Moon of Alabama Brecht quote
September 21, 2008

Declare All Credit Default Swaps Null And Void

Estimates on the productivity advantage of granite countertops and CDS' were too optimistic.


The Paulson plan is useless as it only tries to address the degraded value of Asset Backed Securities.

These are neither the source nor the reason for the very real threat of a total financial crash.

Credit Default Swaps of a nominal value of $65+ trillion are in real danger to implode any minute in a chain reaction that will take down half of the worlds financial infrastructure and impair the real economy for a long, long time.

There is only one possible way to avert this event:

International legislative action that immediately declares all Credit Default Swaps null and void.

Here is why:

At the bottom of the inverted financial pyramid are overvalued land, wood structures, dry walls and granite countertops - i.e. cheaply over-build houses.

These were sold to people who could only afford them with mortgages that had unrealistic starting conditions and on the premise that housing prices would continue to rise forever.

These mortgages were bundled, sliced and diced into Mortgage Backed Securities and sold to investors. Home equity loans, car-loans and credit card debt were converted to Asset Backed Securities and sold off.

On top of these MBS/ABS papers some geniuses constructed an additional financial layer. 

These were insurance contracts that covered against the default of ABS, MBS and various types of bonds. These insurance contracts, Credit Default Swaps, are totally unregulated private agreements. They were widely created and dealt with when the risk of default of the underlying papers was assumed to be low.

Some of the insurers who issued these CDS never had the capital to back all the policies they wrote. In a competitive environment they offered too low premiums to insure against default risks.

Some insurers partly insured themselves via reinsurance. When they sold a CDS on a bond issue of some $10 million they went to other insurers and bought themselves CDS, let's say $5 million or perhaps even for $20 million. The re-insurers partly re-insured themselves again by buying CDS elsewhere.

Some people simply betted on a change in the default risk of some bonds. They did not even own the MBS or bond in question, but bought or sold insurance against the default of a specific MBS or bond anyway. Some may have bought total insurance from different insurers in a way that a default of the MBS would pay them ten times the nominal value of said MBS.

Imagine you could have ten fire insurances on your home that would each pay out the full value of your house if it burns down. That would probably give you some very hot ideas.

That is exactly the reason why fire insurance regulation prevents such a case. But CDS are unregulated, their originators are unregulated and there is no settlement mechanism for them other than the private contracts between the parties.

The original size of the mortgages going into default are probably $300-500 billion. The total mortgage origination in the last years were a few trillion dollars. These and additionally credit card loans and auto loans that were converted to Asset Backed Securities in a volume of about $6 trillion.

But on top of these $6 trillion of MBS/ABS and bonds insurances, re-insurances and re-re-insurances were written with an estimated total nominal value of some $65+ trillion. The real number is unknown, but it is bigger than the whole worlds yearly GDP.

Now the housing bubble busted. There was simply too much supply created to sustain ever rising prices. Without rising house prices a lot of homeowners had to default on their mortgages.

With the mortgages going into foreclosure, the MBS and other asset backed papers where suddenly less worth than expected. This triggered credit insurance events. People who had bought the Credit Default Swaps suddenly demanded money from their insurers.

It turns out that these insurers, or their re-insurers, or whoever meanwhile carries the now negative side of the CDS in question are out of money and the insurance agreements are worthless. The worlds biggest insurer, AIG, was nationalized because it had written too much credit insurance for too low prices.

The big danger now are not defaulting homeowners. The big danger are not Asset Backed Securities that might lose some value.

The big danger is the pyramid of credit insurances that is certain to come down and that will take with it at least half of the existing finance infrastructure.

Banks, hedge funds, pension funds, municipals and others who bought insurance will find that it is worthless. Banks, hedge funds an others who sold insurances will find that they will have to pay out more than their total capital.

We currently see a credit-freeze because nobody wants to lend to anybody as it is impossible to know how much credit insurance the other party has written or how much it depends on their validity. You do not lend to anyone who might already be bust.

That is the situation we are in and it shows why the Paulson plan is utter crap and nothing but a huge robbery.

The Paulson plan would not help at the bottom of the inverted pyramid, the housing market, and not at the top, in the CDS market.

Paulson knows that the crash of the CDS market is inevitable. His plan is an attempt to let the taxpayer pay for the stabilization of the middle of the pyramid in the hope that the big crash will come only after the election (and in the hope that the loot might help Paulson's beloved Goldman Sachs to survive.)

There is only way to avert the crash.

Declare all CDS contracts, worldwide, as null and void. There is precedence for this:

During the Great Depression, many debt contracts were indexed to gold. So when the dollar convertibility into gold was suspended, the value of that debt soared, threatening the survival of many institutions. The Roosevelt Administration declared the clause invalid, de facto forcing debt forgiveness. Furthermore, the Supreme Court maintained this decision.

The maze of the value and ownership of $65+ trillion of financial credit insurance contracts has frozen the credit markets. Nobody is lending to anybody else because the value of the counterparty is in doubt.

Those $65 trillion reasons for the credit market freeze will never go away without a huge crash that then will have worth consequences than the 1929 stock market crash. The only way to eliminate these reasons is internationally concerted action to declare the legal obligations of all CDS' null and void.

At the same time:

  • all financial exchanges and markets of the world close for a week
  • CDS are declared null and void and new CDS creation is forbidden until new regulation is in place
  • the publicly dealt financial entities have seven days to figure out and publicly restate the value of their liabilities and assets excluding all CDS
  • a onetime windfall tax will be created that socializes overt advantages some entities will have from this
  • the proceed of that tax shall be used to prop up the capital of the big losers in a program comparable to the Reconstruction Finance Corporation of 1932.

To spend taxpayer money to buy up some MBS that lost value will do little to avert the coming CDS crash.

A $700 billion bailout can not save a unregulated $70 trillion CDS market that is under severe stress.

There is precedence that decisive legislative action can solve this really big problem. Unless this is done, all money to prop up the markets by whatever means is simply wasted and will make no difference in the final outcome of the crisis.

After CDS' are gone, Congress should set up a new Home Owners' Loan Corporation to solve the foreclosure problem and stabilize housing prices. This will then stabilize the MBS/ABS markets. Losses will have to be taken, but the catastrophe would be avoided.

If you are a U.S. citizen you may want to call your Congressmen and Senator on this issue. Monday morning might be a good time to do that.

Posted by b on September 21, 2008 at 17:42 UTC | Permalink


Just hold on, b, the Carpathia said it will be here by sunrise.

Paulson's (who, in fact wrote it?) "TARP" => Terrific Attack on Retirement Plans

Posted by: Cher Nobyl | Sep 21 2008 18:28 utc | 1

The Last Leaf


by: O.Henry

The following story is reprinted from The Trimmed Lamp and Other Stories of the Four Million. O. Henry. New York: Doubleday, Page & Company, 1919.

In a little district west of Washington Square the streets have run crazy and broken themselves into small strips called "places." These "places" make strange angles and curves. One street crosses itself a time or two. An artist once discovered a valuable possibility in this street. Suppose a collector with a bill for paints, paper and canvas should, in traversing this route, suddenly meet himself coming back, without a cent having been paid on account!

So, to quaint old Greenwich Village the art people soon came prowling, hunting for north windows and eighteenth-century gables and Dutch attics and low rents. Then they imported some pewter mugs and a chafing dish or two from Sixth avenue, and became a "colony."

At the top of a squatty, three-story brick Sue and Johnsy had their studio. "Johnsy" was familiar for Joanna. One was from Maine; the other from California. They had met at the table d'hote of an Eighth street "Delmonico's," and found their tastes in art, chicory salad and bishop sleeves so congenial that the joint studio resulted.

That was in May. In November a cold, unseen stranger, whom the doctors called Pneumonia, stalked about the colony, touching one here and there with his icy fingers.

[format corrected - b]

Posted by: Shilo Landon | Sep 21 2008 18:53 utc | 2

B - I am bowled over (again) by the breadth and depth of your knowledge, particularly U.S. history! Too bad you are not on Obama's payroll as his economic advisor.

I already wrote yesterday and today to both Senators and my Congressman urging them to have the courage to oppose Paulson's bailout proposal, and copying heavily from a letter that Numerian at The Agonist blog sent to Obama. link (Sorry - I am having trouble doing a hot link to this. [done - b])

I tried calling their offices today to see if anyone was working and, if so, how much mail or phone calls they were getting on this. No one there. (Perhaps not surprising, but I was told to be on call 24/7 all weekend...) I am curious how much they are hearing from the public on this. I'll try again tomorrow.

Posted by: Maxcrat | Sep 21 2008 19:06 utc | 3

wonderful, b.

Posted by: Alex | Sep 21 2008 19:13 utc | 4

wonderful, b. - I hope that's a compliment :-)

Posted by: b | Sep 21 2008 19:23 utc | 5

of course, b.

btw, I was trying to think of a good phrase that would not be misinterpreted by a non-native speaker of English, as you are (your English is nonetheless brilliant), but obviously my choice didn't work anyway!

Posted by: Alex | Sep 21 2008 20:03 utc | 6

International legislative action? Do we have an international legislature, or at least an international mafia that could substitute for a legislature?

These are not rhetorical questions, b. I would like to know how this "action" might occur. Where is the "Roosevelt administration" this time around?

You might argue that the world cannot let the U.S. fail, but it's not a U.S. failure that you're describing. Are there different levels of exposure in different countries?

Posted by: alabama | Sep 21 2008 20:19 utc | 7

thanks alex

maxcrat - Too bad you are not on Obama's payroll as his economic advisor.

He would probably lose with a loud mouth, officially social democrat/socialist adviser like me.

If he wins some ideas I have would likely benefit ordinary people.

All of that is irrelevant in an election where the democrats still allow 'cultural values' define things.

Posted by: b | Sep 21 2008 20:20 utc | 8

“This is the derivative nightmare that everyone has been warning about,” says Peter Schiff, the president of Euro Pacific Capital at the author of “Crash Proof: How to Profit From the Coming Economic Collapse.”

“They booked all these derivatives assuming bad things would never happen. It was like writing fire insurance, assuming no one is ever going to have a fire, only now they’re turning around and watching as the whole town burns down.” Buffett's swaps 'time bomb' goes off on Wall Street
Credit default swaps seemed harmless enough, but they've turned out to be 'financial weapons of mass destruction' Five years ago, billionaire investor Warren Buffett called them a “time bomb” and “financial weapons of mass destruction” and directed the insurance arm of his Berkshire Hathaway to exit the business.

Posted by: constant | Sep 21 2008 20:53 utc | 9

Naturally I need to weigh on what is being called the biggest “bailout in history”. I do not believe that is what is going down at all. Instead the US Government is facilitating the greatest asset grab of securities since Alexander Hamilton’s agents and cronies picked off the Continentals from the Rubes back in 1790. Hamilton’s associates (friends of Hamilton) did not pay anything close to par either, instead these Continentals went for enormous discounts. And Paulson’s new Leviathan hedge fund (the US Treasury) will end up paying deeply distressed prices as well. Therefore it is most important to follow the real bouncing ball on this, and not be fooled.
-Questions have been raised about all the derivative exposure out there. This was covered superbly in our last podcast starting at 12:30 by “Trader Joe” (you can hear the lead in to this starting at 6:30 of the free preview portion of the cast). Derivatives (mostly fictitious anyway just like the AAA ratings were) will be subject to novation, effectively renegotiated or even eliminated. Therefore billions in derivatives will go to money heaven also, and of course that will push more uninsured financial institutions into the Tar Pit. This will be conducted at run rate that can be effectively devoured by FOH, with Leviathan controlling the bleed rate. : Massive Bailout? Hardly, a Massive Tar Pit Instead : Novation is a term used in contract law and business law to describe the act of either replacing an obligation to perform with a new obligation, or replacing a party to an agreement with a new party. Novation is also used in futures/options trading markets to describe a special situation where the clearing house takes all positions with all the brokers, buying all the brokers sell, and selling all that the brokers buy. When selling brokers buy, buying brokers tend to sell. ... In business, novation is typically the process by which a newly formed corporation assumes the pre-incorporation liabilities incurred by its founders. Novation is also used in transactions through electronic exchanges.

Posted by: constant | Sep 21 2008 21:06 utc | 10

Want to see in graph form how bad it got and what spooked Paulson, Bernanke and company to act so quickly? Look at these graphs from my friends at Casey Research ( 30 day commercial paper went to 5% from 3% a week ago. The market was literally freezing. And the amount of paper issued is in free fall. Commercial paper is the life blood of the financial and business world. Without it commerce will soon grind to a halt.
We absolutely must move credit default swaps to a regulated exchange, no matter how much investment banks and hedge funds scream. Must be done. Do it now. Real rules about writing mortgages, although now that losses are in the hundreds of billions, underwriting rules are already becoming quite restrictive.

And while we are at it, a thorough revamping of the rating agencies and the rules they use should be at the top of someone's list. : Betting on Financial Armageddon by John Mauldin

Posted by: constant | Sep 21 2008 21:45 utc | 11

Meanwhile HP is sending the Global Mafia a warning.

Remember, our system is a global one, and I'm also going to be pressing our colleagues around the world to design similar programs for their banks and institutions where they are appropriate.

I am very curious what the response of our colleagues will be. Interesting and scary times in deed.

Posted by: PaulsFather | Sep 21 2008 22:45 utc | 12

Great Commentary b,

I predict a Black Tuesday

Posted by: | Sep 21 2008 23:02 utc | 13

Of course credit default swaps must be regulated and/or rubbed out with the big eraser of regulations and laws but of course it's not going to happen. Not for nothing is Obama's biggest backer a wall st banker. McCain won't get the rethug machine to lift a finger unless he, too financially illiterate to see what is happening, if he even cared, does as he is told. It appears every successful pol in washington is in hock to someone with an interest in making sure these ersatz 'securities' pay out.

So johnny amerikan citizen is going to see his hard earned taxed diverted from health and education into paying out the greedy crooks who conned him into taking out an unsustainable mortgage.
At the moment most citizens probably think that means they will be OK too.
I wonder how many johnny amerikan citizens have had the quiet space needed to think the thing through and see that the greedy gutses who have already robbed everyone blind destroying the financial system as they go, are going to turn a profit on this by trying to squeeze every dollar owed on the millions of 'wrong' mortgages.

If the fed hadn't underwritten the whole deal the banks or their receivers would have been forced to renegotiate every shonky loan, looking for a win win that would maximise the return while being no more than the mortgagee could afford.
This is no longer neccessary. Now that their losses are covered whatever happens, the loansharks usurers, call them what you will, can go for broke by squeezing every fast buck they can get outta the homeowners, then foreclosing to finish the deal off and claim any 'loss' ASAP. Before the trough runs dry. Free money like this never lasts forever.

The logic these same shits used to run about government intervention causing distortions and unforeseen circumstances that exacerbate rather than ameliorate a problem is going to be demonstrated for all the world to see. Yet nothing will happen. amerika's two party system virtually guarantees that any pol who stands up and says "the emperor has no clothes - we're getting ripped blind and we will pay and pay and pay" will be immediately crushed by the party machines and never work in this town (washington) again.

Otherwise the populists and renegade pols who live on the fringes of many political systems and who love pulling stunts so close to an election where neither party's platform is appealing, would be popping up promising to 'fix this' all over the joint.

But the two sides of the same coin party and the media conglomerates wouldn't let anyone remotely imagined capable of such a thing win office as a dog catcher.

In other words the same dynamic is afoot in amerika that is running in China over the poisoned milk scam, except China is moving forwards into a more open and responsive political structure whilst amerika is moving the other way - backwards into totalitarian rule by the elite.

Posted by: Debs is dead | Sep 21 2008 23:15 utc | 14

Yet nothing will happen. amerika's two party system virtually guarantees that any pol who stands up and says "the emperor has no clothes - we're getting ripped blind and we will pay and pay and pay" will be immediately crushed by the party machines and never work in this town (washington) again.

Can you say Eliot Spitzer??

Posted by: David H. | Sep 22 2008 0:16 utc | 15

Let's not forget>Deutsche Bank CDS exposure. They rank in top 5 biggest "counterparties."

Uh. Germans, too.

Posted by: slothrop | Sep 22 2008 0:26 utc | 16

After CDS' are gone, Congress should set up a new Home Owners' Loan Corporation to solve the foreclosure problem and stabilize housing prices.

Stabilize housing prices at what level? 1999, or 2006? ("Why do you hate affordable housing?")

One of the solutions to the foreclosure problem is to create house-slaves. Just what the doctor ordered for the predicted era of wrenching American economic change: a labor market that can't relocate. Aren't we supposed to be hating on Europe for labor inflexibility?

Many of the solutions to the foreclosure problem also keep the bid and ask in the housing market comfortably separated in the short term. Makes price discovery of 1999 take years.

Posted by: triangular gutters | Sep 22 2008 0:45 utc | 17

@ DavidH #15 - Yes, yesterday I was wondering if there was a connection between the silencing of Spitzer last winter and this fiasco. I wondered at the time about the timing of the revelations and effective termination of his public career.

Posted by: Maxcrat | Sep 22 2008 1:03 utc | 18

Foreign Banks Hope Bailout Will Be Global
Published: September 21, 2008

PARIS — The financial crisis that began in the United States spread to many corners of the globe. Now, the American bailout looks as if it is going global, too, a move that could raise its cost and intensify scrutiny by Congress and critics.

Foreign banks, which were initially excluded from the plan, lobbied successfully over the weekend to be able to sell the toxic American mortgage debt owned by their American units to the Treasury, getting the same treatment as United States banks.

Posted by: Sayet Aintzo | Sep 22 2008 1:28 utc | 19

david, maxcrat, the wapo article(or was it nyt?) he wrote was on feb 14th, within days he was busted.

i've posted it a few times, i could dig it up again.

Posted by: annie | Sep 22 2008 1:35 utc | 20

Oh yes - now I remember that article. Still, I remember at the time wondering if it really was that direct a cause and effect...just seemed so brazen. Guess I still had a few shreds of some kind of faith in people and systems back then. Seems so long ago now.

Posted by: Maxcrat | Sep 22 2008 2:01 utc | 21

He would probably lose with a loud mouth, officially social democrat/socialist adviser like me.

he'd get MY vote if he had a loud mouth, social democrat/socialist adviser like you.

Posted by: hipparchia | Sep 22 2008 3:05 utc | 22

@DiD #14

"...China is moving forwards into a more open and responsive political structure whilst amerika is moving the other way..."

China is doing no such thing. Read your own link for what typifies Chinese governance. That entire country has become a toxic hell-hole that spills over and kills people every spring when the winds blow sand from the Gobi desert and pick up unregulated heavy metals and other industrial pollutants. It's gotten so bad that they've started registering it on the west coast of North America in the past few years.

Look, I know how much you hate America and everything American, and I can usually temper your hyperbole... but to laud China as becoming progressive and "responsive" to to the needs of their people is nothing short of farcical.

Posted by: Monolycus | Sep 22 2008 4:06 utc | 23

...and just to check any ill-will before it occurs, I'm not just having a go at you, Debs. Your contributions here are some of the best. You write with your heart as much as you do with your head, and that's predominately a good thing.

I've no doubt, though, that you will not be able to get past the source of the message (an American) when I say (because I care), you should be careful about trying to make qualitative comparisons when your bias is as deep as it is. There were many industrial villages in the former USSR where cancer was the only cause of death, but that doesn't keep many from imagining them to be leftist utopias.

I have as many deep seated resentment against American policies as you do... maybe more. However, my resentments do not change bad, unresponsive governments into good ones.

Posted by: Monolycus | Sep 22 2008 4:43 utc | 24

Big Financiers Start Lobbying for Wider Aid

The scope of the bailout grew over the weekend. As recently as Saturday morning, the Bush administration’s proposal called for Treasury to buy residential or commercial mortgages and related securities. By that evening, the proposal was broadened to give Treasury discretion to buy “any other financial instrument.”

The lobbying became particularly intense because Congress plans to approve a package within just two weeks, without the traditional hearings and committee process.

“Of course there will be fierce lobbying,” said Bert Ely, a financial services industry consultant in Alexandria, Va. “The real question is, Who wouldn’t want to be included in the package?”

Mr. Ely said the open-ended nature of the Treasury’s plan could be interpreted to mean that the government was open to acquiring “any asset, anywhere in the world.”

“The question that I am raising — is there any limit?” Mr. Ely said.

Each part of the financial industry is pursuing its own interests.

Posted by: b | Sep 22 2008 5:29 utc | 25

Misdirected Credit Runs Unabated by Doug Noland who for years saw this coming. (scroll down for the analysis part)

A massive inflation of government obligations; a major government intrusion into all matters financial and economic; and an unprecedented circumvention of free market forces have been unleashed – but to what end? I believe it is a grave predicament that such a rampage of radical policymaking has been unleashed in order to maintain inflated asset markets and to sustain a Bubble Economy. Normally, such desperate measures would be employed only after a crash and in the midst of a major economic downturn – not in efforts specifically to forestall the unwind. Not only will such measures not work, I believe they will only exacerbate today’s already extreme Global Monetary Disorder. They will definitely worsen the inevitable financial and economic dislocation.
The current direction of Bubble-sustaining policymaking goes the wrong direction in almost all aspects. At some point, the markets will recognize this Bubble Predicament, setting the stage for a very problematic crisis of confidence for the dollar and our federal debt markets.

Posted by: b | Sep 22 2008 5:51 utc | 26

Barclays and Nomura make promises about fate of Lehman Brothers staff

Last week Barclays paid $1.75 billion to buy Lehman’s North American investment banking and capital markets business. It emerged over the weekend that Barclays had agreed to pay $2.5 billion in bonuses to Lehman bankers in the United States in a move that has angered stricken staff in London.

Posted by: b | Sep 22 2008 6:11 utc | 27

The 'notional amount' of CDS swaps isn't especially interesting, insofar as the full notional is rarely in jeopardy. A CDS is more akin to a low-delta option than a true swap. The real 'value at risk' is much smaller. And tens of trillions of those CDS agreements are in unrelated healthy markets (banks represent only 6% of global CDS exposures.)

Posted by: vaudois | Sep 22 2008 6:20 utc | 28

Imagine you could have ten fire insurances on your home that would each pay out the full value of your house if it burns down. That would probably give you some very hot ideas.

That is exactly the reason why fire insurance regulation prevents such a case.

Except CD Swaps in the vast majority of cases don't affect the likelihood of default, (except perhaps in massively leveraged industries wholly dependent on capital markets for solvency.) The largest CDS market is in government issues.

Posted by: vaudois | Sep 22 2008 6:29 utc | 29

A question taking your analogy of the house insured 3x for fire. And lets assume that the house is already twice overvalued by the bubble. Would it not be cheaper to keep from having to pay out on the fire insurance by not setting the house on fire? Why not just service the underlying house and not have the insured event occur at what would be 1/3 the cost of the fire?

Is the monstrous mechanism created by the asset and mortgage backed securities fundamentally impossible to unravel from the securities end and can only be taken apart from servicing the constituent assets?
If the securities consist of a mystery meat mix of variety of ingredients, when does the meat go bad? When all or majority of the ingredients go bad? And wouldn't the ingredients be in other mystery meat products? Have these financial geniuses designed something that only works if properly serviced, but can not be taken apart to preserve edible portions?

Posted by: YY | Sep 22 2008 6:44 utc | 30

whoops your example was 10 x insured.

The way I see it if one were to spend 700 billion, wouldn't it be more effectively spent by retiring 20% of every recent residential mortgage issued until 700 billion is reached.

Posted by: YY | Sep 22 2008 6:47 utc | 31

Except CD Swaps in the vast majority of cases don't affect the likelihood of default, (except perhaps in massively leveraged industries wholly dependent on capital markets for solvency.)

That would be the current financial industry: AIG, F&F, Morgan, Lehman, ... BofA, Deutsche ... - a massively leveraged industries wholly dependent on capital markets for solvency



Roubini: The shadow banking system is unravelling

The next stage will be a run on thousands of highly leveraged hedge funds. After a brief lock-up period, investors in such funds can redeem their investments on a quarterly basis; thus a bank-like run on hedge funds is highly possible. Hundreds of smaller, younger funds that have taken excessive risks with high leverage and are poorly managed may collapse. A massive shake-out of the bloated hedge fund industry is likely in the next two years.

Even private equity firms and their reckless, highly leveraged buy-outs will not be spared. The private equity bubble led to more than $1,000bn of LBOs that should never have occurred. The run on these LBOs is slowed by the existence of “convenant-lite” clauses, which do not include traditional default triggers, and “payment-in-kind toggles”, which allow borrowers to defer cash interest payments and accrue more debt, but these only delay the eventual refinancing crisis and will make uglier the bankruptcy that will follow. Even the largest LBOs, such as GMAC and Chrysler, are now at risk.
European financial institutions are at risk of sharp losses because of the toxic US securitised products sold to them; the massive increase in leverage following aggressive risk-taking and domestic securitisation; a severe liquidity crunch exacerbated by a dollar shortage and a credit crunch; the bursting of domestic housing bubbles; household and corporate defaults in the recession; losses hidden by regulatory forbearance; the exposure of Swedish, Austrian and Italian banks to the Baltic states, Iceland and southern Europe where housing and credit bubbles financed in foreign currency are leading to hard landings.

Thus the financial crisis of the century will also envelop European financial institutions.

Posted by: b | Sep 22 2008 8:18 utc | 32

Goldman, Morgan Stanley to become regulated banks

Goldman Sachs and Morgan Stanley, the last surviving big investment banks on Wall Street, have become regulated banks.

In a statement issued at 9.30pm Sunday, the Federal Reserve said it had approved their applications to become bank holding companies, subject to regulation by the Fed.

During the transition period, the Fed will make loans to both entities and to the broker-dealer subsidiary of Merrill Lynch against collateral acceptable for posting either by a bank or a securities firm.

Aside from other issues with this, Goldman and Merrill will now have to deleverage from a 20:1 debt/capital ration to a 10:1 ratio.

That will again squeeze asset markets.

Posted by: b | Sep 22 2008 9:05 utc | 33

why is everybody saying the following? ".. Commercial paper is the life blood of the financial and business world. Without it commerce will soon grind to a halt."


You think that just cause money paper is worthless that people will no longer sell what they have produced??

You think that just cause paper money is worthless that people won't buy stuff they need??

Wake the F*ck uP!!!

Commerce will happen, either thru bartering, exchanging anything of value may it be gold, silver, water, food, tools etc...

It actually could be best thing that happens to society and the world..

will it be inconvenient?? yes at first.. but the tools available on the internet make this very possible..

think of ebay on a much grander and more flexible scale. New currency systems, more efficient exchange of goods..possibilities are limitless

The best thing would be is to get the banksters out of the transaction business.

And besides when you play the market like the pension funds did.. well there are down sides to gambling.. a lesson needs to be learned

this ain't the end of the world people!


Posted by: | Sep 22 2008 9:27 utc | 34

I once read (can't remember where) a description of what it was like trying to run an economy without paper money (in the Great Depression): it was like trying to bake a cake when you have all the flour, sugar, butter, and eggs you need, but you don't have any ounces, cups, or pounds.

Posted by: catlady | Sep 22 2008 15:24 utc | 35
Demand that the Bailout Legislation Be Rejected

Posted by: b real | Sep 22 2008 15:55 utc | 36

"Up to 10,000 staff at the New York office of the bankrupt investment bank Lehman Brothers will share a bonus pool set aside for them that is worth $2.5 bn, Barclays Bank, which is buying the business, confirmed last night."

The next time the laissez-fairy taps me to run one of her supposedly bulletproof corporations, believe me, I'll make sure to set aside a huge chunk of change for me and my corporate cronies so that when our corporation crashes and burns, we can still walk from the carnage filthy rich!

Apparently I'm missing something really big here because it's beyond me how anyone can have much of an incentive to keep their corporation afloat if they still profit big time by driving it into the ground!!

Regardless of what's really going on on laissez-faire-land, no one in their right mind can dispute the fact that moral hazard has gone out the window with public outrage nowhere in sight!!!


Posted by: Cynthia | Sep 22 2008 16:04 utc | 37

Just talked to a staffer in my Congressman's office who said they have had a LOT of calls this morning about the Paulson plan/Wall Street bail-out, virtually all of them hostile to it, and some of them so angry the fellow said he had to "hold the phone away from his ear". Not sure it will all do any good, but at least we can try. The Congressman hasn't taken a position yet! Another profile in courage.

Posted by: Maxcrat | Sep 22 2008 16:36 utc | 38

The big danger now are not defaulting homeowners. The big danger are not Asset Backed Securities that might lose some value.

The big danger is the pyramid of credit insurances that is certain to come down and that will take with it at least half of the existing finance infrastructure.


Isn’t it great to have an intelligent host?

thanks to b for all of it.

Posted by: Tangerine | Sep 22 2008 19:20 utc | 39

Ditto others comments regarding you understanding of the current economics problems and proposing a worthwhile solution. I forwarded it to my congressmen via

Posted by: steb | Sep 23 2008 3:40 utc | 40

inner city press: Bernanke Claims Fed Not to Control AIG, Justifies Morgan and Goldman Exclusion of Public, CRA

WASHINGTON DC, September 22 -- "We don't own AIG or have authority over its subsidiaries," Federal Reserve chairman Ben Bernanke said Monday at the Fed's Washington headquarters. Inner City Press asked him if it is correct that any other entity which wanted warrants for 79% of the stock of AIG would have to apply for approval, with a public comment period subject to the Community Reinvestment Act.

Bernanke shrugged and said that CRA should be consider all the time, not necessarily on mergers and acquisitions. But that's when the CRA statute says it must be considered, Inner City Press pointed out, as CRA's only enforcement mechanism. "I don't think that rule makes a lot of sense," Bernanke said. But it's not a rule, but the law, as formally interpreted in 1994 by then U.S. Solicitor General Walter Dellinger. Click here for the government memo.

To the Federal Reserve at present, it appears, the law is just a hindrance and "not very effective," as Bernanke put it on Monday. Inner City Press asked under what authority the Fed had made Goldman Sachs and Morgan Stanley into bank holding companies on Sunday night, without any public notice or comment, including under CRA. We have emergency powers, Bernanke replied, though none were cited in the Fed's Sunday night press release.

Posted by: b real | Sep 23 2008 4:46 utc | 41

Yeah I wondered about that, since when can an entity just declare itself to be a commercial bank?

Posted by: YY | Sep 23 2008 7:39 utc | 42

Just watched Boston Fox News, Tuesdays' include an on location political chat called The Heavy Hitters cause it's a hefty reporter + heftier Boston Herald columnist + B. Phoenix owner/editor. The last suggested a "bailout czar" to make the rules and enforce them, others said yeah yeah.

Eliot Spitzer? Short memories only excite if prodded, and longer memories classify him as tough on financial shenanigans. Bankers may not object to him as much as you might expect, taking their medicine with an inside man.

Posted by: plushtown | Sep 23 2008 11:46 utc | 43

Outstanding analysis. Scary as all get out, but accurate. We do need a 'credit holiday' and declaration that the paper tower is utterly invalid. Samuel Insull brought such a house of cards down in the early part of the 20th century with his bogus energy pyramid - all paper, no real energy generation.The collapse of his Ponzi scheme, similar to today's pile of paper, had a ripple effect that contributed to the crash of '29. Only the radical intrusion of government regulation to end the drain on money and real wealth slowed and finally stopped the disaster. We need real intervention, and this article is the first assessment of what must be done and how.

The problem, of course, lies in securing cooperation from other nations.Perhaps it will be obvious that they need to participate, since today it's not just nations looking out for themselves but the whole global system that is dreadfully interlocked and therefore even more fragile.

I fear we're just seeing the tip of the iceberg. What helped to bring us out of the Depression in the 30s was our nation's basic wealth (versus riches) that lay in producing needed goods with basic manufacturing, but we've torn that down.

We will need to have each nation regain a measure of productive self-sufficiency - what productive base we have must be expanded once again, and other nations need to begin rebuilding their own economic self-sufficiency. The strength of any nation must rest on its internal well-being first, then you can add trade. We have made America weak - and other nations, even China, are equally weak because they are not self-reliant but dependent on outside capital and markets. Without resorting to plunder, each nation must regain a significant measure of economic and political autonomy. If we do not utterly change our priorities, we will all collapse under the weight of this dreadful house of cards.

Posted by: choicelady | Sep 24 2008 5:25 utc | 44

It's the jooz, stupid! The sooner we extract jooz from government, finance and the media the better the USA! Jooz are the maggots of the human race!

Posted by: walt235 | Sep 24 2008 8:37 utc | 45

The notional amount of CDS is in the trillions but how much cash (premiums) actually changed hands? Declaring them null and void is the doomsday scenario Paulsen and his cronies fear--because it will actually leave them holding the (very small, but personally meaningful) bag.

This is the most rational and effective step Congress can advocate in today's environment. And then get ready to actually handle "real" problems (unemployment, bank closures, etc.) that result.
No one has the stones to do this, though.

Posted by: tom elliott | Sep 30 2008 23:48 utc | 46

Solution for Credit Fault Default Crises - (Slightly milder than yours)

• Credit Defaults Swaps are:
- “WMD’s” – Warren Buffet
- Unknown and unregulated – Ben Bernanke
- Insurance based on actual bonds, stocks, etc. - ~$6T (1)
- Bets without any underlying paper – US$45T to US$62.2T less US$6T (2)
- Comparable to the world economy - ~US$65T (3)

• Declare, by legislation, or appropriate government decree, that these contracts have no standing in any court of law unless they are part of a transparent, regulated market
- Holders of existing CDS that do not want to enter into the market can either tear up CDS or get fees returned from CDS vendor.
• Create said market, allow time period for CDS to enter with at least two types:
- Product backed
- Non-product backed

• Creation of transparent, regulated market
• Method of regulation for all future creative financial products


Posted by: Padraic | Oct 5 2008 20:00 utc | 47

I haven't been past this thread in a while and I just wanted to respond to Monolycus's comment that my claim China was becoming more open and responsive is fallacious. I still stand by what I wrote, not because I hate amerika but because I have been China watching for a while now and that includes discussing these issues with Chinese people who see the same thing. China is becoming more open. I will try and explain.

No one is denying that China has been eating itself up destroying the environment with unsustainable practises. Local people (particularly rural people without rights to even go into a city) have been getting shat on from a great height, and they are making it plain that they aren't prepared to allow this to continue. The problem dates back to pre Mao days.

In 1949 Mao incorporated many of the feudal warlord areas into so called 'communist china' rather than fight them. He planed on bringing them down over time, and the cultural revolution was partly, part of that. But of course people being people, the usual thing happened. The regions became somewhat more egalitatrian but the the feudal ways also penetrated the national structure. Dialogue and compromise are two way streets.

Regional corruption continues to this day.
The milk poisoning is a classic example where regional government using the pretext of not wanting a scandal in the year of the Olympics hid the situation from central government and let the poisoners continue to make huge profits, permanently damaging some 38,000 children.

However this will not be covered up as it would have been once. In the past central government would have dealt with it 'quietly' so as not to disturb the people. But now central government recognises that the ordinary citizens are their best allies in fighting the power of the regions.

There is an acknowledgement at national level that the oppressive and corrupt practises at regional level must be squashed or otherwise the people will rise up. On the other hand national pols come from regions so not all of them have a huge commitment to reform. Thus far though the reformers have held the upper hand.

When the tibetans rose up and began murdering Han Chinese in Tibet the first consideration by the central government was for a cover up. Save international embarassment and let the local authorities resolve the situation with realpolitik. The chinese people wouldn't stand for that and began a grass roots campaign to bring the 'tibetans to justice'. Although my personal sympathies are with the indigenous tibetans, we have to acknowledge that the central government did force the Tibetan regional government to abide by the will of the chinese people. Something that would never have happened a few years ago.

The same with corrupt land seizures. They may still continue but at a much smaller rate than before. The Chinese government recognises it must stop the most brutal oppressions if it wants to keep control and it has been doing that.

We all know how this works, (as do the Beijing power brokers) Bit by bit little by little one reform leads to another. Just as going the other way from an open society into a controlled oppressive one is also done in stages. A.Hitler didn't begin in 1933 as he finished. The process of stifling dissent, then introducing more oppression to silence the next level of opposition then concentrating more power, then stifling dissent, then introducing more oppression to silence the next level of opposition then concentrating more power is a process, not an instant 'whisk up a fascist state' solution.

That is why I say "China is moving forwards into a more open and responsive political structure whilst amerika is moving the other way - backwards into totalitarian rule by the elite."

I am happy to respond to criticisms which address issues Monolycus, it is the silly ad hominem laced tirades I no longer respond to. Not because I consider myself above them, but because I find it too easy to slip into that ugly and pointless style as well.

Posted by: Debs is dead | Oct 5 2008 21:16 utc | 48

Crooks and Liars website has the 60 Minutes segment that explains the Credit Default Swaps in "main stream media speak".

60 Minutes - Wall Street's Shadow Market

Posted by: gus | Oct 6 2008 15:24 utc | 49

Interesting suggestion however it is flawed. First, separate the relatively low proportion of CDS that are written against toxic US mortgage-related debt and lenders from the CDS that are written against (e.g.) the Government of Germany, Ford, Sony, BHP Billiton etc. These institutions are sufferring from the economic slowdown but are unlikley to implode in the Lehmann Brothers fashion.

Second, CDS and bond positions are interlinked. Cancel ALL the CDS and you leave anybody investing in bonds (e.g. pension funds) directly exposed to default of the bond issuer, especially the lower credit rating ones.

Third, practically, No CDS and every single financial institution in the world would be faced with completely re-balancing their books by year-end, somehow offsetting their credit risk liabilities using.... what? T-Bills ? Operationally this is a nightmare.

Fourth, most banks have existing hedging strategies in place for their CDS. The big issue is concentration of risk with a counterparty that fails, which is equivalent to the credit risk in holding any portfolio of anything.

Fifth, bear in mind that everybody that sells protection receives an income on each CDS contract. Remove that income stream and look how much extra pressure you are piling up on the financial system, where the big problem at the moment is obtaining funds to service existing obligations. Are you also going to cancel all the liabilities that were expected to be funded using incoming cash from the CDS?

Finally, I hope walt235 is making a poor-taste joke that you are choosing to ignore, otherwise your site is gonna get added to so many exclusion lists....

Posted by: Tom | Oct 7 2008 18:16 utc | 50

Some quite knowledgeable folks start to agree with me:

Instead of a vague, voluntary program to allow banks to tender assets to the Treasury, we believe that the Congress must eventually legislate a mandatory exchange program to remove all of the extant CDS and complex structured assets from the global financial system. So serious and enduring are the negative effects of financial cancers such as CDS and complex structured assets, in our view, that the only way to save the patient - that is, the global economy and financial system - is mandatory surgery.

Posted by: b | Nov 20 2008 9:49 utc | 51

Same source as above, Institutional Risk Adviser, on What Barack Obama Needs to Know About Tim Geithner, the AIG Fiasco and Citigroup

As part of the presentation (Page 17-21), IRA co-founder Chris Whalen argued the case made by a reader of The IRA a week before (see “New Hope for Financial Economics: Interview with Bill Janeway,”) that until we rid the markets of CDS, there will be no restoring investor confidence in financial institutions. Here is how we presented the situation to about 200 finance and risk professionals in the auditorium of JPM last week. Of note, nobody in the audience argued.
The bailout of AIG represents the last desperate rearguard action by the CDS dealers and the happy squirrels at ISDA, the keepers of the flame of Wall Street financial engineering. Hopefully somebody will pull President-elect Obama aside and give him the facts on this mess before reality bites us all in the collective arse with, say, a bankruptcy filing by GM (NYSE:GM).

You see, there are trillions of dollars in outstanding CDS contracts for the Big Three automakers, their suppliers and financing vehicles. A filing by GM is not only going to put the real economy into cardiac arrest but will also start a chain reaction meltdown in the CDS markets as other automakers, vendors and finance units like GMAC are also sucked into the quicksand of bankruptcy.

Posted by: b | Nov 24 2008 16:11 utc | 52

Institutional Risk Adviser:

Bank Stress Index Up in Q3; Will the Final Solution for CDS Start in EU?

We hear from a very well placed Buy Side investor with extensive business interests in the US and EU that three primary banking institutions in Europe, two French and one German, have such significant CDS exposure and other problems that they cannot even begin to fund the payouts anticipated over the next quarter.

The funding squeeze reportedly is exacerbated by a near-collapse among weaker players in the hedge fund market, who were accustomed to receiving loans from one large French institution, which then stupidly converted the loans into equity. That's right. This past summer, when the bank put out a call for redemptions of $4 billion in hedge fund investments, says the source, only $400 million was returned. And the French bank also used these same hedge funds and others to reinsure some of its own CDS exposure. Sound familiar? Yup, just like AIG.

Unlike the approach taken by Paulson and Geithner to bailout AIG and JPM (via the Bear Stearns rescue), however, the investor claims that EU officials are considering a moratorium on CDS payments by the three Euroland banks in question. The banks would be given ten years to write down their CDS and hedge fund exposures and would receive additional infusions of capital by their respective governments. The source claims that French banks have such huge exposure to both hedge funds and CDS, sometimes linked together, that the positions are beyond the ability of the EU governments to bail them out without a cessation of CDS payments.

The IRA was not able to obtain a comment from EU officials over the weekend about these allegations. We'll be making some calls Sunday night and Monday. But if this unconfirmed report turns out the be true, then the beginning of the end of the CDS market as we have known it will be at hand. And ironically, the catalyst for the final solution will come not from the failure of a US dealer, but instead by a moratorium on CDS payments by an EU bank.

Posted by: b | Dec 1 2008 8:47 utc | 53

Rick Bookstaber:

In academic theory, derivatives and swaps are intended to help "span the state space"; that is, they are intended to allow investors to efficiently hedge their specific risks, to more precisely meet contingencies of the market, and to mold their returns to meet investment objectives.

In practice, however, swaps and derivatives are often used for less lofty purposes. They are used to: avoid taxes (for example, total return swaps are used to take positions in UK stocks in order to avoid transactions-based taxes); take exposures that are not permitted in a particular investment charter (for example, index amortizing swaps were used by insurance companies to take mortgage risk); speculate (for example, the main use of CDSs is to allow traders to take short positions on corporate bonds); lever beyond an allowed level; and take risk off-balance sheet, where it is not as readily observed and monitored.

Posted by: b | Dec 1 2008 12:37 utc | 54

Insight: Annihilation on Main Street

In a disturbing new trend, international banks are creating syndicated credit facilities that “weaponise” credit default swaps (CDS) by using the trading price of a borrower’s CDS to set the interest rate paid by the borrower. Unfortunately, banks don’t understand that they are arming speculators to ambush and kill unsuspecting and otherwise healthy companies. Regulators are oblivious to this danger as are the victims.
Recently, it was reported that banks have started tying commercial loan interest rates to the price of a borrower’s CDS. This seemingly innocuous loan provision allows speculators to bet that a borrower’s stock price will go down while insuring that the bet pays off by manipulating the borrower’s CDS prices upward.

Higher CDS prices increase the borrower’s interest expense and destroy its earnings per share. Dropping earnings per share cause the borrower’s stock price to fall, which means that speculators make money on their bet that the borrower’s stock price will decline. This new bank interest rate provision is like selling fire insurance to arsonists and then giving them cans of petrol to burn down the neighbourhood.
The unintended consequences of using CDS for dynamic credit pricing are predictable, unnecessary and dangerous. Regulators must get these financial weapons away from economic arsonists immediately and ban the tying of loan interest rates to CDS prices. And, policymakers need to think clearly about why it is “good” to allow speculators to make naked bear bets on companies and then “shave the odds” by trading in the unregulated CDS market. Substantive regulation of CDS is needed immediately before unsuspecting companies are destroyed.

Unlike the author, I do not think that banks don't understand what they are doing with this. They fully understand this and will speculate against the companies they give loans to. A fine way to rob main street.

Posted by: b | Dec 2 2008 11:35 utc | 55

In the Financial Times (!)

Put the credit default swaps market out of its misery

For several years, I have been among those calling for thoughtful, prudent, moderate steps for the reform of the credit default swaps market. They should be put on exchanges, put through central clearing houses, settlement backlogs reduced and then eliminated . . . etc.

I was wrong. The global credit default swaps market should just be liquidated, the contracts allowed to expire and the booby traps defused. Where they can't be defused, they will explode, and we will have to deal with the loss of capital and litigation.

Essentially, while the back office messes of the CDS market are being cleaned up, that leaves the question of why we need these things. We don't. The outstanding credit default swaps should be offset against each other, where possible, and the rest allowed to run off or be paid out as defaults occur.

Posted by: b | Dec 9 2008 12:32 utc | 56

Well, yes, b: your solution is obvious, or as Chomsky would say, "trivial," as would be the enactment of a "Tobin tax" on all financial transactions.

I think the point is that these vehicles were designed to "blow up," resulting in the "necessary" transfer of wealth from public to private corporate control, "for the public's protection," of course.

Posted by: Malooga | Dec 9 2008 12:57 utc | 57

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