An Exit

My grandfather passed away this weekend. A long, successful, and altogether worthy life. For those interested, the obituary.

Credit Default Swaps

Why are CDS outstanding growing so quickly? The Financial Times reported they grew from $34.8 trillion to $62 trillion outstanding in a single year.

OH THE MARKET WILL CORRECT ITSELF! IT HAS AN INVISIBLE HAND! THE MARKET IS A MAGIC FORCE THAT MAKE PONY = NO BETTER THAN MARXIST DOGMA!

Prediction

American consumer was the engine of global econ growth. What will be the next one?

renewable energy - global warming related stuff. just wait.

2006

On the radio

I'm going to attempt to answer your original question and shy away from comments on Basel II's effectiveness as a regulatory accord, please forgive me but I know little about the specific risk measurement enhancements that it contains.

I know that the current situation, spurred by the subprime situation, was forecasted. It was forecasted by my professors at school, who warned about this very specific problem for my three years of Economics courses, and it was even known by our administration. Of course, I have no real hard evidence of the latter claim, but the very fact that they chose Ben Bernake to be our Chairman is interesting - Bernake's main work, throughout his entire life, has been on the Great Depression - its causes, the failed remedies, and the lessons learned. He is a pioneer in this field.

Many many economists pointed out the subprime situation, but also the general housing bubble and its historic proportions. And many economists, including my professors, made the link between securitized subprime bonds, their eventual bust, and the subsequent decline in home prices.

Almost everyone believed the subprime bonds would go bust and lead to a lot of losses. The main debate was a question of degree of losses. Many economists believed that, even if the subprime bonds went bust, it would not lead to a general decline in home prices nationwide. Their evidence for this? It never happened before - there has never been a national decline in home prices since the Fed started keeping track of home prices in the 1960s. That is, until today.

So, among Economists, it's not like this situation is a great surprise.

So how was the federal reserve to deal with such a situation in 2004? They could have easily raised interest rates out of concerns for all the leveraged loans and leveraged mortgages that were in existence. They could have easily instituted a regulatory regime, beyond mere paper records, for the OTC Derivatives market. Such a regime would have included close risk monitoring(I say this but the Fed clearly understood some risks in credit derivatives when they stepped in and started regulating it by mandating paper records), and people from the Fed even started warning about the interconnectedness of their securities and their sheer size, and thus the panic their implosion would cause. I think they should have started planning for an asset backed receivables exchange, like the new exchange being built in New Orleans. The best remedy however would have been a third party intermediary able to judge the credit worthiness of each party to adhere to the derivative contracts being traded. This would have had a similar effect as price controls, I believe, because if a CDS contract requires that one party pay up one billion if X company goes default, which is a somewhat normal number, well that is just ridiculous - but these kinds of risks were being taken.

So basically, what I think should of been instituted, and I would be real surprised if they didn't do this in the future, is an accurate measure of counter party risk calculated in terms of how much exposure they have to similar contracts. So if Lehman Brothers had 28 billion in CDS contracts - well that's their entire worth right, and the risk rating would of been very high, and then the Fed would say, hold on, these ten contracts could wipe out the entire bank, or at least make their reserve ratio illegal, and thus the "rating agency" would raise a red flag and cause the fed to investigate and approach the banks with their conclusions.

And I dont think the monitoring of these types of securities is really outside of the Fed(or another rating agencies) control. These derivative markets are big, but there are few players, much much fewer players than the public markets, yet the public markets seem to get regulated fairly well - people go to jail for all sorts of fraud and insider trading and what not.

This solution looks good on the surface but the problem that arises are the bond insurers. The bond insurers insured bonds(if something went bust, and the counterparty cant pay, we will!). But these bond insurers were totally unregulated as well - the were on the surface regulated by the rating agencies but underneath they were woefully undercapitalized for the task they were going to take on - and this is the fault of the rating agencies, not the federal reserve, but it's painfully obvious. Perhaps there should be minimum capital reserves for bond insurers?

The point is that these risks were known, talked about, but the only thing the federal reserve did was ask the banks to start using paper to record these transactions.

And furthermore, the Fed could have simply raised interest rates when they started seeing the ridiculous amounts of homeowner debt, private debt, and leveraged loans that existed. These issues regularly showed up in their reports - graph upon graph showed huge spikes in credit. To put these spikes in perspective - from 1962 to 2001, the amount of homeowner debt expanded 48%. From 2001 to 2008, it expanded 36%. This is massive.

So in conclusion, the situation was known, and a remedy could have been as simple as raising interest rates - which would have been short term fix - to really figuring out a way to measure counterparty risk on these derivatives contracts which are really "financial weapons of mass destruction" which could have been quite possibly "devised by madmen"(thank you Warren Buffet). But yet no rating exists for, for example, the CDS counterparies in a contract in the form I have spoken about, on a per contract basis assuming all contracts, compared with the total assets of the company coupled with a risk assesment of that banks impact on the broader financial system if it were to take big losses on its derivatives contracts. This would have limited excess greatly by causing the fed to ring alarm bells on the risks to the financial system in the banks' faces, all while bringing the shadow banking system under control.

But the Fed did nothing but ask banks to start keeping it on paper, and in 2004, when the CDS market was ohh only 34 trillion. Surely, if you disagree with my perscriptions, you agree they could have definitely done more - that they are not helpless children who have no idea how our economy works. These are experts. Logic says they could easily have done something more than what they did.

Victory

FT: "Some senior Wall Street figures are now warning that, if the industry does not swiftly act to tackle this counterparty risk issue via the creation of a clearing house or other mechanisms, it could be forced to accept higher regulation %u2013 or shift its activity into an exchange."

Three hours prior, unrelated posting on bigthink.com you will find:

Ben Fisher: "They could have easily instituted a regulatory regime, beyond mere paper records, for the OTC Derivatives market. Such a regime would have included close risk monitoring(I say this but the Fed clearly understood some risks in credit derivatives when they stepped in and started regulating it by mandating paper records), and people from the Fed even started warning about the interconnectedness of their securities and their sheer size, and thus the panic their implosion would cause. I think they should have started planning for an asset backed receivables exchange, like the new exchange being built in New Orleans. The best remedy however would have been a third party intermediary able to judge the credit worthiness of each party to adhere to the derivative contracts being traded. This would have had a similar effect as price controls, I believe, because if a CDS contract requires that one party pay up one billion if X company goes default, which is a somewhat normal number, well that is just ridiculous - but these kinds of risks were being taken."

Called it.

The Third Wave

We are entering the third wave of the credit crisis. How do I know this?



This is a similar graph to the TED spread, the first graph posted in the post below. It is different in that the TED spread is largely a measure of risk associated with all types of debt, measured by the interest rate spread between riskless treasuries and LIBOR, and this is the spread between for best grade and the worst grade commercial paper - or short term debt that needs to be paid back in nine months or less. The commercial paper markets are seizing again. This is because modern financial engineering decided to invent Asset Backed Commercial Paper - short-term debt issued in the name of assets(most usually property). The banks puts it assets in a bond(or securitize it like subprime bonds were)and allow investors to invest in the bond. The bonds maturity value is the value of the assets used to create the bond.

Perspective

The first one always gets higher the more severe deterioration occurs.

Trading

Short IBanks
Short Commercial Real Estate REITS
BUY Emerging Markets ETFs which shorts emerging market companies
Short Regional Banks, ie Regions in st. louis
Short Online AD Companies
Short Clothing
Buy CCU
Short CDS contracts of retail companies
Buy Swiss Franc, its a real asset

A Much Different World

It’s the official policy of the Federal Reserve to debase the currency,” Jim Rogers told Keith Fitz-Gerald in an exclusive interview published in the Rude Awakening this morning. “Washington has sent a very clear signal: ‘We want the dollar to decline. We’re gonna do our best to make it decline’…

“[Bernanke] and Greenspan together will probably bring [about] the end of the Federal Reserve. We’ve had two central banks in America that failed. This third central bank will probably fail, too, because of Bernanke and Greenspan.

“The Federal Reserve last week put $200 billion more onto its balance sheet of mortgages. Now I don’t know how big they can expand their balance sheet, but if they keep doing it, there’s only so much they can do. Maybe that balance sheet is infinite. I doubt it. And it can be said to be infinite; they just print money like Zimbabwe or someplace. But that has to come to an end, eventually…

“Well, everybody has to make their own decision. I’m trying to do what the Federal Reserve wants me to do, and I’m selling dollars… All Americans should…”

Iron (law of wages) Will

Any of us could have written George Will's column yesterday about Obama's "bitter" comment, perhaps Robot most easily: take some American history, sprinkle it atop conservative boilerplate about the "liberalism of condescension," and there you go.

Now let's take a peek at his Sunday column, "Horrors of a 'Crisis,'" wherein this salt-of-the-earth man of autonomy gives the entitlement-crazed masses a good dressing down:

The idea that protracted golden years of idleness are a universal right is a delusion of recent vintage. Deranged by the entitlement mentality fostered by a metastasizing welfare state, Americans now have such low pain thresholds that suffering is defined as a slight delay in beginning a subsidized retirement often lasting one-third of the retiree's adult lifetime.

It strikes me as funny that a man of supreme comfort like Will can talk down to "Americans" all day long, and then promptly write a column attacking Obama's "elitism" within a span of two days. His use of "delusion," "deranged," and "entitlement mentality" also pose problems for his jabs at liberals' (purported) belief in the "false consciousness" of the masses. Consider this passage from the anti-Obama column:

Obama's dismissal is: Americans, especially working-class conservatives, are unable, because of their false consciousness, to deconstruct their social context and embrace the liberal program.

Now look how easily it becomes...

Americans...are unable, because of [the delusion of entitlement mentality], to deconstruct their social context and [shut up and work].

People seem to go easy on Will, perhaps because unlike some conservatives in the media he can walk and chew gum at the same time. But the man's a douche, I say!

AIPAC Minus AIPAC Equals NOPAC

Finally. I urge people to sign up.

MBIA Downgraded

A rating agency, FITCH, downgraded MBIA two notches. It has lost its Triple A rating. The Fed's actions appear to have been band-aids; there is real reason to worry.

On a certain strand of conservative thinking about "expanded government power"

There are a number of interesting things about this New Criterion comment, not the least of which is the fantasy it gives rise to of seeing Lenin's reaction were he able to read of Eliot Spitzer being described as a "born-again Leninist." (Chief among Spitzer's upper-class social advantages is his father's net worth of half a billion dollars.)

But what this (no-doubt hastily written) piece of reactionary bellybutton lint really drives home for me is the utter bankruptcy of traditional conservative talk about the "expanded government power" of American liberalism. The author in question (probably Roger Kimball) makes all the usual connections between liberalism and Communism, totalitarianism, and collectivism, despite the fact that his main areas of concern are health care, taxes, food and drink, and tobacco, as if these constituted the thrust of Communist policy. (I can see the pamphlet now, circa 1930: "Toward a Dialectical Understanding of Cheeto Rationing in Elementary Schools.")

But this argument's "lack of purchase," to use the financial metaphor, has less to do with the inaptitude of its target than with the actual results of Republican policy over the last several years. Only the most disingenuous special pleading will allow taxation to fall within the boundary of "areas where [government] has no business intruding," while exempting spying, data mining, and civil rights curtailment, to make no extensive mention of acts which forcefully intrude upon our very bodies -- torture, detention, etc.

Such special pleading is typically justified by appeal to state security and the "unique powers" of the commander-in-chief during wartime. This supposedly "libertarian" theory of conservatism then has a fun time carving out pockets of exceptional circumstances from its purportedly "universal" championing of absolute individual liberty. My problem is not so much that some rights could be conceived of as subordinate or "lexically prior" to others (this is a staple of much Rawlsian argument, for example), or that Republicans per se are more prone to torture and death (this is a difference of degree rather than of kind from Democrats). What infuriates me is that the Republican position as outlined here is so blatantly a form of class warfare. Its drive to subordinate powers of life and liberty to a central executive authority is matched by a denial of that power of the state to alter positively the conditions of social life. It has broached the supposed "absolute standard" of individual liberties while maintaining a free market dogmatism completely at odds with its acknowledgment of the randomness and fragility of "free choice." Freedom is so obviously in the hands of the government, in an unchecked and quite terrifying way: yet we are told to conduct our business as though nothing were more important than the "free actor" being "responsible for himself." This is to say nothing of the positive extraction and transfer of wealth from lower to upper income brackets that tends to proceed under Republican administrations.

I'm quite open to the idea of free and autonomous transactions among individuals. But the blind approbation of such a concept -- in the face of a massive state apparatus regulating not only individual choices but the foibles of big capital itself -- is ridiculous without a more nuanced, party-transcending theory of society. (Surely some conservative thinkers realize this...?) The tendencies of climate change and the meltdown of the financial sector, where the socialization of risk is butting up against the unaccountability of private ownership more than ever before, can hopefully helpt to reverse and discredit this pernicious mindset. The New Criterion bit is low-hanging fruit but it's symptomatic of a larger discourse which, even if it's not making ludicrous claims about Spitzer being a Leninist, rules so much of our "common sense" talk about the welfare state.

Another bad political writing contest

What do decapitation, wine bottles, sledgehammers, firehoses, and cobwebs have in common? They're all in the lede to this atrociously mixed-metaphor-populated piece in Dissident Voice about Paulson's regulation plan. While I sympathize somewhat with the spirit of the article, I was completely distracted by the bizarre outpouring of images on display in every paragraph. I blogged about this sometime back.

Other examples:

"Many people still naively believe that planning their retirement should not have to be a Darwinian tussle with a crafty junk bond salesman."

"It was all part of Maestro’s 'New Economy': trickle-down Elysium, where the endless flow of low interest credit merged with financial innovation to create a Reaganesque El Dorado. There are no regulations in Eden; anything goes and to heck with the public, they can fend for themselves."

"Now it’s Paulson’s job to keep the neoliberal flame lit long enough to make sure that government busybodies and bureaucratic do-gooders don’t upset the applecart. That means concocting a wacky public relations campaign to convince the public that Wall Street is not just a pirate’s cove of land sharks and bunko artists, but a trusted ally in maintaining a strong economy through vital and efficient markets."

"Paulson should be removed immediately and returned to his wolf’s lair at G-Sax. If Bush is serious about straightening out Wall Street, then bring in Eliot Spitzer. He’s available. And he’ll do what it takes to clean house, that is, put a truncheon-wielding robo-cop in every trading-pit at the NYSE, and dispatch government accountants to every office of every CFO making sure they have a Big Red Pen in one hand and a taser in the other. That’s the only way to get the attention of the bandit class."

My personal favorite (deep breath):

"What nonsense. The house is on fire and hyperventilating Hank is still wasting our time with this rubbish. The real problem is that Paulson and his buddies at the Federal Reserve think of the financial system as their personal fiefdom so they refuse to loosen their hoary grip even though the economy is listing starboard and the water is flooding into the lower decks."

Because fiefdoms are on boats...? Sweet hyperventilating Jesus in a flaming sidecar.