Thanks for your support - to have another version than the bonddad one visible over there... In the long run, we're all dead. John Maynard Keynes
I know, not exactly fair and really does give the ol "sanctity of contracts" are firm kick in the butt, but this game was rigged from the get go.
The problems I have with honoring these contracts comes down to two major points for me:
1) When they were bundling these assets into pools, there were casing of out right fraud that passed on to the buyers. Mortgage specialists bundled CCC and BBB mortgages in with the AAA, just a sprinkle mind you, but put them in the mix and then sold them as AAA pools. This would also make these pools of asset fraud and not the savvy "toxic" name they currently enjoy.
I am still waiting for the indictments against these yahoos. I think I will be waiting a long time.
2) Now correct me if I am wrong, but if the mortgage value was fulfilled to the buyers by a bailout, then doesn't that make the CDS insurance/bet/looting null and void?
If the contract was fulfilled, even if artificially by a bail out, but fulfilled none the less, then isn't the insurance been covered?
It appears to be that AIG payouts are an elaborate scheme for certain hedgefunds to double dip at the taxpayer trough. When world history is written, Texas will appear as a long elaborate joke.
one that acknowledges that the issue is liabilities rather than assets, and that focuses on the fact that a lot of these liabilities are wholy unrelated to any economic or financial activity, and are contingent rather than actual - ie nobody loses anything if they are cancelled. If a 100:1 bet you made is cancelled, your actual loss is not 100, it is 1 - something that could be paid back to you.
I agree with you that by (say) making the CDS voidable - so that the premium may be refunded and the contingent liability may be extinguished if there is no insurable interest - is a cool idea.
This would limit the leverage, and hence further systemic damage, but it doesn't actually limit the existing - increasingly unsustainable - liabilities which at least some of the CDS legitimately insured.
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An out-of-town visitor was being shown the wonders of the New York financial district. When the party arrived at the Battery, one of the guides indicated some handsome ships riding at anchor. He said, "Look, those are the bankers' and brokers' yachts". The naive customer asked: "Where are the customers' yachts?"
"Look, those are the bankers' and brokers' yachts".
The naive customer asked:
"Where are the customers' yachts?"
The customers still don't have the yachts do they? The mechanisms you list only addresses the symptoms of the Anglo Disease which gave the bankers and brokers the yachts.
First, people have to become more creditworthy, and that can only be achieved through a fiscal mechanism. And redistributing taxes on income will not be enough, since it leaves wealth untaxed.
I advocate Systemic Fiscal Reform, by taxing Privilege not People. We may achieve this by shifting taxes away from earned income and onto the unearned gains and income and arising from privileges such as limited liability, and exclusive property rights over Commons.
Second, we must make the credit worthy of the people.
I advocate "Open" Credit - ie undated redeemable credits - issued directly Peer to Peer by producers of money's worth or value. "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
"Who built seven-doored Thebes? In the books are the names of kings. Did the kings haul the rocks? And Babylon, many times destroyed- who built it up these many times? In which houses of golden-gleaming Lima did the construction workers live?
In the evening, when the Chinese wall was finished, where did the masons go? The great Rome is full of triumphal arches. Who erected them? Who did the caesars triumph over?
Did the many-sung Byzantium have only palaces for its inhabitants? Even in legendary Atlantis, the night the sea vanquished it, did the drowning cry for their slaves.
The young Alexander conquered India. He alone? Caesar defeated the gauls. Didn't he have at least a cook with him? Philip of Spain cried after his fleet had sunk. Did no one else cry?
Frederick the Second was victorious in the Seven Year war. Who won besides him? Every page a victory. Who cooked the victory feast? Every ten years a great man. Who paid his expenses?
So many reports. So many questions." "Schiller sprach zu Goethe, Steck in dem Arsch die Flöte! Goethe sagte zu Schiller, Mein Arsch ist kein Triller!"
Given that these products were and are largely to totally unregulated, why should we not expect that there are examples of multiple CDSs on a given default exposure, in some cases by the same institution? Given the lack of appetite for prosecuting very wealthy individuals, why should there not be cases that have deliberately been set up to fail and then multiply insured? As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."
according to the Financial Ombudsman
The essential components of fraud are intent to deceive and desire to induce the firm to pay more than it otherwise would. Establishing these points can require an analysis of the claimant's motives.
Unless you wish to ad,it it's all just a big casino I think it fits. Any idiot can face a crisis - it's day to day living that wears you out.
CDS contracts have been compared with insurance, because the buyer pays a premium and, in return, receives a sum of money if one of the specified events occur. However, there are a number of differences between CDS and insurance, for example: the seller need not be a regulated entity; the seller is not required to maintain any reserves to pay off buyers in the United States CDS contracts are generally subject to mark to market accounting, introducing income statement and balance sheet volatility that would not be present in an insurance contract; Hedge Accounting may not be available under US GAAP unless the requirements of FAS 133 are met; if it were not possible to, it could increase income statement and balance sheet volatility if the CDS was purchased to hedge an exposure; The buyer of a CDS does not need to own the underlying security or other form of credit exposure; in fact the buyer does not even have to suffer a loss from the default event.[2][3][4] By contrast, to purchase insurance the insured is generally expected to have an insurable interest such as owning a debt.
CDS contracts have been compared with insurance, because the buyer pays a premium and, in return, receives a sum of money if one of the specified events occur. However, there are a number of differences between CDS and insurance, for example:
http://mast-economy.blogspot.com/2009/03/how-toxic-assets-turn-to-gold.html
It will just take time... (which the government has) GNE
It will just take time... (which the government has)
If the US economy were self contained, then yes, they have time. But it is not self contained in the way it was after the Great Depression - in particular it is not self contained in terms of its energy needs or its gigantic debts.
The current and future creditors of the US will IMHO certainly not be foisted off with the US plan. China in particular is getting extremely restless.
This
China urges new global reserve currency | The Australian
CHINA has called for the creation of a new international reserve currency to replace the US dollar over time, laying down an unusually direct demand for an overhaul of global finance ahead of next week's summit to craft a response to the financial crisis.
is only two hours old. "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
If Citibank sells a pool of mortgage assets to someone else and they write it down, who is able to present a CDS against that pool and demand payment?
Second: are not a lot of those CDS counter-cancelling? If SG asks Citi to pay, can't Citi find some counterobligation of SG and use it to settle?
So just where were these bets you are worried about placed? Who's holding the magic lottery tickets that will pay off 100:1? Who besides AIG has major CDS exposure? Extraordinary claims need a bit more than hand waving.
These numbers come from the above report, the Federal Reserve Board's Report on the Condition of the U.S. Banking Industry: Second Quarter, 2006 Neither assets nor loans increase anywhere near as much as derivatives. In fact, as we are seeing now, the huge growth of derivatives has triggered a financial collapse in which the supply of credit is rapidly diminishing.
Main sources are The Office of the Comptroller of the Currency: Quarterly Derivative Fact Sheet (last update: 2008Q3)
Each quarter, based on information from the Reports of Condition and Income (call reports) filed by all insured U.S. commercial banks and trust companies as well as other published financial data, the Office of the Comptroller of the Currency prepares a report. That report describes what the call report information discloses about banks' derivative activities.
Ask the question from another direction. If there's trillions being lost, who's making it? The top 25 hedge fund managers made $11 billion in comp which implies $50-100 billion in earnings (and only 3-4 really hit home runs). So if the money isn't showing up in hedge funds and the large I-banks and commercial banks are uniformly getting whacked and needing bailouts, just where is all that speculative profit flowing?
I still don't hear the dog barking.
Me neither. I'm reminded of the Brent 15 day market with loads of open contracts but net exposure relatively minimal.
Bringing in a Central Counterparty is one way of netting out such open bilateral (OTC) contracts, but at the price of concentrating all the residual market risk in one Single Point of Failure.
Alternatively, a neutral custodian could hold the contract data, and clearing agent software like Ripple could net contracts out wherever possible.
Ripplepay.com - About Ripple
And that's how Ripple works. You create a profile on the system and indicate who you know and how much you trust them by connecting to people by email address and giving them credit limits. Then whenever you want to make a payment to another Ripple user using only friendly obligations, the system finds a chain of intermediaries connecting you to the person you want to pay, and records the payment in each intermediary's account all the way down the chain. You end up owing one of your "neighbours" on the system, and the payment recipient ends up being owed by one of her neighbours.
AIG was the nexus here. They were fools taking all bets with no capacity to take a hit. But if their largest counterparties only had $10 billion ish of exposure (much of it already margined), how much more can be out there?
now on the CDO's there's still big problems if real estate continues to melt down. But from what I see, real estate is getting cleared at about 60 cts on the dollar for the most part (some real disaster auctions in the central valley of CA). So there's a floor under them much higher than the trading price of the paper. Some bright sparks will make a killing off of the big banks puking this paper.
As for how to prevent this, I've no great idea other than requiring huge margining such that no one player can get too big to fail. Your system has elements of the system that just failed us. AIG was AAA with open credit all around. Until suddenly they weren't and didn't.
I've heard some interesting tales of how the major oilcos simply shut down all credit with the wall streeters last fall. Nearly brought physical trade to a halt. Ugly.
Some bright sparks will make a killing off of the big banks puking this paper.
According to news reports - so take with appropriate amounts of salt - some bright sparks already are. Reportedly a company in California is picking-up the paper for 22 cents on the dollar.
Net current credit exposure increased 7% from the second quarter to $435 billion, a level 73% more than the $252 billion exposure of a year ago. The notional value of derivatives held by U.S. commercial banks decreased $6.3 trillion in the third quarter, or 3%, to $175.8 trillion. Derivative contracts remain concentrated in interest rate products, which comprise 78% of total derivative notional values. The notional value of credit derivative contracts increased by 4% during the quarter to $16.1 trillion. Credit default swaps comprise 99% of credit derivatives.
Throwing about the figure of $150 trillion overstates the CDS problem by a factor of 9.
(See my reply to a parallel top-level comment by HiD) Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
In any event, when it comes down to pay that large sum, the actual value will not match notional value. Contracts are not money,
... Legally enforceable netting agreements allowed banks to reduce the gross credit exposure of $2.8 trillion by 84.3% to $435 billion in net current credit exposure. ... The second step in evaluating credit risk involves an estimation of how much the value of a given derivative contract might change in the bank's favor over the remaining life of the contract; this is referred to as the "potential future exposure" (PFE). PFE increased 6% in the third quarter to $884 billion. The total credit exposure (PFE plus the net current credit exposure) increased from $1.2 trillion in the second quarter of 2008 to $1.3 trillion in the third quarter.
The second step in evaluating credit risk involves an estimation of how much the value of a given derivative contract might change in the bank's favor over the remaining life of the contract; this is referred to as the "potential future exposure" (PFE). PFE increased 6% in the third quarter to $884 billion. The total credit exposure (PFE plus the net current credit exposure) increased from $1.2 trillion in the second quarter of 2008 to $1.3 trillion in the third quarter.
This is the "credit exposure" for all the derivatives, not just "credit derivatives".
It's interesting that you can have $16 trillion (notional) of outstanding CDS for a credit exposure of less than $4 trillion. Does that mean the credit risk is "insured" at least 4-fold, maybe more than 10-fold?
rootless2:
Contracts are not money
Even if the banks are successful in cleaning up their books; what guarantees are there for them to lend again since the US has no regulations in place requiring the banks to lend?
Why hasn't the US government allow for the consumers who can afford the payments, to recalculate their mortgages with amortization schedules over 50-75 years but on a 10 year note which would be affordable for many people to stay in their homes and provide a floor for the housing market? Allow their credit card debt to be rolled into the same mortgages but with the caveat they have to pay by debit card going forward?
Aren't the banks likely to keep all of the 'decent toxic' assets and therefore what will be left to bid on will be just total crap that even with the incentives provided by the government; will drive away most bidders?
That's the point made by Simon Johnson and James Kwak (from The Baseline Scenario) in today's LAT:
Geithner's plan isn't money in the bank - Los Angeles Times
Second, there is a "lemons" problem, also known as adverse selection. Even with a reasonable degree of disclosure, the selling banks will still know more about their assets than the buyers. The banks will be trying to dump their most toxic assets (their lemons); the buyers, fearing exactly this behavior, will reduce all their bids accordingly. This will make it harder for buyers and sellers to meet.
