or mortgage debt being insured.
Also, issuers of credit default swap contracts should be required to document sufficient collateral or other assets to pay out if a contract comes due.
Anyone have a problem with that?
--The proper balance between defense and welfare are the tectonic plates that lie beneath our political discourse.
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)just curious.
--"Perhaps we also ought to run off people who abuse our toleration of differing viewpoints."
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| parent )the restrictions on "naked shorts" (short selling without actually having the stock in possession) and proposed limitations on commodity trading, where you'll have to be in a position to actually take possession of the commodity in order to trade in it. The only downside I see is that if you restrict the market too much, you lose liquidity and if the transaction volume falls too far then the market isn't as good at signaling pricing as it would otherwise be.
--I blame it all on the Internet
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| parent )I believe you meant "naked calls" and both require collateral.
But your comment on liquidity is spot-on; you are beginning to get a handle on the overall situation, well done.
--"Perhaps we also ought to run off people who abuse our toleration of differing viewpoints."
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| parent )IMHO
However, allowing someone essentially insolvent to begin with the freedom to naked short-sell stocks is profoundly foolish, again IMHO.
Naked derivative contracts feature similar risks but when untethered from any relation back to the underlying security offer exposure at many multiples of the actual real world economic reality.
Only solvent players should be able to play at derivatives AND the government needs to monitor all this to make sure no one is placing bets they cannot reasonably cover if they lose.
As I said elsewhere, the current bubble is analogous to check kiting.
I write HankP a check for $100,000 payable in two weeks (except I have NO money in my account). HankP uses that check as collateral (10% down) for a $1 million line of credit at his broker based on my collateral and his credit-worthiness.
An inherently dubious idea.
--The proper balance between defense and welfare are the tectonic plates that lie beneath our political discourse.
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| parent )I blame it all on the Internet
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| parent )well, my friend, my check is in the mail!
;-)
--The proper balance between defense and welfare are the tectonic plates that lie beneath our political discourse.
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| parent )or projected any explosion of them if they weren't watched? I never heard of them until I read a WSJ article attempting to explain the meltdown. I kind of blew it off when I read that market had a "notional (doesn't than mean sewing-type things?) value of $55 trillion, but now that you say it's $62 trillion I am starting to worry.
I've heard it described as a sort of musical chairs game, where the chump left holding the insurance obligation when there actually is a default gets blown up by a hot potato filled with gelignite, along with everyone else in the room. But that hasn't happened yet, right?
--Sincerity is the first casualty of capitalism. John Burdett
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)a lot of these trade very infrequently, so there's no market price for them. The problem is that banks and other financial institutions are known to have them on their books, but no one knows how much and since no one knows what their value is no one knows which financial institutions are solvent or not. So financial institutions don't want to lend to each other, since the FDIC could (and has) seized the bank you lent to overnight. That's the problem right now, there's liquidity in the system but no one knows who's solvent and who isn't.
--I blame it all on the Internet
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| parent )they don't trade at all. you can, however, enter into an offsetting contract. think of a "credit swap" in the same terms as you would a "direct pay letter of credit", the key driver is the counterparty risk, the credit risk is similar but the cash flows are not.
--"Perhaps we also ought to run off people who abuse our toleration of differing viewpoints."
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| parent )I'm not so sure about that.
There are indexes of "baskets" of swaps that are very liquid, as well as a secondary market for CDSs themselves. Selling a CDS just requires both the protection buyer and seller to agree on the sale to a third party.
--"The strongest drive is not love or hate. It is one person's need to edit another's copy."
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| parent )but I am.
--"Perhaps we also ought to run off people who abuse our toleration of differing viewpoints."
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| parent )n/t
--"The strongest drive is not love or hate. It is one person's need to edit another's copy."
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| parent )and if you make an assignment, you have only hedged your risk.
--"Perhaps we also ought to run off people who abuse our toleration of differing viewpoints."
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| parent )Novation is the replacing of either of the counterparties.
--"The strongest drive is not love or hate. It is one person's need to edit another's copy."
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| parent )subject to the aproval of the other, hence, the position is not traded.
--"Perhaps we also ought to run off people who abuse our toleration of differing viewpoints."
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| parent )A novation often involves an exchange of money, i.e., a sale price. That, in my book, is a trade.
Don't forget, also, that you can buy and sell CDSs through an index.
--"The strongest drive is not love or hate. It is one person's need to edit another's copy."
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| parent )is closing out the position.
Buying an index is different and I'm sure that you know that.
--"Perhaps we also ought to run off people who abuse our toleration of differing viewpoints."
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| parent )not just closing the position. There's a fee above and beyond that--a "sale price".
And how about you explain why an index is different? Show your work! :)
--"The strongest drive is not love or hate. It is one person's need to edit another's copy."
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| parent )so as I said earlier, the nominal value of these isn't the net value, although I'm guessing the offsetting contracts don't cancel out completely? Do you have any figures on the net value of this market?
When you talk of cash flow being different, do you mean that unlike insurance it's a one-off transaction with no renewal?
Also, do you think the underlying problem is of financial firms questioning solvency rather than liquidity?
--I blame it all on the Internet
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| parent )it is referred to as the "notional value' but you are correct.
"guessing the offsetting contracts don't cancel out completely"
you are correct you have not transferred your contractual risk, rather you have just hedged your position. that is, you carry a different counterparty risk in the offsetting contract, you still have exposure.
in "direct pay letter of credit" you have biannual cash flows. in the swap, the only cash flow is when the swap is exercised.
the big problem, has been liquidity and antiquated accounting rules. that is, when you down grade a firm to a certain threshhold that firm has to cash collateralize its various positions.
--"Perhaps we also ought to run off people who abuse our toleration of differing viewpoints."
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| parent ). . . the bubble pops.
If popping is inevitable, aren't smaller pops, sooner to be preferred?
--The proper balance between defense and welfare are the tectonic plates that lie beneath our political discourse.
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| parent )if the bubble had popped you would certainly know about it.
--"Perhaps we also ought to run off people who abuse our toleration of differing viewpoints."
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| parent )Fancy phrase for back up its obligations to avoid the appearance of insolvency.
--"Something I think most liberals don't understand is exactly how stupid many conservative leaders are." - Matt Yglesias
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| parent )to insure the credit worthiness of your counterparty.
--"Perhaps we also ought to run off people who abuse our toleration of differing viewpoints."
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| parent )high risk sub prime's insured and if so why the persisting problem with the credit markets?
If the contracts required real insurance then we wouldn't be in this mess, the fact that swaps performed an insurance function but not really, is the exact reason why we are in it.
--"Something I think most liberals don't understand is exactly how stupid many conservative leaders are." - Matt Yglesias
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| parent )After we factor in coverage by the PMI carriers, how much actual loss has there been?
Link
http://en.wikipedia.org/wiki/Private_Mortgage_Insurance
--The proper balance between defense and welfare are the tectonic plates that lie beneath our political discourse.
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| parent )we didn't have sufficient to make the deposit requirement, but since the proposed mortgage was well within our qualification amount we simply took out a second mortgage for the balance to avoid the PMI on the 1st mortgage. Then paid paid off the 2nd mortgage over about an 18 mth period.
I suspect there's no PMI involved in the majority of the HELOC transactions that are now underwater, but all the sub prime 100% 1st time stuff should be covered. Yet another nail in the coffin of Timmy's 'theorem'.
--"Something I think most liberals don't understand is exactly how stupid many conservative leaders are." - Matt Yglesias
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| parent )I think we're a little beyond that now.
--I blame it all on the Internet
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| parent )that are intertwined.
There's the underlying problem created by the housing bubble of an unknown quantity of bad debt collateralized in CDO's of indeterminate value and then there's the problem of the much larger speculative market in 'Swaps' built on top of it.
--"Something I think most liberals don't understand is exactly how stupid many conservative leaders are." - Matt Yglesias
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| parent )appears to me to be a tiny fraction of the enormous financial bubble constructed from those mortgage backed securities.
The guilty parties of course do not want the real numbers in the public record.
--The proper balance between defense and welfare are the tectonic plates that lie beneath our political discourse.
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| parent )I can predict your answer, but please provide backup if you have any. An explanation of the roles of Chris Dodd, Barney Frank, Jamie Gorelick, Chuck Shumer and their ilk would be appropriate, also.
--Sincerity is the first casualty of capitalism. John Burdett
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| parent )but primarily the financial houses with $62 trillion worth of credit default swaps (not merely housing but corporate bonds as well).
--The proper balance between defense and welfare are the tectonic plates that lie beneath our political discourse.
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| parent )As a lawyer, doesn't it seem to you that there is something essentially fraudulent in the way those folks' essentially kept creating new kind of widgets made of air and then constantly traded them back and forth, making a profit each time even though no value has been added? Enormous fortunes were made doing that, totally enough to perhaps make a dent in some of the liabilities to taxpayers that that kind of conduct resulted in. I'm thinking actions for restitution of those profits here. Followed perhaps by public lynchings, but that would be optional.
--Sincerity is the first casualty of capitalism. John Burdett
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| parent )Ponzi
--The proper balance between defense and welfare are the tectonic plates that lie beneath our political discourse.
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| parent )to pay off old purchasers, and misrepresented as being profit from prior investments. Which I thought was the essence of a Ponzi scheme.
Ponzi btw was a very interesting guy who came up with a smart and apparently legal way to make money trading on postal money orders and teh disparities in their values depending on the countries they were purchased from and sold in. Not enough for him, apparently.
--Sincerity is the first casualty of capitalism. John Burdett
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| parent )...the folks who created, bundled, and now hold the securities.
This is not to accept your fundamental premise that the financial crisis came about exclusively due to the actions of selected Democratic lawmakers combined with the actions of fraudulent loan applicants.
--It's impossible to debate if people simply hold beliefs that have no grounding in reality.
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| parent )however the GOP has controlled Congress for a long time prior to 2006 and George W. Bush has been in the White House for 8 years.
Mark Penn? He is a Democrat I'd run out of Washington.
--The proper balance between defense and welfare are the tectonic plates that lie beneath our political discourse.
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| parent )The diary blames the excessive leveraging largely on Gramm, which I am prepared to believe for the time being. The point is that that was back in 2000, and there have been legislators on both sides of the aisle supposedly monitoring the economy and passing, amending or repealing laws as necessary to keep financial matters on the right track. Yet as far as I know no one has even raised the alarm about 100:1 leveraging before, let alone publicly demanded the repeal of Gramm's legislation.
That raises two possibilities: the people in Congress are too dumb to know what's going on (certainly possible), or they've been bought off by the millions Wall Street pours into the war chests of both parties.
Whenever these subjects come up there is an army of liberals here trying to blame in on Bush and/or the GOP. I mentioned the names of some Democrats who themselves have apparent laibility for the problem. I've raised these names and issues before (along with the $126K the two FMs gave to Obama) without any defense or response here. Perhaps I should accept that as meaning there is no defense of these people that can credibly be made.
The concept of a Senator who received a $75K bribe from a bank presiding over the bailout of that bank is incredible to me, regardless of the party involved. Yer no one here seems bothered by it.
--Sincerity is the first casualty of capitalism. John Burdett
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| parent )...is that the bar of corruption and/or incompetence has simply been raised through the roof. In the light of the US outright losing $9 billion in Iraq, or the establishment of a gulag archipelago of torture chambers across the world, or the failure to capture Osama bin Laden seven years after the 9/11 attacks, no one has any outrage left for financial shenanigans.
At this point, if something is horribly wrong, it is simply assumed that the Republicans are to blame. And anyone who has spent the past eight years supporting the Republicans is assumed to have such an enormous tolerance for corrupt incompetence that any anger toward Dems is viewed as manufactured at best.
I will be honest -- I didn't even bother to check out the stuff you posted on this subject. I figured either that it was massively overblown or that pretty much every Republican who would possibly replace Dodd had something far worse in his closet. Outrage fatigue.
--It's impossible to debate if people simply hold beliefs that have no grounding in reality.
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| parent )The whole point of Collateralized Debt Obligations, the thing that supposedly made them safe investments, was the underlying collateral available in the event of default. In the case of CMOs, a given residential mortgage can only be packaged into a single CMO, so there is always a 1:1 ratio between the amount of mortgage debt outstanding and the value of CMOs comprised of portions of that mortgage debt. That is unaffected by leveraging, and is true regardless of how the interest payouts are tiered. so unless you are talking about leveraged purchasing of CMOs, I don't understand how you can say that the "housing bubble" and the "financial bubble" based on the purchase and sale of mortgage instruments are enormously different in dollar value.
As Hank has pointed out, the 100:1 leveraging hugely magnified the effect of housing market perturbations, but that seems like a different point; it is still the housing market that underlies the infirmity of the investment.
--Sincerity is the first casualty of capitalism. John Burdett
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| parent )you will have a crash, period.
--It's impossible to debate if people simply hold beliefs that have no grounding in reality.
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| parent )how do you get there?
--"Perhaps we also ought to run off people who abuse our toleration of differing viewpoints."
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| parent )With 100:1 leverage done by people who lack the collateral to cover losses it doesn't matter what the underlying security was originally -- ALL markets fluctuate and being over-leveraged will pop the bubble.
Its like blaming the Euro if you lose money gambling in Monte Carlo. If only we'd been betting USA dollars (not Euros) at that craps table, I woulda won!
Just say No! to 100:1 leveraging (unless the players satisfy regulators they have the reserves to pay up when they lose)
--The proper balance between defense and welfare are the tectonic plates that lie beneath our political discourse.
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| parent )As does naked short selling. Still I always wished that I could borrow a couple of million and buy say Google when they went public and then sell off enough to pay back the loan with interest. They opened at what 60 and are 350 today.... If only I were rich... :0 I new a couple of young guys that wanted that IPO and were basically shut out because institutional investors got the first chance at the stock.
--Ask courageous questions. Do not be satisfied with superficial answers. Be open to wonder and at the same time subject all claims to knowledge, without exception, to intense skeptical scrutiny. Be aware of human fallibility. Cherish your species and your
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| parent )-
--Sincerity is the first casualty of capitalism. John Burdett
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| parent )posted in the wrong place
--The proper balance between defense and welfare are the tectonic plates that lie beneath our political discourse.
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| parent )and how much money do bookies handle? That's the difference with the swaps we're talking about, you don't need to own the underlying bonds to buy a swap against it (that's how it got to be a ~$60 trillion market). In fact, unless I'm mistaken you can buy multiple swaps that guarantee different things about the same underlying bond.
BTW, I've done a simplified form of this type of investing. For example, I'll buy a fund that pays 3X the gain on the Dow but limits you to the actual loss on the downside (within certain limits like -20% to +20%). Or another that pays 7% as long as the dollar doesn't appreciate or depreciate more than 10%. I'm out of all these now, as about 2 months ago my broker told me that he was worried about whether the funds would be able to actually pay what they were promising. I'm about 90% cash now.
--I blame it all on the Internet
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| parent )the issue was the supposed disparity between the mortgages and an implied much larger market in securities derived from those mortgages. Which does not exist. The CDS market has nothing per se to do with mortgages.
--Sincerity is the first casualty of capitalism. John Burdett
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| parent )and the financial products bubble built using those mortgages simply is the point and the problem.
All markets fluctuate and when folks are betting numbers that exceed a trillion dollars while highly leveraged someone will prove unable or unwilling to pay when they lose.
And the bubble pops. Your point is essentially beside the point. Not relevant even if true.
It would seem our major financial institutions both wrote and accepted a number of very large checks that couldn't be cashed.
--The proper balance between defense and welfare are the tectonic plates that lie beneath our political discourse.
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| parent )It's in the nature of CMOs that the value of those in circulation equals the value of the aggregated mortgages, and that each mortgage can only be aggregated and/or sold once. What "financial products [that were] built using those mortgages" are you talking about, specifically?
A leveraged purchase of a CMO is just a credit purchase of a mortgage-backed financial product, not a financial product in and of itself. Purchase of, say, a BBB- tranche in a CMO is, but again, the CMO from which that income stream is derived is a financial product linked to and limited by the underlying mortgages, so there's no way it can magically grow beyond those mortgages' values. So your point doesn't make sense as phrased.
--Sincerity is the first casualty of capitalism. John Burdett
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| parent )Wikipedia:
These contracts exceed the face value of debt instruments they are derived from.
--The proper balance between defense and welfare are the tectonic plates that lie beneath our political discourse.
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| parent )which was my original point. I understand the CDS issues with regard to market size; in fact, I raised it here several days ago but didn't attract any attention. But there is no direct link between CDSs and mortgages, as I said above.
--Sincerity is the first casualty of capitalism. John Burdett
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| parent )LINK.
--I blame it all on the Internet
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| parent )There is no direct linkage between the CDS market and mortgages AFAICT, and your article doesn't indicate anything to the contrary. the chart there is useful, though it treats CMOs as different from CDOs, while I think the former is just a subset of the latter. Anyway, the MBSs are at the bottom of the chart, while the CDSs are linked to another $2 trillion (I think) in CDOs, which the article characterizes as securitized short-term debt.
So it looks like the linkage is between a variety of derivative debt instruments and the potential risks of corporate bond defaults and insurance against same, of which only a part is derivatives based on mortgage securities. Which was my original point, and part of my effort to try to understand these things in as much detail as I can.
--Sincerity is the first casualty of capitalism. John Burdett
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| parent )in particular the substantial growth in mortgage backed CDO's, by providing 'insurance' to offload the risk.
--"Something I think most liberals don't understand is exactly how stupid many conservative leaders are." - Matt Yglesias
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| parent )http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=120&Freq=Qtr&FirstYear=2006&LastYear=2008
Check out that last line. We've been averaging 2-4% net savings for years now.
This was going to happen. There simply is no way the country can remain solvent, long-term, if we aren't putting at least 10% of our money aside. That isn't a liquidity problem, and it isn't particularly a bubble problem. It's a fundamental collapse of our capacity to make rational decisions about the future.
--It's impossible to debate if people simply hold beliefs that have no grounding in reality.
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| parent )by building house of cards pyramids of cash from derivatives and Bank of America is offering Joe Sixpack a 12 month credit card cash advance at 2.99% why is it rational to save?
Yes, it is a rhetorical question.
--The proper balance between defense and welfare are the tectonic plates that lie beneath our political discourse.
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| parent )even with the lending facilities the Fed has expanded over the last month or two? It's been hundreds of billions of dollars, since I assume these contracts have an expiration date why haven't we seen a beginning of an unwinding of these types of instruments? I assume no one is writing new ones right now.
Also, what's the source of the downgrades, rating agencies downgrading bonds or capital requirements of the financial institutions holding them?
I hope you don't mind me asking these questions, but it's hard to find answers to them if you don't know the lingo (just like with tax issues).
Also, I think everyone here would appreciate a diary on how this problem exploded with little advance warning, and why these types of financial instruments and the firms that use them should/shouldn't be regulated.
--I blame it all on the Internet
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| parent )indeed
--"Perhaps we also ought to run off people who abuse our toleration of differing viewpoints."
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)I asked last week for help on CDSs but no one responded.
--Sincerity is the first casualty of capitalism. John Burdett
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| parent )with respect to the transactional risk. that is, you own xyz bonds, the credit swap provider guarantees the performance of xyz bonds pursuant to the terms of the contract. in the contract the swap provider will be subject to a certain credit rating threshhold. if the credit rating declines below that threshold, the swap provider will have to cash (or treasuries0 collateralize his obligation.
counterparty risk is key and if you ratings are not acceptable you have to collateralize your position upfront.
contracts are netted. that is, i might be long $1 billion and short $1 billion with the net payout being zero.
--"Perhaps we also ought to run off people who abuse our toleration of differing viewpoints."
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| parent )these swaps guarantee the bond payments (coupons) as opposed to the bond principal?
--I blame it all on the Internet
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| parent )but more than likely they guarantee unfavorable mkt movement or default risk. but there is flexibility, I've written swaps for as short as five days and as long as ten years, liquidity options from thirty days to five years and swaptions up to a year and a half.
--"Perhaps we also ought to run off people who abuse our toleration of differing viewpoints."
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| parent )and they're much more common than people think they are.
--It's impossible to debate if people simply hold beliefs that have no grounding in reality.
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| parent )do you mean things like Fed fund rate changes?
--I blame it all on the Internet
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| parent )Only as it's called a 'swap' it isn't, because if it were it would be subject to regulation which it isn't. See Gramm, Phil and the Commodity Futures Modernization Act.
--"Something I think most liberals don't understand is exactly how stupid many conservative leaders are." - Matt Yglesias
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| parent )cover FX, Interest (fixed vs variable) and credit. you also have swaptions.
--"Perhaps we also ought to run off people who abuse our toleration of differing viewpoints."
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| parent )It would seem that you mangled the who made what, billions and millions, for or from Gramm & wife and Enron.
--"Something I think most liberals don't understand is exactly how stupid many conservative leaders are." - Matt Yglesias
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)good diary as usual. One thing I should point out: a nominal figure of $60 trillion doesn't mean a net value of $60 trillion, as many of those items cancel each other out (one may be a bet that a particular asset will rise in value, another that the same asset will fall in value). The danger is that because it's unregulated and there are no asset requirements to participate, you run the risk of transactions not clearing - i.e., one of the parties can't pay up. That's when it stops being a market and starts being an abattoir, and is why AIG was taken over, they write insurance on a lot of these types of transactions.
--I blame it all on the Internet
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)but I'm afraid there could be dozens of such corrections, given my cro-magnon grasp of the issues. Between you, franklin, hobbesist, PM, et al., the comments'll likely be more useful than the diary.
--"Those who can make you believe absurdities can make you commit atrocities."
–Voltaire
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| parent )I hope "average Joe" starts to understand that it's not stupid homeowners that caused this whole financial calamity...I just had a long discussion with my 70yo dad about this...he thought it was Fannie and Freddie giving out bad loans that caused the whole meltdown. Not so. When you have $62 trillion of overleveraged investments that end up being worthless, that's a bigger problem. And regulating those investments would have helped a ton, if not prevented, this meltdown.
Of course, hindsight is 20/20, but the events of the last eight or so months are likely repudiation of laissez-faire financial sector governance.
--"The strongest drive is not love or hate. It is one person's need to edit another's copy."
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)is helpful. Thanks.
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)... from n+1 Magazine, in two parts. Read, as they say, the whole thing. Or things.
--Bene vixit, bene qui latuit
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)