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Is the Crystal Ball Clearing?

by rifek Sun Mar 11th, 2012 at 11:39:53 PM EST

No, not as far as being able to predict what's going to happen, just in figuring out what's happening.  Over at Credit Slips and London Banker, we're discussing different aspects of the Greek default, and we may have stumbled upon a couple of insights.


On Credit Slips, we're discussing CDSes and whether CDS buyers in general should expect to be compensated according to the terms of the swap.  My position is a harsh "No", for the simple reason that, as I've been saying for years, we call a CDS an insurance policy but treat it as a security.  Calling a truck a boat doesn't mean you should expect it to float.  Moving on from there, I noted that if an investor really wanted to insure an investment position, he needed to find someone who would sell him a policy.  If, as many claim, such a policy can not be had and a CDS is all that's available, that should give everyone significant pause.  They'll sell you an investment position, and they'll sell you a thing they call an insurance policy but that is really just another investment position, and they won't sell you actual insurance, although they'll insure themselves via stacked tranches and inside hedging.  How much more evidence do we need that the markets are a casino with every table rigged?

At London Banker's blog, we're discussing regulatory reform.  I'm backing another commenter who says the rule for permitting a particular investment should be simple: If the regulator doesn't understand it, it doesn't fly.  I'm running with that one for the simple reason that, if the regulator can't understand it, how can an investor, and what good is "transparency" if comprehension is impossible?  LB is concerned about regulators logrolling investments they don't understand to keep from looking stupid on the golf course, but we already have that problem.  The "understanding" standard is the only way to make transparency work, so given that transparency is what our entire regulatory regime is about, we'd better head that way.  Unless we want transparency to be a sham, and our whole regulatory system is just a come-on to get the suckers into the rigged casino.  Oh my, did I say that in my "out loud" voice?

Display:
Excellent.
The superficial moral-hazard argument (CDS should be paid out because otherwise who would buy risky debt?) assumes an insurance function. But the correlation between ownership of greek debt and cds is probably not strong, and unknowable by design. So... Fuck'em on that criterion.

The ontological criterion (CDS should be paid because there has been a credit event) is apparently unclear; and since there is a liquid market, it can be presumed that current owners are aware that it was always going to be a crapshoot. So... Fuck'em on that criterion.


It is rightly acknowledged that people of faith have no monopoly of virtue - Queen Elizabeth II

by eurogreen on Mon Mar 12th, 2012 at 02:59:00 AM EST
I'm backing another commenter who says the rule for permitting a particular investment should be simple: If the regulator doesn't understand it, it doesn't fly.

Also, if an untrained intern has difficulty understanding the asset, it shouldn't qualify as collateral at the discount window.

- Migeru

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Mar 12th, 2012 at 03:30:27 AM EST
I like Mig's better.  Safer and funny.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Mon Mar 12th, 2012 at 07:43:38 AM EST
[ Parent ]
It ought to be accompanied by a cartoon.

Untrained intern = bank teller, discount window = teller's station, a banker is presenting an unidentifiable object as collateral.

It is rightly acknowledged that people of faith have no monopoly of virtue - Queen Elizabeth II

by eurogreen on Mon Mar 12th, 2012 at 09:12:12 AM EST
[ Parent ]
I have a cartoon from the mid-90s - it show a guy in striped suit, poorly shaven (i.e. fairly obviously a shady character) being interviewed for an unspecified job and the guy's saying "I was an intern at the Crédit Lyonnais"

Wind power
by Jerome a Paris (etg@eurotrib.com) on Mon Mar 12th, 2012 at 05:47:48 PM EST
[ Parent ]
But then how are you supposed to get a drive-through loan?
by rifek on Mon Mar 12th, 2012 at 06:27:43 PM EST
[ Parent ]
European Tribune - Is the Crystal Ball Clearing?
My position is a harsh "No", for the simple reason that, as I've been saying for years, we call a CDS an insurance policy but treat it as a security.

Could you expand on this? If not an insurance policy, then what is a CDS and how does it work?

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Mon Mar 12th, 2012 at 03:30:55 AM EST
It's not an insurance policy because you don't have to own the asset you're "insuring" (you can do the equivalent of taking out fire insurance on your neighbour's house for three times its value), and the "insurer" who sells it does not set aside regulatory capital for it.

It works like a bucket shop, in that you are placing side bets on exchange transactions. Bucket shops used to be illegal, for very good reason. Then the Commodity Futures Modernization(sic) Act happened.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Mar 12th, 2012 at 03:37:16 AM EST
[ Parent ]
The modern paradigm of mathematical finance is that the One True Way to manage risk is to create risk indices, create liquid markets for assets based on those indices, and then use those assets for hedging risk exposures.

CDS fit the bill as long as they never trigger but the fiction that they might trigger is maintained by all concerned. Then, the "CDS spread" is a risk measure with an associated more-or-less-liquid asset, the CDS, which people can use to hedge the sensitivity of their pricing models to credit risk.

As soon as CDS start triggering, selling CDS becomes a risky proposition and the market for CDS becomes a lot less liquid, making it unsuitable for hedging and potentially leading CDS spreads to decouple from any "fundamentals-based estimate" of credit risk.

If credit events start happening and CDS don't trigger, the sale of CDS is exposed as a scam in the eyes of the genuine credit risk hedgers (those concerned about default losses, not about daily noise in prices and CDS spreads) and not only the market for CDS becomes illiquid again, but also people suddenly realise that <gasp> credit risk is not hedgeable, and in the current banking risk paradigm credit-risky business lines are abandoned.

Recall "Anglo-Saxon" banking abhors credit risk. The investment banking model prefers transaction-based or underwriting businesses where small amounts of capital are turned over at high speed in high-margin transactions. The ongoing collapse of Project Finance due to the problems of the Continental European banking system illustrates this: "Continentals" do credit risk (even in "Anglo-Saxon" markets), or used to until the current crisis hit.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 04:53:54 AM EST
[ Parent ]
but project finance is not quite "collapsing" yet.
From one of the data aggregators (sorry, no link, and data slightly camouflaged for confidentiality reasons):


Global Project Finance volume reached $[400]bn in 2011, the highest annual total on record and up 13% on the $[350]bn recorded in 2010. 4Q 2011 volume of $[90]bn was the lowest quarterly total of 2011 but was still 14% up on 4Q 2010

A record [900] projects reached financial close in 2011, an 8% increase over the previous record recorded in 2010



Wind power
by Jerome a Paris (etg@eurotrib.com) on Mon Mar 12th, 2012 at 06:59:39 AM EST
[ Parent ]
Obviously you know more about the state of project finance. I am reacting to news such as these:

Yields on kangaroo bonds blow out (November 22, 2011)

The European Union's crisis of confidence has reached the distant shores of the local dollar debt market as once-unimpeachable EU institutions suffer huge rises in borrowing costs.

The last few days have seen a dramatic deterioration in the market for even the highest-rated EU sellers of kangaroo bonds, paper denominated in Australian dollars and sold in Australia by foreign firms.

The starkest example was the European Investment Bank (EIB), a triple-A credit funded by all 27 members of the euro zone and one of a group of borrowers known as supranationals.

European banks have not only lost a lot of the Eurodollar funding (leading to divestment from project finance portfolios in North America as you covered in your diary The first victim of the European bank crisis: investment in the US of September 15th, 2011) but they are also losing access to funding in Australia and elsewhere. And, as a consequence, BNP beats retreat on local loan exposure as euro crisis bites (December 17, 2011)
BNP, which is one of the oldest banks in Australia (it established operations here 130 years ago), has withdrawn from the $3.7 billion syndicated loan for the Victorian desalination plant and ended its $230 million participation in the $2.1bn financing for Sevenwest Media, for which it had been one of the lead banks.

Other syndicated loans from which European banks have withdrawn include the Royal Adelaide Hospital and the port business, DP World.

Funding packages for several blue-chip companies have also been affected, including Wesfarmers and Healthscope.

And, also, MUFG in talks on RBS Australia unit (June 29, 2011)
Bank of Tokyo-Mitsubishi UFJ is in advanced talks to buy RBS Australia's Sydney-based infrastructure advisory unit and its portfolio of public-private project finance assets.

The talks reflect MUFG's determination to expand its international operations as its domestic lending market stagnates and follows its November 2010 deal to acquire £3.3bn ($5.3bn) worth of assets in Royal Bank of Scotland's project finance portfolio in Europe, the Middle East and Africa.

The 30-strong Sydney unit, set up by Dutch lender ABN Amro more than a decade ago, is one of the largest groups specialising in private-public partnerships in Australia.

In other words, European banks are disappearing fast as global players in project finance, and the slack is being picked up not by Anglo-Saxon but by Asian banking.

This is partly because Europe is adopting credit-unfriendly financial regulation, in addition to the effects of the Euro crisis on foreign funding positions.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 07:34:24 AM EST
[ Parent ]
From a commment on the London Banker thread linked to by rifek in the diary:
I see that you are now feeling the pains of reality. "Is it possible to reform a failed regulatory system sufficiently to restore a functioning market? "

My answer to you is: not this time. There is nobody with the will and the strength to stand up to Power.

...

The US is about to implode followed by the UK and then EU. There is a shift now and it is towards Asia between Perth WA and Vladivostok. Singapore has been preparing to become the main financial services sector in the World and it is also there.

The West is dying of its own incompetence and arrogance expressed in its inept "leadership.



There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 07:58:43 AM EST
[ Parent ]
which I'm not, I would see signs of "shock doctrine" here.

The crisis is the opportunity to kill euro-style project financing, replacing it with "anglo-saxon" banking? Does "follow the money" tell us anything here?

It is rightly acknowledged that people of faith have no monopoly of virtue - Queen Elizabeth II

by eurogreen on Mon Mar 12th, 2012 at 09:24:53 AM EST
[ Parent ]
The West is dying of its own incompetence and arrogance expressed in its inept "leadership.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 09:39:47 AM EST
[ Parent ]
Does "follow the money" tell us anything here?

Japan, China and Singapore?

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 09:40:10 AM EST
[ Parent ]
I think they are taking advantage, more than propelling the change.
by Metatone (metatone [a|t] gmail (dot) com) on Mon Mar 12th, 2012 at 10:22:11 AM EST
[ Parent ]
I don't think a conspiratorial reading holds water.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 10:24:28 AM EST
[ Parent ]
Most conspiracies confuse cause and effect.  Reaping a benefit does not mean one is causing the benefit.  It just means you're paying attention.
by rifek on Mon Mar 12th, 2012 at 06:48:25 PM EST
[ Parent ]
Or one is the last one left standing after the competition self-immolates.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 07:21:08 PM EST
[ Parent ]
Credit-unfriendly financial regulation?
by Metatone (metatone [a|t] gmail (dot) com) on Mon Mar 12th, 2012 at 10:21:58 AM EST
[ Parent ]
Credit risk is heavily penalised (relative to market risk) by regulatory requirements and market perceptions of capital adequacy.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 10:24:02 AM EST
[ Parent ]
My memory is getting worse and worse recently...
by Metatone (metatone [a|t] gmail (dot) com) on Mon Mar 12th, 2012 at 11:55:55 AM EST
[ Parent ]
Would you please elaborate on this?

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Mon Mar 12th, 2012 at 12:38:18 PM EST
[ Parent ]
True credit risk cannot be collateralised.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 12:58:41 PM EST
[ Parent ]
Because of the fact that most defaults happen at the same place in the business cycle?

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Mon Mar 12th, 2012 at 02:49:05 PM EST
[ Parent ]
... and the fact that you can't outsource your due diligence.

The opinion of some dude who hasn't done his own due diligence on the credit risk of a security is just his opinion. The opinion of a million dudes who haven't done their own due diligence on the credit risk of a security is also just their opinion. Putting their opinions together and calling it a "market" does not make it any more than the opinion of some dudes who haven't done their own due diligence.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Mar 12th, 2012 at 04:29:41 PM EST
[ Parent ]
But you can actually outsource the credit risk to someone else. Thah's just what the big Wall Street banks did when they sliced and diced all those toxic mortages, repackaged and sold them on to Düsseldorf and all the others.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Mon Mar 12th, 2012 at 04:41:04 PM EST
[ Parent ]
You can transfer credit risk, but you cannot hedge it.

Because, unlike market (price) risk, which is anonymous, credit risk is associated to a particular counterparty.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 04:49:07 PM EST
[ Parent ]
You can pool it, and you can subdivide the pool. But you cannot make the risk go away.

In some jurisdictions you can take it off balance sheet, but that doesn't make it go away.

Or you can sell it, but then the buyer is exposed to the full credit risk as if they had originated the loan.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 04:54:47 PM EST
[ Parent ]
But you can actually outsource the credit risk to someone else. Thah's just what the big Wall Street banks did when they sliced and diced all those toxic mortages, repackaged and sold them on to Düsseldorf and all the others.

Yes and no. You can sell it, obviously, but you can't outsource it in any meaningful sense. At most, you can buy CDS on your credit risk, but this does not hedge your credit risk - it merely substitutes one credit risk for another.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Mar 13th, 2012 at 09:39:14 AM EST
[ Parent ]
Due diligence cannot protect you from shit happens.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 04:56:07 PM EST
[ Parent ]
shit happens

The preferred term, used by all the Serious People©, is "Black Swan Event."

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Mon Mar 12th, 2012 at 05:12:58 PM EST
[ Parent ]
That's not what I'm talking about. Suppose you know that the True Probability™ of someone being unable to repay you is 5%. Then what? Did due diligence protect you form credit risk?

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 05:20:34 PM EST
[ Parent ]
If you know that the True ProbabilityTM of non-payment is 5 %, you can discount those five per cent when making the loan.

If that renders the effective interest incompatible with the customer's business plan, then you can not make the loan. If the loan represents a large fraction of your equity, then you can not make the loan.

This is why you need to do it before making the loan.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Mar 13th, 2012 at 09:54:18 AM EST
[ Parent ]
Non-payment will be a lot more damaging to your balance sheet than a nominal loss of 5% interest, surely? In accounting terms you have to list the bad debt in full.

But this is tangential to CDOs, where you can sell the same worthless non-coverage to multiple buyers over and over, with the certainty that if any of them try to claim on their 'coverage' you can shrug and say it's not your problem.

Oh - and the government will probably bail them out anyway.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Tue Mar 13th, 2012 at 10:12:42 AM EST
[ Parent ]
But as long a you have the capital to issue a lot of independent 5 % non-payment risk loans, you can get away with simply discounting it 5 %.

The salient point here is that you only get to do that with idiosyncratic risk, because systemic risk is, by its nature, not independent. This is why properly run industrial societies use government back-stops to ensure that not everyone is unemployed and broke at the same time. Because the government, as the only entity which is definitionally solvent, is the only entity which can serve as a backstop against systemic risk.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Mar 13th, 2012 at 10:17:36 AM EST
[ Parent ]
I think the key thing we should have learned from LTCM is that it's difficult to determine which risks are independent, which are not, and what sort of feedback the dependent ones will create for one another.
by rifek on Tue Mar 13th, 2012 at 03:00:20 PM EST
[ Parent ]
No, the key take-home points from the Long Term Capital Management fiasco are:

  • The market can remain irrational longer than you can remain solvent.
  • Don't bet your entire business that you're the smartest guy on the block.
  • Don't bet your entire business on any single transaction, particularly when that transaction does not keep the two first bullets firmly in mind.

Of course, none of this should have been in any way novel or surprising, and the fact that humanity regularly has to re-learn such simple matters of common prudence does not auger well for our collective cognitive prowess.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Mar 13th, 2012 at 03:18:59 PM EST
[ Parent ]
We knew those before.  LTCM thought that, if some risk spreading is good, more is better, but they never took into account that if you spread risk far enough, it becomes recursive.
by rifek on Wed Mar 14th, 2012 at 02:41:54 PM EST
[ Parent ]
They drank their own cool-aid.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Mar 14th, 2012 at 04:34:04 PM EST
[ Parent ]
Non-payment will be a lot more damaging to your balance sheet than a nominal loss of 5% interest, surely? In accounting terms you have to list the bad debt in full.

Precisely! The problem with credit is that the risks are all "in the wrong direction". You get a small income stream at a rpofit in exchange for the risk of a large loss. And risk-aversion magnifies the perception of losses.

Also, diversification doesn't quite work. If you have 20 bonds with a default probability of 5% you're virtually guaranteed a loss of 5% no matter what so it's all pain, no gain. You're maybe better off gambling on just one bond where at least you have a sizeable probability of making a profit.

Naked CDS are much "better" - you pay a small fee in exchange for the chance of a big payout.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Tue Mar 13th, 2012 at 10:20:34 AM EST
[ Parent ]
No, you can diversify it away as long as it is idiosyncratic risk. The fact that you are virtually guaranteed to suffer on the order of 100 defaults out of 2 thousand loans just means you have to charge 5 % extra on all the loans.

Where this breaks down is when everybody goes broke at the same time, because some right-wing idiot (but I repeat myself) was allowed to play with levers of government that he has neither the understanding nor the inclination to handle safely.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Mar 13th, 2012 at 10:29:05 AM EST
[ Parent ]
The fact that you are virtually guaranteed to suffer on the order of 100 defaults out of 2 thousand loans just means you have to charge 5 % extra on all the loans.

It means you're virtually guaranteed no upside and all downside. Logarithmic utility can be really nasty on the downside.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Tue Mar 13th, 2012 at 10:30:42 AM EST
[ Parent ]
No, it means I'm virtually guaranteed a payment stream of 95 % of the nominal payment stream, assuming the defaults are uncorrelated.

You need to look at the discounted value of the expected cash flow rather than the nominal principal, for the same reason you need to look at MWh produced rather than nameplate capacity when evaluating the required price of volatile energy sources.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Mar 13th, 2012 at 10:36:35 AM EST
[ Parent ]
I agree fully with Jake's side of the argument here.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Tue Mar 13th, 2012 at 10:46:09 AM EST
[ Parent ]
"assuming the defaults are uncorrelated."

Um.

by Colman (colman at eurotrib.com) on Tue Mar 13th, 2012 at 10:54:33 AM EST
[ Parent ]
In a properly run economy, they are. Because the sovereign employer and investor of last resort makes sure that the macroeconomy does not go boom.

If you hand the keys to the sovereign over to right-wingers, then of course they break it. But that is not dependent on the particulars of finance theory - right-wingers break your economy because breaking countries for fun and profit is what right-wingers do.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Mar 13th, 2012 at 11:05:36 AM EST
[ Parent ]
Analytical simplicity. The general argument still holds even with correlated defaults.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Tue Mar 13th, 2012 at 12:33:23 PM EST
[ Parent ]
because due diligence forces you to have prepared a plan B for lots of different things, and to demonstrate your general ability to deal with the unexpected.

Wind power
by Jerome a Paris (etg@eurotrib.com) on Mon Mar 12th, 2012 at 05:57:26 PM EST
[ Parent ]
In other words, due diligence is at least as much about "Know thyself" as "Know thy counterparty".
by rifek on Mon Mar 12th, 2012 at 06:53:32 PM EST
[ Parent ]
Sun Tzu and the Art of Finance.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 07:18:11 PM EST
[ Parent ]
And Lao Tzu and Musashi.
by rifek on Tue Mar 13th, 2012 at 01:49:01 AM EST
[ Parent ]
Due diligence cannot protect you from shit happens.

Define "protect."

Part of doing your due diligence is to make sure that the contract you are entering into will not cause your firm to cease to exist if shit happens. Unless said shit is so bad that your firm has a meaningful risk of ceasing to exist anyway. Part of doing your due diligence is to ask "what could possibly go wrong?" come up with a reasonably comprehensive answer, and then make contingency plans for all of those situations. Even if the contingency plan is just "in case of nuclear war, roll over and die."

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Mar 13th, 2012 at 09:52:59 AM EST
[ Parent ]
:)

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty
by melo (melometa4(at)gmail.com) on Tue Mar 13th, 2012 at 05:07:38 AM EST
[ Parent ]
Because if I loan you money but ask you to collateralise it...

...it's not a loan. It's a liquidity operation.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 04:47:44 PM EST
[ Parent ]
That is the pawn broker business model, right?

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se
by A swedish kind of death on Mon Mar 12th, 2012 at 05:16:17 PM EST
[ Parent ]
project finance loans are weakly correlated to the business cycle.
This is a sector that's been studied left and right - it has lower default rates, higher recovery rates in case of default, and limited correlation to other banking assets.

Banks know that and they keep on doing it, even as it goes out of fashion.

Wind power

by Jerome a Paris (etg@eurotrib.com) on Mon Mar 12th, 2012 at 05:49:51 PM EST
[ Parent ]
Because if it's collateralized, it isn't at risk?
by rifek on Mon Mar 12th, 2012 at 06:50:14 PM EST
[ Parent ]
What's the credit risk of a secured credit card?

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Tue Mar 13th, 2012 at 04:34:13 AM EST
[ Parent ]
None, it's fully liquid.  Non-liquid collateral is a different issue.
by rifek on Tue Mar 13th, 2012 at 02:33:52 PM EST
[ Parent ]
Are you talking about different kinds of risk here?

If I pawn a clock or a house, the lender does not have a credit risk, but a risk that their evaluation of the value of the collateral will not be correct when if a time comes when the collateral needs to be sold.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Tue Mar 13th, 2012 at 03:54:43 PM EST
[ Parent ]
They have a credit risk, that you won't pay. Only after you don't pay do they get to liquidate your collateral. Then they have liquidity risk.

Then again, some people say "all risk is liquidity risk".

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Tue Mar 13th, 2012 at 04:39:25 PM EST
[ Parent ]
But that is clearly false. Liquidity risk can be made to go away entirely (at least within the system of banks in good standing) through appropriate central bank policy. This will not, however, do anything about credit risk.

Liquidity risk is a political problem of whether you get to defer payment. Credit risk is a fundamental problem of whether you are able to make payment.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Mar 13th, 2012 at 06:55:13 PM EST
[ Parent ]
So why are people made to pay interest from the privilege of borrowing from their own collateral?

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Tue Mar 13th, 2012 at 04:44:12 PM EST
[ Parent ]
I suppose it's just a way to trick retail bank customers. Like "actively managed" mutual funds that behave exactly like index funds, but have three times as high fees.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Tue Mar 13th, 2012 at 06:04:54 PM EST
[ Parent ]
No, it's actually a way to extract tribute from people with poor credit.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Tue Mar 13th, 2012 at 06:06:46 PM EST
[ Parent ]
No one is forced to have a credit card. But people can be tricked into it. Just like people can be tricked into putting their savings in "actively managed" funds.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Tue Mar 13th, 2012 at 06:10:20 PM EST
[ Parent ]
In the US, you're practically an unperson without a credit card:
You need one to make a hotel or plane reservation, or to rent a car, even if you plan to pay cash. Many stores require a credit card to accept your check. Responsible use of a credit card builds a good credit rating, too, marking the owner as mortgage-worthy.

But people who have never had credit or need to repair a poor credit history may not qualify for a regular credit card.

(link)

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Tue Mar 13th, 2012 at 06:11:05 PM EST
[ Parent ]
I've never used or even had a credit card in my entire life. Why not just use a debit card instead? I do that all the time.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Tue Mar 13th, 2012 at 06:24:21 PM EST
[ Parent ]
The US system appeared absurd to me too, the first time I heard of it, but there it is. If you can't deliver a credit card company that says you payed your bills on time, you are not creditworthy.

Sweden instead uses implicit credit worthyness unless the central government register says that we failed to pay a bill so many times that it ended up with Kronofogden.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Wed Mar 14th, 2012 at 04:35:20 AM EST
[ Parent ]
In France, you get to be "interdit bancaire" (blacklisted by a government file, and denied all banking services), basically if you ever write a dud cheque. There is now (this is recent) a government-mandated minimum service that banks are obliged to provide to people who are blacklisted, which amounts to a debit card.

The advantage of this system is that you can (could, until a few years ago) write a cheque for just about anything. The banks are trying hard to stamp out the massive use of cheques (because they cost them money) and force us to use credit (or debit) cards.

Credit card balances are paid off automatically every month from your bank account, so you can't have outstanding balance on your card (what you have instead is an overdraft).

It is rightly acknowledged that people of faith have no monopoly of virtue - Queen Elizabeth II

by eurogreen on Wed Mar 14th, 2012 at 06:59:05 AM EST
[ Parent ]
You still use cheques in France? I think we phased them out in like the mid 80's.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Wed Mar 14th, 2012 at 10:40:39 AM EST
[ Parent ]
We still use them in the U.S......(I've never seen them in Italy). But the system is broken.
by gk (gk (gk quattro due due sette @gmail.com)) on Wed Mar 14th, 2012 at 11:14:54 AM EST
[ Parent ]
As do I.  The bulk of debit cards here in the US can be used the same as a credit card.  Secured credit cards are frankly a predatory practice no one sees fit to regulate.  They prey on the patently ignorant and on those whose creditors would garnish any bank account they opened.
by rifek on Wed Mar 14th, 2012 at 02:59:15 PM EST
[ Parent ]
You have obviously not been denied a mobile phone contract because you didn't have a credit rating (good or bad: no credit rating is worse than bad credit) which you could only establish with a credit card.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed Mar 14th, 2012 at 03:02:31 PM EST
[ Parent ]
People in that situation should be able to get pre-paid cell phones. If not, that is a real abuse, as there is no risk. As soon as you reach your pre-paid limit you can only use the phone to dial 911 or the provider's line to add more minutes. Now, if you don't have a credit card, it may be necessary to go to a retail outlet to add more minutes to your cell phone. In Arkansas there are plans specifically for low income people designed to provide them with basic communications for health and safety. Such plans provide much better phones than the cheapest available. That is probably a boondoggle for the providers.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Mar 14th, 2012 at 04:42:48 PM EST
[ Parent ]
That's just one example of what you can be denied for having no credit history. You can be denied anything that involves a credit check, which is becoming increasingly standard when dealing with corporations. You may be denied an apartment rental application, for instance. You may be denied a car rental. Your debit card may not be accepted for online payments. And so on and so forth.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Thu Mar 15th, 2012 at 05:22:04 AM EST
[ Parent ]
From Wikipedia: In Hungary Sweden debit cards are far more common and popular than credit cards. Many Hungarians Swedes even refer to their debit card ("betéti kártya" "kontokort") mistakenly using the word for credit card ("hitelkártya" "kreditkort").

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Tue Mar 13th, 2012 at 06:27:48 PM EST
[ Parent ]

European banks are disappearing fast as global players in project finance

Not really. They have been reducing their exposure by selling well-identified portfolios or local activities which don't limit their ability to continue the rest of the business (for instance, BNPP sold a large portfolio of "reserve-based assets" in the US, i.e. loans to medium sized oil&gas operators in the US backed by rights to the underlying resource (i.e. the oil reserves). With good geologists (which most banks doing this business have in-house), this is a low risk business, but it's fairly capital-intensive. Selling this is something you can do as a decent price (other banks know these are sound assets, so there is enough competition to ensure the discount is not large), and which frees up quite a lot of capital; at the same time it's specialized enough that getting rid of it does not cut into your other activities.

The league tables for 2011 show the usual suspects at the top, i.e. the Indian banks (big local market), the French, the Japanese, the Spanish and the Dutch banks.

Japanese banks are indeed moving up, but the there ones are not disappearing.

Wind power

by Jerome a Paris (etg@eurotrib.com) on Mon Mar 12th, 2012 at 05:56:21 PM EST
[ Parent ]
FWIW i saw on bloomberg yesterday that there is a significant uptick in 'angel' investing, which i assume is investment money planted in projects of intrinsic social worth, not just for the quickest, largest profits.

seems like a Good Thing.

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Tue Mar 13th, 2012 at 05:06:29 AM EST
[ Parent ]
"Angel investing" refers to very early stage venture capital. It is called so not because of any implied generosity - they fully expect to get paid - but because very early startups have no tangible assets to serve as collateral for the "angel investor."

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Mar 13th, 2012 at 10:19:25 AM EST
[ Parent ]
What Jake said.  And this is just more evidence that the system has become addicted to abnormally high rates of return.  It has to be a killing, it has to cover the front-end load, and it has to happen now.
by rifek on Tue Mar 13th, 2012 at 02:37:05 PM EST
[ Parent ]
Actually, of all sectors of finance, I would think project finance would be relatively strong right now, albeit highly dependent on the country we want to reference, given everything going on in the energy markets as well as residual stimulus spending by a lot of countries.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Mon Mar 12th, 2012 at 07:46:09 AM EST
[ Parent ]
Beppe Grillo's Blog
The public debt mole
Information regarding the high-speed railway project has been totally lacking, probably because the interests that lie behind these major works had no interest whatsoever in informing the public. On the other hand we have this extraordinary mobilization and support that the No TAV movement is seeing today, particularly in the Val di Susa ...
For the past 20 years now this valley's numerous technical experts have been informing the citizens and the mobilisation that we are seeing now is the fruit of twenty years of effort and of awareness of the technical merits that Valley reflected in the numbers that show the total uselessness of this major public works. In this regard, the fact that the major media have chosen to ignore this issue for the past 20 years and now tend to focus on reporting only on those issues relating to public order and appear to be incapable of evaluating the merits of this issue is proof that interests, probably even in the cultural collapse of this Country, lie only in slogans, in ideologies and the flags that certain works of this nature may represent for the ruling class and that these kinds of works are merely an extension of their total inability to conceive any sort of vision for the future. But I am becoming ever more convinced that this ruling class is structurally bound to worry only about the present because the minute there is any sort of appraisal of the effects that their actions have on the future, they stand to immediately lose all of their privileges.
The only interests are the annual budget and short-term results and for the bankers, it is getting their hands on some serious stock options, while for the politicians who live in the here and now, it's all about next month or next year's political outcomes and for the entrepreneurs in charge of the virtual companies, it's all about managing the debt.
There will probably be no winners and we are all going to lose out in the end! They are gambling the future of our economy on these major public works, particularly here in Italy, because the financial architecture that is built on these major works are mechanisms designed to dig out hidden public debt from the accounts of privately held companies, this so-called project financing that has many politicians talking since public resources have become more scarce. However, this is precisely the mechanism that brought about the 2009 crash. In that case the debt was built on private funding while in this case the debt is being dumped into the public debt. That's what project financing is all about, a mole that causes future public debt that has to and will inevitably surface at some point in the future. This mole has been digging away for many years already, since way back in the 90's, since the post-Tangentopoli era and it is going to surface sooner or later because it is a hidden debt. The project financing debts or the debts of privately owned public companies may not be reflected in the 120% of GDP, but they are nevertheless public debt that is concealed in the accounts of private companies and will have to surface sooner or later. It is difficult to say when this will happen, however, it is not going to be in the long-term and when it does happen, any of these major works that have already begun will go to the wall and this debt will explode and reverberate on us all and on the economy as a whole!

kindly deconstruct.

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Wed Mar 14th, 2012 at 07:41:09 AM EST
[ Parent ]

this is precisely the mechanism that brought about the 2009 crash.

That's false. What is true is that governments have used PPP (public private partnerships) as a way to avoid public debt (they pay "rent" on infrastructure which is privately-owned for a number of years after it's built) and this tends to be more expensive in the long term than the State building it itself and paying for it. Depending on how well the tender is defined, it can be an effective tool, and a real way to pass on some risks to the private sector.

So PPP is a different way to build infrastructure, with more private sector involvement, and it can result in some unnecessary transfers of money  from public to private hands over time, but it's not crazy and it does not create systemic risk.

Even if not done in the most effective way, it is lending to real infrastructure projects. Whether these are necessary or not is not really linked to how they are financed (private contractors would lobby for them anyway if government were to pay for them), and that financing certainly did not create the financial crisis.

Wind power

by Jerome a Paris (etg@eurotrib.com) on Wed Mar 14th, 2012 at 08:43:26 AM EST
[ Parent ]
And both the "policy" and the "premium stream" are dealt down the line, unlike insurance policies.  You can't tell who's actually obligated to cover.
by rifek on Mon Mar 12th, 2012 at 06:34:02 PM EST
[ Parent ]
From what I understand of CDO/CDS from reading too much Michael Lewis, they were designed to avoid the regulatory structures which surround proper insurance.

Portfolio - Michael Lewis - The End of Wall St

After taking a fee, he passed them on to other investors. His job was to be the C.D.O. "expert," but he actually didn't spend any time at all thinking about what was in the C.D.O.'s. "He managed the C.D.O.'s," says Eisman, "but managed what? I was just appalled. People would pay up to have someone manage their C.D.O.'s--as if this moron was helping you. I thought, You prick, you don't give a fuck about the investors in this thing."

Whatever rising anger Eisman felt was offset by the man's genial disposition. Not only did he not mind that Eisman took a dim view of his C.D.O.'s; he saw it as a basis for friendship. "Then he said something that blew my mind," Eisman tells me. "He says, `I love guys like you who short my market. Without you, I don't have anything to buy.' "

That's when Eisman finally got it. Here he'd been making these side bets with Goldman Sachs and Deutsche Bank on the fate of the BBB tranche without fully understanding why those firms were so eager to make the bets. Now he saw. There weren't enough Americans with shitty credit taking out loans to satisfy investors' appetite for the end product. The firms used Eisman's bet to synthesize more of them. Here, then, was the difference between fantasy finance and fantasy football: When a fantasy player drafts Peyton Manning, he doesn't create a second Peyton Manning to inflate the league's stats. But when Eisman bought a credit-default swap, he enabled Deutsche Bank to create another bond identical in every respect but one to the original. The only difference was that there was no actual homebuyer or borrower. The only assets backing the bonds were the side bets Eisman and others made with firms like Goldman Sachs. Eisman, in effect, was paying to Goldman the interest on a subprime mortgage. In fact, there was no mortgage at all. "They weren't satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn't afford," Eisman says. "They were creating them out of whole cloth. One hundred times over! That's why the losses are so much greater than the loans. But that's when I realized they needed us to keep the machine running. I was like, This is allowed?"



keep to the Fen Causeway
by Helen (lareinagal at yahoo dot co dot uk) on Mon Mar 12th, 2012 at 04:02:40 AM EST
[ Parent ]
Good article.

As I have learnt on ET CDO and CDS has very little in common, except being scams that start with CD. CDO is a way to divide the cash flow from credit and pretend that the debtors can not possibly fail to deliver all on the same time, even if the credit is all crap to begin with. CDS are (apparently) a bet on if a credit will pay or not. So I guess you can take out CDSs on CDOs too, if you want to maximise your scamming potential.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Mon Mar 12th, 2012 at 09:59:47 AM EST
[ Parent ]
I guess you can take out CDSs on CDOs too, if you want to maximise your scamming potential

That is what The Big Short is about.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 10:01:44 AM EST
[ Parent ]
CDSs on CDOs is just the beginning... You can makes CDOs of those again, and then go on to cubic CDOs..

Un roi sans divertissement est un homme plein de misères
by linca (antonin POINT lucas AROBASE gmail.com) on Mon Mar 12th, 2012 at 07:47:14 PM EST
[ Parent ]
Sounds like a sequel to Inception.
by rifek on Tue Mar 13th, 2012 at 01:43:14 AM EST
[ Parent ]
You don't have to have an "insurable interest" in order to buy CDS.

One way people have proposed to fix the CDS problem is to change the law so you need to deliver a defaulted bond in order to collect on your CDS. That would still allow people to buy CDS to speculate/hedge on the fluctuations of the CDS spread, but you could only collect the payut if you actually own a defaulted security, which you would exchange for the CDS payout. The CDS seller would then have the job of collecting "recovery" on the defaulted bond.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 04:43:30 AM EST
[ Parent ]
Yes, but then they'd invent another "instrument" that didn't have such limitations and trade those instead.

We're at the stage where the financial industry has to be told what it can do and everything else is illegal

keep to the Fen Causeway

by Helen (lareinagal at yahoo dot co dot uk) on Mon Mar 12th, 2012 at 05:07:44 AM EST
[ Parent ]
There's a term for that.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 05:10:52 AM EST
[ Parent ]
aka regulated market mechanism capitalism, increasingly it seems to be the the only sort compatible with democracy.

I like the way neolibs invent pejorative terms for sensible things they dislike

keep to the Fen Causeway

by Helen (lareinagal at yahoo dot co dot uk) on Mon Mar 12th, 2012 at 07:05:26 AM EST
[ Parent ]
Yes, the terminology is highly tendentious. I encountered it for the first time in the otherwise excellent This time is different: 800 years of financial folly by Reinhart and Rogoff.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 07:36:15 AM EST
[ Parent ]
In addition to financial repression we need a nastier big brother which I would call financial smothering. Apply financial smothering to the entities that most vociferously protest financial repression. A great way to re-size the financial industry back to something we can live with.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Mon Mar 12th, 2012 at 11:15:37 AM EST
[ Parent ]
I wonder when Reinhart is going to bother to notice modern monetary theory.
by rifek on Mon Mar 12th, 2012 at 06:42:11 PM EST
[ Parent ]
I actually think a model in which CDS can be bought and sold freely but you can only collect the CDS payout by delivering a defaulted bond, would "work" because it would satisfy the needs of both "credit hedgers" and "credit-spread-market hedgers".

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 05:41:42 AM EST
[ Parent ]
Insurable interest is the most basic requirement for any functioning insurance market. Else it is ripe for abuse.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Mon Mar 12th, 2012 at 11:17:24 AM EST
[ Parent ]
If you're not careful, that can lead to a real mess.  Here in the US we probably will never sort out all the "show me the note" issues on mortgages and end up just drawing an arbitrary line.
by rifek on Mon Mar 12th, 2012 at 07:00:11 PM EST
[ Parent ]
That is why you have central property registries and notarised transactions.

If you don't have central registries and notarised transactions, then you are guaranteed to have a mess, irrespective of what instruments you allow to be traded.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Mar 13th, 2012 at 10:30:57 AM EST
[ Parent ]
Except that the notes are not typically recorded or filed.
by rifek on Tue Mar 13th, 2012 at 02:39:05 PM EST
[ Parent ]
In that case you do not, in practise, have a central registry of deeds and property.

Breaking such registries is one of the things right-wingers do, because they neither understand nor care to understand the institutional basis for prosperity.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Mar 13th, 2012 at 03:27:32 PM EST
[ Parent ]
Notes have no effect on title.  Only mortgages and deeds of trust do, and those are recorded or there are consequences.  But those are just collateral instruments and don't show evidence of the underlying debt.  Notes, CDSes, and other securities don't have recording systems to readily determine who holds them.
by rifek on Wed Mar 14th, 2012 at 02:52:42 PM EST
[ Parent ]
The whole point of having exchanges rather than simply trading over-the-counter is to have a paper trail of who owns what. If the exchange does not keep track of who owns what securities, then it's not doing its job. And tools that do not do their jobs should be replaced or discarded.

Of course, alphabet soup derivatives are typically traded over the counter rather than on exchange. But that's a bug, not a feature.

In Denmark, notes are notarised and placed in a similar sort of central registry as deeds and titles. But then again, in Denmark, everything is noted and registered and recorded in a central registry somewhere.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Mar 16th, 2012 at 05:39:28 AM EST
[ Parent ]
If a CDS were actually treated like an insurance policy, it would not be tradeable.  The CDS could only be held by the buyer of a named beneficiary, and the payment obligation could be transferred only under highly regulated conditions.  But then no one would score an endless series of commissions.
by rifek on Fri Mar 16th, 2012 at 10:06:15 PM EST
[ Parent ]
You need to prevent people from shorting them, because that creates credit risks against the short-seller as well as the original issuer.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Mar 13th, 2012 at 10:21:59 AM EST
[ Parent ]
Insurable interest is just one side.  Assignment of policy obligations and premium streams in the other.
by rifek on Mon Mar 12th, 2012 at 06:36:03 PM EST
[ Parent ]
Isn't it terrible for the poor 1% ters having all this money and nowhere safe to put it?  They want to "earn" extra interest on it risk free and the other 99% simply won't pay up. Maybe it's because they don't have it any more in the first place.  How can you earn more money on existing money in a world of declining resources and diminishing returns?  It just isn't fair.  People who own billions should be entitled to "earn" more billions because they are the "wealth creators".  Perhaps we should re-name them the "value destroyers"...

Index of Frank's Diaries
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Mon Mar 12th, 2012 at 08:05:11 AM EST
is in order. From now on, if you want what were routine returns a few years ago (in the 10-20% range) you'd better be prepared to take big risks (BRIC stocks, for example). If you want a safe, sustainable return in a stable economy, you'd better be prepared to accept 3-5%.

The 2008 bubble was the last throes of "everyone deserves a huge return", and it killed the goose that laid those eggs. Now only vultures are extracting that sort of return.

It is rightly acknowledged that people of faith have no monopoly of virtue - Queen Elizabeth II

by eurogreen on Mon Mar 12th, 2012 at 09:20:22 AM EST
[ Parent ]
But you still hear people who have invested for their pensions saying that they are just not getting enough interest nowadays to afford to live properly, and  governments suggesting that10% returns are around the corner, a rate that can only be raised by settinbg part of your economy on fire.

Any idiot can face a crisis - it's day to day living that wears you out.
by ceebs (ceebs (at) eurotrib (dot) com) on Mon Mar 12th, 2012 at 08:28:30 PM EST
[ Parent ]
For the last 200 years, the US stock market has produced a 7-8% real annual return, ie a doubling every 10 years. Same is true for the Swedish stock market for the last 100 years,

The interesting thing however, is that there were actually quite few years when you got these 7-8%. Having a 20% increase or a 10% fall was more par the course, and there were periods (such as after the 1929 crash) when it took 25 years or more for the stock market to recover.

What's the lesson here? Well, there are some really basic lessons a lot of people keep forgetting. Like, a share is not something abstract: it is a share in a company. And if said company is a reasonably stable and solid business, it will pay you dividends. The (reinvested) dividends are in general half of the the total returns from the stock market in the last 100 years. So don't ignore those sustainable dividend payers.

With solid dividends you can get a reasonable cash stream from your savings even when the economy falls into the dreaded liquidity trap, and while you wait out that 20 year lull in the stock market. And don't worry: if you die while waiting, your kids can always inherit your shares.

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Mon Mar 12th, 2012 at 09:03:28 PM EST
[ Parent ]
But that's so boring!  You can't live like a rock star investing like that, and neither can your broker.
by rifek on Tue Mar 13th, 2012 at 01:45:53 AM EST
[ Parent ]
For the last 200 years, the US stock market has produced a 7-8% real annual return, ie a doubling every 10 years. Same is true for the Swedish stock market for the last 100 years

That can only hold if the stock market represents a small fraction of GDP. I doubt everyone's pension could grow at 7-8%

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Tue Mar 13th, 2012 at 04:28:32 AM EST
[ Parent ]
Until the '80s the entire financial secto WAS a small fraction of GDP - certainly far smaller than recently.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Mar 13th, 2012 at 09:33:58 AM EST
[ Parent ]
And that growth of the sector at the expense of the body as a whole allows larger returns and reinvestmet as long as it keeps growing. But there are of course limits to growth even for cancer.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se
by A swedish kind of death on Tue Mar 13th, 2012 at 10:47:53 AM EST
[ Parent ]
Agent Smith: I'd like to share a revelation that I've had during my time here. It came to me when I tried to classify your species and I realized that you're not actually mammals. Every mammal on this planet instinctively develops a natural equilibrium with the surrounding environment but you humans do not. You move to an area and you multiply and multiply until every natural resource is consumed and the only way you can survive is to spread to another area. There is another organism on this planet that follows the same pattern. Do you know what it is? A virus. Human beings are a disease, a cancer of this planet. You're a plague and we are the cure.
by rifek on Tue Mar 13th, 2012 at 02:50:04 PM EST
[ Parent ]
Except of course if Mr Smith were a biologist, he would know that moose, foxes and other mammals behave that way as well. What make us different is that we have devised ways to increase the carrying capacity of the land, through the use of cleverness and fossil fuels.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Tue Mar 13th, 2012 at 04:33:56 PM EST
[ Parent ]
Hence, "Extend and pretend."
by rifek on Wed Mar 14th, 2012 at 02:46:02 PM EST
[ Parent ]
It can work as long as not all of the proceeds are reinvested. A consol paying 7 % can be perfectly sustainable. Expecting to be able to take the payout from the consol and use it to buy another 7 % consol, and so on most certainly is not.

Compounding interest is usually unsustainable, which is why a prudent lender should insist that interest be paid as it accrues.

This, incidentally, breaks money neutrality. Hard.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Mar 13th, 2012 at 10:24:53 AM EST
[ Parent ]
The assumption the proceeds can be reinvested is central to the very concept of internal rate of return and the associated concept of reinvestment risk.

So investment theory is bollocks. Oh, well...

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Tue Mar 13th, 2012 at 10:28:44 AM EST
[ Parent ]
Well, yeah, the usual interpretation of discount rates is garbage. This surprises you why?

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Mar 13th, 2012 at 10:32:44 AM EST
[ Parent ]
A not insignificant fracion of all capital is not in the stock market, but in (generally) far less risky investments like bank accounts, corporate and sovereign bonds, or real estate. As they (usually and in the long run) have a lower return, a higher return on stocks might very well be sustainable even in the long run, as long as economic growth runs at a reasonable clip.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Tue Mar 13th, 2012 at 10:55:12 AM EST
[ Parent ]
A not insignificant fraction of all capital assets is not in the stock market, but in (generally) far less risky investments like bank accounts, corporate and sovereign bonds, or real estate. As they (usually and in the long run) have a lower return, a higher return on stocks might very well be sustainable even in the long run, as long as economic growth runs at a reasonable clip.

Only assuming that you do not reinject your gains from the stock market into the stock market. If you do, then the stock market's fraction of all assets in the economy will increase.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Mar 13th, 2012 at 11:07:56 AM EST
[ Parent ]
But why build a factory when you can simply invest in one with less risk and better return?  Of course sooner or later you run out of bricks and mortar and are left with paper and electrons, but isn't it loverly while it lasts?
by rifek on Tue Mar 13th, 2012 at 02:52:13 PM EST
[ Parent ]
Because it might be cheaper to build a new one compared to buying an already existing one, depending on market valuations.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Tue Mar 13th, 2012 at 04:37:02 PM EST
[ Parent ]
But that involves lags and risks that buying an existing asset doesn't have.

Also, if you buy the existing asset on credit, the existing asset acts as collateral. If you borrow to build, there's no collateral until the thing is built.

Therefore, the banking sector has a bias against lending for capital formation and for lending towards asset bubbles.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Tue Mar 13th, 2012 at 04:42:56 PM EST
[ Parent ]
But that involves lags and risks that buying an existing asset doesn't have.

True. Which is why people talk about risk-adjusted returns, and why choosing the highest risk-adjusted return is what you should, given that the absolute level of risk is something you can stomach.

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Tue Mar 13th, 2012 at 06:06:54 PM EST
[ Parent ]
is what project finance is about.
And - again, it works, it's quite safe, but it's also quite a bit of work. Which may be the problem...

(Also - project finance bankers do not get million-dollar bonuses)

Wind power

by Jerome a Paris (etg@eurotrib.com) on Wed Mar 14th, 2012 at 08:48:21 AM EST
[ Parent ]
I have been wondering, how much of banks lending is project financing and how much is based on existing assets?

Ball-park figures is what I am looking for really.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Wed Mar 14th, 2012 at 09:07:23 AM EST
[ Parent ]
most bank lending is still to corporations, and it is impossible to tell if that money is used for investment (and if so, in what) or for other purposes.

Wind power
by Jerome a Paris (etg@eurotrib.com) on Wed Mar 14th, 2012 at 01:08:52 PM EST
[ Parent ]
Still, a a lot of non project-finance new construction projects are done by established actors, not startups, which actually have collateral available to pledge.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Wed Mar 14th, 2012 at 10:44:01 AM EST
[ Parent ]
A not insignificant fracion of all capital is not in the stock market, but in (generally) far less risky investments like bank accounts, corporate and sovereign bonds, or real estate.

The extent to which it's less risky is basically a function of credit seniority and recovery/collateral values.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Tue Mar 13th, 2012 at 12:32:45 PM EST
[ Parent ]
Creditors always have greater seniority than shareholders, that's why shareholders demand higher returns.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Tue Mar 13th, 2012 at 12:38:25 PM EST
[ Parent ]
There are more tiers of seniority than "creditors" and "shareholders" or "debt" and "equity".

Interestingly, in English there's "equity" and "debt" = "fixed income", but in Spanish there's no word for "equity". Rather there's "fixed income" (renta fija) and "variable income" (renta variable).

What makes equity more risky than debt is not the seniority but the discretionality of dividend payments.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Tue Mar 13th, 2012 at 01:12:55 PM EST
[ Parent ]
Well, that too.

But of course, there are differnt kinds of seniority when it comes to bonds as well, and the more junior bonds pay higher interest. That's completely reasonable and not mysterious at all.

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Tue Mar 13th, 2012 at 01:27:50 PM EST
[ Parent ]
The comment stream on this diary is one of the most informative and accessible I recall. That is truly one of the glories of ET.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Mon Mar 12th, 2012 at 08:09:05 PM EST
Unfortunately, financial smothering seems to be what the financial sector is doing to the rest of the economy in The West.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Mar 13th, 2012 at 01:30:45 AM EST
[ Parent ]
speaking from a PIIG country, that's exactly what 'austerity' feels like, having a pillow forced down over the economy, complete with muffled dulcet tones of reassurance that this will bring an end to the pain.

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty
by melo (melometa4(at)gmail.com) on Tue Mar 13th, 2012 at 05:15:04 AM EST
[ Parent ]
After all, life is suffering. Don't Christian Democrats believe that?

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Tue Mar 13th, 2012 at 05:21:48 AM EST
[ Parent ]
i thought it was the buddha that said 'life is suffering'.

whatever... it sure is for most folks most of the time.

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Tue Mar 13th, 2012 at 01:29:34 PM EST
[ Parent ]
That, too.

So, why do religions oppose euthanasia?

And, why not call the current policy the euthanasia of the periphery just like Keynes talked about the euthanasia of the rentier?

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Tue Mar 13th, 2012 at 01:33:08 PM EST
[ Parent ]
Because it ends the suffering, and suffering is control.
by rifek on Tue Mar 13th, 2012 at 02:54:35 PM EST
[ Parent ]
That explains the Eurozone crisis policy as well as any other theory.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
by Migeru (migeru at eurotrib dot com) on Tue Mar 13th, 2012 at 04:36:07 PM EST
[ Parent ]
And because the ability to inflict great suffering enhances fear, which is a prime mechanism of control and manipulation.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Mar 13th, 2012 at 04:47:01 PM EST
[ Parent ]
Mortification of the flesh.
by rifek on Tue Mar 13th, 2012 at 02:53:52 PM EST
[ Parent ]


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