Moon of Alabama Brecht quote
October 14, 2008

Financial Markets: What's Next?

The social conservatives conservative socialists have now partly nationalized the major banks. That seems to have been the right thing to do, though I would have liked more strings attached to the move.

But what's next?

The stock markets have regained a bit and some lending may eventually restart, but the underlying problems have yet to be solved.

There have been some $650 billion of losses from mortgage lending recognized within the banking system, but the IMF expects the total losses to be $1.4 trillion. When these additional losses will get recognized all the capital the governments just injected in these banks will not be enough to make up for them. The situation will then be the same as it was last Friday and require additional capital injection.

The shadow financial system of hedge funds and private equity funds still exists and will need to further deleverage to eventually dissolve. This guarantees another two to four quarters of quite massive selling in about any asset class but, maybe, treasuries.

The Main Street economy will go deep into recession and there are yet no plans on how to soften the fall and eventually restart growth. A big infrastructure program would certainly help. (For my country, east Europe and Russia: a new fast-freight railroad from Hamburg to Shanghai.)

The collateral damage on pension funds, the Federal Deposit Insurances Corp, municipal funds etc is immense. Is there a way to repair them or do they need to be replaced?

All of the bad side effects from these current gigantic interventions need to be cleaned up. LIBOR manipulation is only one of them. The Fed and other central banks will need to mop up the additional liquidity they injected before it ignites serious inflation.

What we have seen so far can be exaggerated as 'the poor got robbed so the rich can make more loans to the poor.'

Where is the social benefit?

Can we please have a plan for a financial system that is a service to the economy and not a drag -  not a monster that depends on over-leveraged quant strategies nobody really understands?

This one sounds good to me:

[Berkshire Hathaway's vice chairman] Munger wants Wall Street balance sheets reduced by 70% and insists that the firms "be a market maker, a broker, an underwriter and a custodian of securities but not the hedge funds they have become." He wants to restrict leverage to 50% on every securities transaction except for the Treasury trading desk where "you're dealing with the safest securities around."
...
To rid Wall Street of its Las Vegas tone, Munger suggests leveling the options exchanges in Chicago and New York, and banning completely all derivatives contracts, a rather impossible vision but one that's true to his spirit.

Banning derivatives is certainly not an impossible vision. Declare them illegal and send anyone to jail who uses them anyway. But even if we have plans to make banking as boring again as it should be, how do we get from here to there?

There seems to be no unified plan yet on how to tackle all the above problems. I am afraid the only idea people will come up with is to again inflate the system and feed cheap money into it until another bigger bubble of fantasy profits forms somewhere (alternative energies are a candidate). That was the Greenspan strategy which created the current problems.

The politicians seem to believe that now all is well and we can go again down the same old path. That is wrong and we need better ideas. Those ideas will a first view seem radical or shrill. But a year ago socializing Wall Street was a shrill idea too.

I'll try to come up with some policy ideas over the next days. Any suggestions are welcome. What are your's?

Posted by b on October 14, 2008 at 17:33 UTC | Permalink

Comments
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[deleted two troll comments - b]

Posted by: b | Oct 14 2008 19:46 utc | 1

so if we're going to ban leverage, does that mean we also ban foreign exchange trading? Because every single one of those trades is a forward, which are illegal in the New World Order. And so of course are bond futures. So if you need to protect yourself against a rise in interest rates for any purpose whatsoever, you'd better have a lot of cash on hand to post margin to short real treasuries (money you can taste!)

Actually, I think youd better just do away with hedging altogether, since practically all hedges involve huge amounts of leverage. Yes, no more hedging. investors should just have to kind of "roll the dice" and go for it if they buy into some asset with a lot of scary economic risks. Thats what warren buffett thinks anyway, and he's rich, so he must be a genius.

Serious question, before you ban those too.

Posted by: Banaholic | Oct 14 2008 19:57 utc | 2

Big infrastructure program...or the next big bubble?


A New Bank to Save Our Infrastructure
...
In a world of $4-a-gallon gas and $40,000-a-year college, raising tolls will be unpopular with many families, whether poor or well-to-do. But we must either accept congestion and delay—together with ever more deteriorating and dangerous infrastructure—or use tolls to limit public use while providing a new source of revenue for transportation improvements.
...
The central idea of the CSIS commission proposal is to establish a National Infrastructure Bank, an institution that would be similar to the World Bank, a private investment bank, or any other entity that evaluates project proposals and assembles a portfolio of investments to pay for them. Traditionally, public financial institutions such as the one we propose are created to correct problems in capital markets, whether they be the failure of markets to fund projects that support development in the world's poorest nations or their undue pessimism regarding the long-term solvency of a particular city or state government. This is not the case here. State and local governments generally can borrow for infrastructure purposes in line with their ability to service debt and the strength of their credit ratings. The issue here is not the efficiency of capital markets but rather the efficiency with which federal programs work and spend funds. The purpose of the National Infrastructure Bank would be to use federal resources more effectively and to raise additional funding. We propose this bank because we believe that markets for capital do work and can be harnessed to solve the critical shortfall in funding infrastructure.
...
According to our plan, most of the funds the federal government now spends on existing programs (along with many of those program's experts and facilities) would be transferred to the bank, which could not only finance the projects but also resell the loans it makes to investors in capital markets, much as other assets are rebundled for investors. The receipts from these sales would allow a new round of lending, giving the bank an impact far in excess of its initial capitalization.


http://www.nybooks.com/articles/21873

Posted by: Tom | Oct 14 2008 19:57 utc | 3

Don't buy the headlines b! Nationalized? Not! That's the cover for the give away in the US, but without any say in running the banks it is just a give away. The banks were "forced" to accept terms vastly more favorable to them than the Buffett deal with GS. Yeah right.

Posted by: jeff65 | Oct 14 2008 20:10 utc | 4

[deleted two troll comments - b]

how sad...clearly our host is a sad little man with a brittle ego. and he has no idea why derivatives exist, why they have always existed, and why they will continue to exist with or without his comprehension of them.

You need to pick up a book or two, "b" and read up on all this stuff you'd like to ban willy nilly, and try to fathom why your ham-fisted idea to ban leverage and derivatives- admittedly based upon insecurity and ignorance - is so very silly.

>not a monster that depends on over-leveraged quant strategies nobody really understands?

Speak for yourself!!

Posted by: An honest quant | Oct 14 2008 20:18 utc | 5

@ 5 "Sad little man..." -- that's crapola! Your ad hominem attack is without any content or argument.


Posted by: Chuck Cliff | Oct 14 2008 20:43 utc | 6

Your ad hominem attack is without any content or argument

Hmmmm as if slurring the integrity of a whole industry isn't ad hominem? As if calls to ban entire industries because you find them complicated has "content?"

Am I calling for the criminalization of blogging? What if someone proposed to ban whatever it is you do for a living? Do you think you might take it a bit personally?

Posted by: an honest quant | Oct 14 2008 20:53 utc | 7

@6&7

Man, this is really hotting up!

Posted by: Spyware | Oct 14 2008 20:59 utc | 8

It never ceases to both amuse and irritate me when folks drop by with their life doctrine and proceed to shit the floor and then expect our host to be gracious and even gratuitous. It amuses me because, they really just want to vent/vomit their ideology which is fine, however, it irritates because they don't really want to dialogue or debate, they just want to purge. "My way or the highway mentality", which I suspect, carries over into their offline interpersonal life like and albatross. Never bothering to examine their preconceived notions, ideas nor makeup like a zealot.

Their wounds lead them by the nose, and they are miserable and want everyone in their path to feel the same. These are the real 'sad little men'.

Posted by: Uncle $cam | Oct 14 2008 21:24 utc | 9

@10

Look out gutter, here we cum!

Posted by: Spyware | Oct 14 2008 21:44 utc | 10

Looking back : I think all that actually happened
is that Russia stopped buying U S Treasuries.

To make up the difference , the Federal Reserve has done several
things to drive most banks to buy nothing but U S Treasuries.

The best way out is to forget the U S Dollar ,
and start up a global clearing house.

Can be denominated in anything -- why not "the global."

primordial dwarf

Posted by: the Primordial Dwarf | Oct 14 2008 21:56 utc | 11

When is a hedge not a hedge? When your counter-party goes belly up. Ask Goldman Sachs or the euro banks about AIG. The lesson here is that if you write insurance contracts (which CDS are) you should have to demonstrate your ability to cover them. It's a lesson that wont be learned. It's too expensive to consider a six sigma event.

It's no accident that the sophisticated models never manage to do a simple count of the lifeboat capacity versus the passengers. See 1987 and "portfolio insurance". Or the Titanic.

I think the call to ban derivatives is over the top. The financial wizards will always be one step ahead of the regulators anyway. How about we just tax the hell out of their ill-gotten loot?

Posted by: jeff65 | Oct 14 2008 22:09 utc | 12

Perhaps Moa has finally been targeted by troll HQ. Rig Int has had them for years; pros who are always there to try and distract, obfuscate, derail good discussion. They can be extremely stupid but, as long as they are not permanently banned, will continue unabated like an abused dog who feels no pain.

I suppose it is a mark of honor to have them assigned to this site; it indicates that HQ masters feel threatened by Moa content and attitude.

Yes I know it could all be a simple coincidence that multiple trolls show up at once, but I've been developing this theory of central troll control for a few years now, and it all fits neatly.

Posted by: rapt | Oct 14 2008 22:12 utc | 13

haha.. well of course. That's how I know how bad their shit stinks.

Posted by: Uncle $cam | Oct 14 2008 22:15 utc | 14

then expect our host to be gracious and even gratuitous

Are you kidding? Thats the last thing I'd expect. You think because he foots the bill for bandwidth this allows him to throw around disgraceful slanders and not be called out? Nothing more sad and irresponsible than running for cover of 'decorum' after shitting on someone else's floor (mine, by calling me a dishonest criminal and threatening to ban my livelihood!)

Sure, let's debate the merits of the proposal (banning derivatives.) You could start with answering the questions I posed above about hedging (whether it is desireable in the first place, and whether it is possible without leverage and derivatives). You might also tell me whether you think derivatives have made lending more competitive, have lowered corporate and taxpayer borrowing cost, have permitted most of the gdp growth over the past 30 years or whether this is all a fiction cooked up by wall street sleazeballs liars and crooks (but really you mean this in the most gentle and constructive sense!)

Data would be helpful, ad hominem laced invective less helpful.

Thanks a lot in advance and god bless.

Posted by: an honest quant | Oct 14 2008 22:24 utc | 15

The lesson here is that if you write insurance contracts (which CDS are) you should have to demonstrate your ability to cover them

I agree completely, and a public clearinghouse (with transparent mark to market, netting and margining) is the answer. Mutualization and transparency are better answers than calling in an army of lawyers and regulators (they only make money for the structured financiers who are one step ahead.)

Posted by: an honest quant | Oct 14 2008 22:34 utc | 16

an honest quant:
Maybe you missed the gist of my post. If AIG, for example, had to demonstrate their ability to pay out in the "unlikely" event everyone tries to jump in the one lifeboat all at once, would there be any money to be made in writing CDS? I say no. The capital requirements would make it unprofitable.

Posted by: jeff65 | Oct 14 2008 22:59 utc | 17

@5
its not as if the quants did not have enough computing power to accommodate an adequate domain of assumptions & boundary conditions into their models. But for whatever reason, they did'nt. Which is why their models are failing and hence theres no support left today for the now miserable derivatives.

allowing quants & managers to create new derivatives & models as they please is just as prudent as leaving food-service specifications & standards to the discretion of cooks & restaurant managers.

and whenever the underlying assumptions & boundary conditions of an instrument are not properly & comprehensively factored into the risk, the tax-payer will always be the ultimate loser.

any derivative that cannot be modeled, risk-measured & regulated to a safe standard should be banned.

Posted by: jony_b_cool | Oct 14 2008 23:07 utc | 18

jeff65@13
It's no accident that the sophisticated models never manage to do a simple count of the lifeboat capacity versus the passengers. See 1987 and "portfolio insurance". Or the Titanic.

this is what I'm saying

Posted by: jony_b_cool | Oct 14 2008 23:11 utc | 19

Latin: "argument to the man",

as if slurring the integrity of a whole industry isn't ad hominem?

another version of corporate personhood. industries have feeeeelings.

lol

You think because he foots the bill for bandwidth this allows him to throw around disgraceful slanders and not be called out?

actually it does ;)

shitting on someone else's floor

you should rethink who has the floor here in this bar bigshot.

You might also tell me whether you think ...blabla...blabla...street sleazeballs liars and crooks (but really you mean this in the most gentle and constructive sense!)

why don't you ask nicely you little scumtrollpieceofcrap.

Posted by: annie | Oct 14 2008 23:17 utc | 20

People upset at the suggestion derivatives should be banned should be glad that I'm not in charge of anything down there, because I surely wouldn't just ban them.
Yet, as usual, it's only when all will be done and over that most people will realise what deep trends are now in play, and how much things will change.

Posted by: CluelessJoe | Oct 14 2008 23:40 utc | 21

jeff I don't see any difference between AIG (or in fact their unregulated reinsurers) writing too much fire insurance versus too many CDSes. Do we have any idea whether there collectively is too much fire insurance written in the world? of course we dont but no one is calling for banning insurance altogether. why are actuarial models more robust than CDS models?

jony no one is asking you to trade derivatives if you dont understand them. If you feel exposed to them, get unexposed: find out what stocks you own that invest in them and sell those stocks. just dont be surprised if people who are willing to take risks you dont like or understand push back when you try to ban what they're doing, even when its none of your business.

annie, for the final time I'm not complaining about the lack of decorum: you on the other hand are. Clearly you (or the host) can't take it, so don't even try to dish it out. if you care to argue with facts, even facts laced with personal insults, I'd be happy to. but i see not very many facts in your posts. if you talk shit, and invite comments, someone is going to call you on your shit, and you will look like a defensive hypocrite if you resort to banning and/or whinging about decorum. i know youre trying to help out your friend (its a nice gesture) but attack poodles like yourself don't help 'b' regain the upper hand here.

Posted by: an honest quant | Oct 14 2008 23:52 utc | 22

jeff65 (13)

The financial wizards will always be one step ahead of the regulators anyway. How about we just tax the hell out of their ill-gotten loot?

The first part is hilarious!! Not cause I think the financials are 'wizards', just excellent confidence tricksters, sorta like financial Jim Jones's, and their followers (Jim Jones would be jealous) are simply easily manipulated by their greed, which sorta makes like a creepy sticky agent orange blanket over their common sense...

Now to the 'regulators' -- I don't think the 'regulators' don't understand the regulations, or are behind in what's going on; I think they are simply hired NOT TO ROCK THE BOAT...; but to be the proverbial THREE MONKEYS... The current regulations aren't even enforced..

Frankly, your suggestion of tax the shit out of them, sounds more reasonable.

Finally, listen to this: Irrespective of the fact that these 'financial wizards' are in a 'dizzy,' 'petrified,' 'don't trust each other' and such like... consider this:

Nor have the hedge funds been in the slightest bit interested in succumbing to normal rules: of the world's thousands of hedge funds only 24 have volunteered to sign up to a code of conduct.

Emilio Botin, the chairman of Santander, the Spanish bank that has enjoyed phenomenal success during the credit crunch, once said: "I never invest in something I don't understand." A wise man, you may think.
~ A £516 trillion derivatives 'time-bomb' of "financial weapons of mass destruction" ~

Can someone explain to me, how any individual can be considered anything remotely resembling 'INTELLIGENT' not even close to a 'WIZARD', when they haven't the faintest clue, THAT IT IS AN HONOURABLE CODE OF CONDUCT, (I.E. THAT YOU MEAN WHAT YOU SAY, THAT YOU WILL HONOUR YOUR WORD, THAT YOUR WORD MEANS SOMETHING, THAT YOU ARE SOMEONE WHO IS WILLING TO PUT YOUR MONEY WHERE YOUR MOUTH IS KIND OF PERSON) THAT INSPIRES OTHERS TO TRUST YOU!!!!!!

Now, if they won't sign up to a CODE OF CONDUCT, LET ALONE A CODE OF HONOURABLE CONDUCT: WHO IS TO BLAME FOR THEM NOT TRUSTING EACH OTHER, AND BEING A BUNCH OF TWO-FACED LYING, THIEVING -- TOTALLY DEVOID OF AN HONOURABLE BONE IN THIER BODIES -- SHARKS???????????

Lara

Posted by: Guerrylla Law for Patriots | Oct 14 2008 23:56 utc | 23

This is a complex subject and over many peoples heads. The problem is Credit Default Swaps were unregulated and leveraged 30-1. As stated above there was never enough money in the system to cover. This is the credit market freeze. Banks are holding assets to cover and froze interbank and business lending to cover the swaps in case of calls.

Derivatives can be usefull if used as a hedge to get a commodity or interest rate at a price you want or insure delivery of goods. Wiki gives the example of a farmer and miller. The farmer get a certain price and the miller makes sure he gets delivery of a needed commodity. They are bad when short sellers use them to drive down an asset and destroy it.

The bubble in oil futures was nothing but driving the prices up for two things. To suck pension funds into the oil market then massively short and suck the money out. Hedgers have found a way to suck the weekly pension contributions out of the market. There is billions a week going into retirement accounts. Yet in inflation adjusted dollars there has been a bear market for the average investor (joe six-pack) while hedge fund operators, (investment banks, insurance companies and regular banks have been acting like hedge funds) have sopped up the money with their financial scams, paying themselves millions while the average person has to delay retirement. The average worker and pension funds have been suckered and derivative type instruments have been the culprit. The same would have happened if Social Security would been invested. Wall Street was salivating like Pavlovs dog at the thought of sticking their sifering hose into SS.

Derivatives that have a function should be allowed with minimal leverage. Others should be banned including using derivatives to drive a company out of business. That is not the free market deciding. Thats some number cruncher on Wall Street deciding who to pray on. The SEC wouldn't have banned short selling if hedging wasn't dangerous to a stable market. The banks were saved, hedge funds (speculators) took the hit.

At #3. That is the worst idea I've ever heard of. The secret to the boom after WW II was government money investing into the country. GI loans for college and housing. This created a better educated population and created the suburbs, it can be argued if the suburbs are good or bad. But those two factors were economic fuel. The other great economic fuel was the interstate road system. This created an easily mobile population fueling car sales, easy travel for business and vacations (the rise of Disney). These factors were great fuel after WW II. These programs were all funded by high tax rates on the rich and the economy never boomed as much. (Don't whine to me if your rich because I believe you should start paying your fair share. And don't give me that "I pay high taxes" already when my SS payments are funding your rich asses tax cut.)

While we didn't see that during the 1990s (the post WW II type boom, it was an asset bubble), Clinton still made sure lots of money went back to the states. The COPs program, infrastructure projects all contributed to a booming economy even while manufacturing was being hollowed out. The elites will switch to this type of structure under Obama. The Feds pumping money into the states always causes a boom.

A further contributing factor is low fuel prices. For years oil price per barrel was set by the Texas Railroad Commission. The Saudis and OPEC felt they were getting ripped. Oil was $3 a barrel from 1955 to 1970 not even taking inflation into account. While the US said the war with Israel caused the oil embargo (1973), thats just not true. But one consistent thing since 1970, oil prices are lower under democratic admins. The one anomaly is Carter and that shortage was consumer panic driven due to the Iran hostage crisis. (And Carter was a victom of Nixon war inflation and the demise of Bretton Woods) Google Will Grieder for the facts. His book "Secrets of the Federal Reserve" gives details. So, hedgers and speculators drove oil up this year above $140 per barrel. The cycle has ended and oil could go below $50 and could touch $20. Just remember, the next time a republican is elected, buy commodities.

Sorry to be so long winded. But, "an honest quant", I do understand derivatives and some are alright, but the majority of users are speculative scumbags stealing peoples money by explaining that, oh, we're just hedging our bets. And thats the bottom line.

Posted by: jdp | Oct 14 2008 23:56 utc | 24

jdp, heres a quiz for you. which energy commodities have more price volatility: those with futures contracts or those without? which price went up more this year: coal (with no substantial futures market) or oil?

why don't you look up freight rates, or coal forwards, or lng prices in the far east, where no derivatives exist at all, and explain to me how those prices are pure while the WTI price is a construct of hedge funds and manipulated?

better still, explain how the hell any trade is supposed to happen with no fx market, no bond futures, and no way to hedge any kind of forward economic risk of any kind.

Posted by: an honest quant | Oct 15 2008 0:20 utc | 25


don't help 'b' regain the upper hand here.

i don't need to help b do anything, he has the upperhand here and certainly doesn't have to 'regain' anything. you may think you can change the balance by channeling teacher by challenging jdp (longtime poster) to take your 'quizs' but nobody is falling for your positioning.

I'm not complaining about the lack of decorum

excuse me??? who said to throw around disgraceful slanders .... shitting on someone else's floor (mine

i already ask you once to ask nicely. you are in no position to guess what i can or cannot take. you are being rude.

jpd, thank you very much for the incredibly sensible post(especially for a layman like myself). i completely agree w/you about #3 which, btw, is just a massive privatization scam. one of the authors Everett Ehrlich is cited in this circa '95 U.S. Is Aiming to Privatize Index of Leading Indicators

from #3's link

But while private investors and states and cities are devoting more attention to this, the federal government has failed to provide the leadership it alone can supply. Federal spending on infrastructure, corrected for inflation, is actually lower than it was in 2001, despite the growing economy, the well-known disrepair and obsolescence of our assets, and the rising costs of their inadequacy. And this level of spending, as a share of GDP, is much lower than it was two or three decades ago.

no doubt he is part of the 'starve the beast' crowd. why should we selling off all our public infrastructure? what's so 'national' about a National Infrastructure Bank, an institution that would be similar to the World Bank, a private investment bank. that's not national anymore than the clean air act makes clean air.

and back to those squealing like slaughtered pigs about the loss of their 'industry'. take the medicine like the manufacturing crowd why don't you..evolve. were you screaming when jobs were being shipped off to india?

Posted by: annie | Oct 15 2008 1:18 utc | 26

btw, maybe the federal government has failed to provide the leadership it alone can supply. because the those ruling the executive branch of government HATE government and have ejected all the professional and replaced them w/political operatives. gee, ya think?

giant f'ing ponzi scam, string em up by their balls!

Posted by: annie | Oct 15 2008 1:24 utc | 27

quant,

while taking delivery and insuring delivery for oil or coal or other commodities is fine with me, its the pure greed and sucking of assets that pisses me off. And really, I don't care what the price inflation of a corrupt Pakistan or other country is. I just don't want them unleashing their nukes. We were supposed to have transparent systems with self policing by commodities traders, banking institutions, etc. But it became a casino.

You cannot conflate lng, coal delivery and trucking, great lakes shipping of coal, pipeline delivery of natural gas on December first guaranteed by a futures contract to the CDSs that caused the market meltdown and freeze.

Our community has been fighting a utility for several years about high gas rates and we have suggested better contracts, or buying directly from a firm that does have better buying and hedging practices and larger storage for winter needs.

It is the manipulative practices that rip off pension funds, the push by shorters to crash a stock. That drives down fund prices and creates losses for pension holders and stock holders. The market will tell you if a stock should go down. I saw an ETF pushed to nothing this summer. Wasn't orderly, created market volatility. Thats what hedgers do in those instances. Hedging creates wider swings in markets and much more volatility.

I knew four years ago this country was in trouble when Greenspeak was before congress talking about "financial instruments" like some mad scientist was standing there in a science lab mixing the next brew of toxic instruments.

Human behavior cannot be predicted and thats what CDSs tried to do with scientific calculations. There is a big difference in securing future commodities for delivery in an orderly market. And don't try to compare our mature market to inflated, manipulated markets of less mature economies. Wall Street knew better and shot themselves anyway.

Posted by: jdp | Oct 15 2008 1:29 utc | 28

an honest quant:
Writing too much flood insurance doesn't change the weather. Cheap bond insurance (CDS) does.

Posted by: jeff65 | Oct 15 2008 2:53 utc | 29

Mr. or Ms. quant,
Could it be that the price of coal now reflects it's value and cost of production? Can't have that can we. The derivatives that don't exist are those that users were too stupid to buy. So what? Show me where coal has been more volatile than oil or gas, *on a sustained basis*. Show me where derivatives have prevented monopolies from abusing their position. On second thought, just start over trying to show some benefit to society of derivatives.

Posted by: dacorilitter | Oct 15 2008 3:03 utc | 30

@26
why don't you look up freight rates, or coal forwards, or lng prices in the far east, where no derivatives exist at all, and explain to me how those prices are pure while the WTI price is a construct of hedge funds and manipulated?

this is such a bogus comparison, it defies me. And if you actually believe that WTI pricing is "purer" than LNG pricing, then your intent on this forum is highly questionable.


@23
jony no one is asking you to trade derivatives if you dont understand them. If you feel exposed to them, get unexposed: find out what stocks you own that invest in them and sell those stocks. just dont be surprised if people who are willing to take risks you dont like or understand push back when you try to ban what they're doing, even when its none of your business.

very condescending to say this to a tax-payer. Its just like saying if I do'nt understand the health-code, I should'nt eat out.

and overall you have not responded at all in the manner of one with a quants perspective

Posted by: jony_b_cool | Oct 15 2008 4:13 utc | 31

actually I'll take the last part back as I am absolutely sure there are many working quants who do not appreciate the importance of assumptions & boundary conditions. Or they just do'nt care. Or they just give the front-office whatever it wants -- which is actually the norm most of the time.

Posted by: jony_b_cool | Oct 15 2008 4:18 utc | 32

FWIW,
this discussion on derivatives would be more helpful if we would try to distinguish between the impacts of poor-modeling & that of excessive speculation & that of outright intentional manipulation.

theres been plenty of all three of the above.

Posted by: jony_b_cool | Oct 15 2008 4:29 utc | 33

@2 Actually, I think youd better just do away with hedging altogether, since practically all hedges involve huge amounts of leverage. Yes, no more hedging. investors should just have to kind of "roll the dice" and go for it if they buy into some asset with a lot of scary economic risks.

Yes. And investors would be much more careful and responsible.

@7 - Hmmmm as if slurring the integrity of a whole industry isn't ad hominem? As if calls to ban entire industries because you find them complicated has "content?"

The financial markets are NOT an industry. The are a necessary service for real industry and trade. To make them equal to, let's say shipyards, is a very wrong understanding of their role.

You might also tell me whether you think derivatives have made lending more competitive, have lowered corporate and taxpayer borrowing cost, have permitted most of the gdp growth over the past 30 years or whether this is all a fiction cooked up by wall street sleazeballs liars and crooks (but really you mean this in the most gentle and constructive sense!)

The lowering of borrowing costs was not some financial entities success but (bad) public policy acted out through the Fed.

The real GDP growth of the last 30 years was much smaller than it could have been. This was a result of much too big financial arm in the economy.

Real wages have not been growing in the last 30 years? Why would that be?

jeff I don't see any difference between AIG (or in fact their unregulated reinsurers) writing too much fire insurance versus too many CDSes. Do we have any idea whether there collectively is too much fire insurance written in the world? of course we dont but no one is calling for banning insurance altogether. why are actuarial models more robust than CDS models?

And here is where I believe that the "honest quant" does not know s*** about quantitative mathematics.

Real insurance is given for INDEPENDENT events. If Geico insures 1,000,000 cars across the country against accidents it is impossible that those 1,000,000 cars come together in one big crash.

CDS insurance is on RELATED events. If one CDS party fails it is highly possible that other parties fail too. If one insures 200 different Mortgage Backed Securities the chance is pretty good that all of them go bad the same time. That is exactly what killed AIG. It insured events that had a high chance to all happen at the same time.

It is actually frightening to see someone who does not get that difference working on anything financial.

Posted by: b | Oct 15 2008 5:40 utc | 34

http://www.commondreams.org/view/2008/10/10-15>Brooksley Born warned against derivatives over a decade ago:

[...] more than a decade ago, a woman you're likely never to have heard of, Brooksley Born, head of the Commodity Futures Trading Commission-- a federal agency that regulates options and futures trading--was the oracle whose warnings about the dangerous boom in derivatives trading just might have averted the calamitous bust now engulfing the US and global markets. Instead she was met with scorn, condescension and outright anger by former Federal Reserve Chair Alan Greenspan, former Treasury Secretary Robert Rubin and his deputy Lawrence Summers. In fact, Greenspan, the man some affectionately called "The Oracle," spent his political capital cheerleading these disastrous financial instruments.

On Thursday, the New York Times ran a masterful and revealing front page article exposing the culpability of Greenspan, Rubin and Summers for the era of dangerous turbulence we live in.

What these "three marketeers" --as they were called in a 1999 Time magazine cover story--were adept at was peddling the timebombs at the heart of this complex crisis: exotic and opaque financial instruments known as derivatives--contracts intended to hedge against risk and whose values are derived from underlying assets. To cut to the quick, Greenspan, Rubin and Summers opposed regulating them. "Proposals to bring even minimalist regulation were basically rebuffed by Greenspan and various people in the Treasury," recalls Alan Blinder, a former Federal Reserve board member and economist at Princeton University, in the Times article.

In 1997, Brooksley Born warned in congressional testimony that unregulated trading in derivatives could "threaten our regulated markets or, indeed, our economy without any federal agency knowing about it." Born called for greater transparency--disclosure of trades and reserves as a buffer against losses.

Instead of heeding this oracle's warnings, Greenspan, Rubin & Summers rushed to silence her. [...]

Posted by: DeAnander | Oct 15 2008 6:01 utc | 35

Real insurance is given for INDEPENDENT events.

You're wrong of course. Hurricanes and wildfires don't lead to a string of "independent" claims, and similarly a widespread selloff in real estate is an underpinning all the CDS-related problems now. And of course monoline insurance is much the same as default swaps, and so is personal mortgage insurance, and unemployment insurance and a host of other economic insurance classes which are just as likely to pay off in clusters.

the chance is pretty good that all of them go bad the same time.

Obviously the chance seems pretty good now in the rear view mirror. You must be writing this from your private island, then? I am privileged to know you, milord. Well played on those Dow Jones puts!

I agree with you that CMSes are poorly used, poorly modeled, and should wherever possible be firewalled from the public sector (as should any highly leveraged derivative). This isnt an argument to BAN DERIVATIVES. Your sweeping conclusion does not follow this very narrow premise.

It is actually frightening to see someone who does not get that difference working on anything financial.

What dare i ask is your academic or professional background, your highness? It is not frightening but totally expected and unfrightening to see someone with no financial background (you)threatening to BAN something because you don't understand it.

and overall you have not responded at all in the manner of one with a quants perspective

I'm sorry my manner has not been to your liking, your majesty.

The financial markets are NOT an industry. The are a necessary service

Erm, maybe this is a language difference but "industry" simply means an area where work (in english: 'industry') is performed.

Yes Brooksley Born and Warren Buffet are geniuses because they warned something bad could happen in derivatives, which is like predicting the sun will rise tomorrow. Something bad has always been happening in derivatives. Yet Warren Buffett uses derivatives heavily in his business, and always has.

CDSes don't impact a companies balance sheet. The trading of a CDS between two parties unrelated to AIG doesnt influence AIGs 'chance of default', no, any more than a newspaper article about AIG's earnings influences its future earnings. So we should ban those too?

Yes. And investors would be much more careful and responsible.

There would be no investors. With no fx market there would be no cross border trade of any kind. With no interest rate market the bond market would be monopolized; borrowing costs would soar and ordinary interest paid would plummet.

Its just like saying if I do'nt understand the health-code, I should'nt eat out.

Most ordinary people arent even eligible to trade OTC derivatives, so this analogy isn't that great. No one is asking you to own securities of any kind, US bonds included. Plenty of people don't and still manage to make money for themselves.

this is such a bogus comparison, it defies me.

Whats bogus about it? Why is LNG more or less manipulated than WTI (since its gone up much more and there are no derivatives traded on it)?? Why is coal more manipulated than WTI for the same reason? My point is that these markets have soared with no speculation whatsoever for the same reasons driving oil's more subdued and controlled rally.

Posted by: an honest quant | Oct 15 2008 6:56 utc | 36

. On second thought, just start over trying to show some benefit to society of derivative.

Dacorilitter, if you work in derivatives you see these benefits every day. You don't, that's fine. No one is forcing you to participate in the vast gambling den that is modern finance. No one is forcing you to buy derivatives, or even securities at all! Yet you are claiming your personal distaste for these things warrants a wholesale ban. The burden is clearly on you to show clearly, with facts and data, how ALL derivatives (and not a much narrower subset of them) are to blame for a widespread social ill. B makes no effort to do this. And he can't do it, because derivatives of all kinds are used to no bad effect in all corners of the economy.

Posted by: an honest quant | Oct 15 2008 7:04 utc | 37

So its been fun, but my "industry" (which is really about plundering and sucking from the commonwealth) demands I leave you now, likely for good.

Look forward to reading some well developed arguments establishing why FX trading should cease and why bond dealers deserve a monopoly in interest rates.

Thanks, kids.

Posted by: an honest quant | Oct 15 2008 7:19 utc | 38

Time to resurrect the idea of the Tobin Tax?

Tobin Taxes are excise taxes on cross-border currency transactions. They can be enacted by national legislatures, followed by multilateral cooperation for effective enforcement. The revenue should go to global priorities: basic environmental and human needs. Such taxes will help tame currency market volatility and restore national economic sovereignty. (The name Tobin Tax and the original concept derives from James Tobin, a Ph.D. Nobel-laureate economist at Yale University.)

Posted by: Una lacrima furtiva | Oct 15 2008 7:28 utc | 39

Obviously the chance seems pretty good now in the rear view mirror.

This is really funny. After some turning point in 2005 or 2006 the chance was provably 100%, unless you want us to believe that income and house prices could continue to diverge forever. The only question was how long it would drag out.

Your weather analogies remain faulty. Insurance companies that stay in business do not only write policies on the Gulf Coast.

And finally - Hurricane insurance does not change the weather. Cheap CDS obscured risks, which increased the demand for the insured bonds and so on.

Posted by: jeff65 | Oct 15 2008 7:34 utc | 40

Interesting thread, despite a lot of flaming invective, and perhaps not coincidentally, rather few links. This is a "general interest" blog, but I suspect that many regulars could handle (or, alternatively skip over) the more quantitative discussion and data necessary to raise the level of discussion from polemic to didactic.

Several theses have been advanced here, and I would like to see some detail and documentation. It's pretty clear that something out of the ordinary has happened in and around global equity and futures markets over the last few months, and I'd like to understand that and the "way out" with as little moralizing as possible.

Of course, it's difficult to avoid moralizing when one witnesses decades of politico-economic rhetoric in favor deregulation against state intervention abandoned, if not at the drop of a hat, then at the drop of some market averages. Hank Paulson on bended knee in front of Nancy Pelosi is an "iconic moment" still to be comprehended in full.

Posted by: Hannah K. O'Luthon | Oct 15 2008 7:46 utc | 41

show some benefit to society of derivative.

maybe #38 was a long winded way of saying..'i can't'.

Posted by: annie | Oct 15 2008 7:54 utc | 42

@quant - No one is forcing you to participate in the vast gambling den that is modern finance. No one is forcing you to buy derivatives, or even securities at all! Yet you are claiming your personal distaste for these things warrants a wholesale ban.

Hmm - then why do we, the taxpayers, now have to bail out the derivative traders like you with trillions of dollars?

Derivative trading away from the very basic farmer-miller example has external costs the society has to carry. That gives the society all justification it needs to shut down such activities. They obviously do more harm than good.

We don't allow cars without brakes to drive on our roads. Why would we allow trades that have no brakes speeding downhill?

What dare i ask is your academic or professional background, your highness? It is not frightening but totally expected and unfrightening to see someone with no financial background (you)threatening to BAN something because you don't understand it.

Hmm - for starters a combined master degree in business administration and engineering. Then some eight years of teaching in the economic department at a university followed by many years as manager in various industries.

Maybe I don't want to ban something because I do not understand it, but because I do understand the inherent danger?

CDSes don't impact a companies balance sheet. The trading of a CDS between two parties unrelated to AIG doesnt influence AIGs 'chance of default', no, any more than a newspaper article about AIG's earnings influences its future earnings. So we should ban those too?

A newspaper article about AIG's earnings certainly does influence it future earnings. If the article is damning AIG, future earnings will likely be lower. If the article is lauding AIG future earnings may well be higher. That's the sole reason why AIG and other companies have public relation departments.

The trading of a CDS between two parties unrelated to AIG doesnt influence AIGs 'chance of default'

It certainly does as the costs of defaults get externalized. I have absolutely no relation to ANY CDS but will see my tax payments go up as a consequence of CDS dealings.

Posted by: b | Oct 15 2008 8:50 utc | 43


this is such a bogus comparison, it defies me.

Whats bogus about it? Why is LNG more or less manipulated than WTI (since its gone up much more and there are no derivatives traded on it)?? Why is coal more manipulated than WTI for the same reason? My point is that these markets have soared with no speculation whatsoever for the same reasons driving oil's more subdued and controlled rally.

if you were arguing that theres some price manipulation going on in LNG & coal, you probably have a point. But you neglect to consider that the types of manipulation occurring may be entirely different in all three cases (WTI, LNG, coal).

Note that the type of manipulations going on with the exact same commodity can vary dramatically from exchange to exchange.

Posted by: jony_b_cool | Oct 15 2008 8:50 utc | 44

Frankly, if people were serious about reforming the banking and trade systems, they would just go back to the basics of what shares really were originally. That is, end the stock market as we know it and make sure that the shares' value isn't fixed by a retarded demand/offer system as if they were themselves a commodity, but would be fixed on a yearly basis directly dependant on the business' results. Or at the very least, we could impose a 1-month delay before anyone who just bought stocks can be allowed to sell them back; this would seriously weaken the bulk of speculation and leave only real investors in the game.
Sure, this would slow down the economy, but then, the whole current system is just a scam that has less in common with the actual reality of this world than chess or Dungeons and Dragons gaming rules.

Posted by: CluelessJoe | Oct 15 2008 9:08 utc | 45

now have to bail out the derivative traders like you with trillions of dollars?

You aren't bailing *me* out of anything. And issuing <1bn in public debt at 0% effective interest rate isn't taking "money from the taxpayer" but from the bond market.

but will see my tax payments go up as a consequence of CDS dealings

its a "result" of your government's decsion to use CDSes to judge capital adequacy. A very bad decision, made by some very well schooled economists with no practical experience. Your government's stupid decision means we should ban FX trading and bond futures? Thats ridiculous.

Note that the type of manipulations going on with the exact same commodity can vary dramatically from exchange to exchange.

the point being that derivatives or lack thereof doesn't dictate how volatile or manipulated a market may be. mkts with listed derivatives are by definition less vulnerable to these things than those without. price volatility on all listed futures is lower than in similar unlisted products.

Posted by: ahq | Oct 15 2008 9:20 utc | 46

@37
My point is that these markets have soared with no speculation whatsoever for the same reasons driving oil's more subdued and controlled rally.

I give up because I can't construct a satisfactory response to this statement

but it bugs me sometimes when people refer to speculation in a manner that obscures whether they actually mean manipulation or not. Or they make/push the assumption that manipulation requires speculation. Its a common device by people trying to play-down or deny the existence of manipulation by traders. Or by those who oppose tighter regulation.

Posted by: jony_b_cool | Oct 15 2008 9:39 utc | 47

and I also doubt that @47 is worth responding to

Posted by: jony_b_cool | Oct 15 2008 9:49 utc | 48

An honest quant (39)

So my [derivative and stock market] "industry" is really about plundering and sucking from the commonwealth....

Honest quant!! You get five stars, from me, for the honesty of your above statement. Thanks, appreciate the brutal candour.

But I am well aware that brutal honesty aint highly appreciated, by many, who prefer to insulate themselves from the realities that brutal honesty require them to confront, by enslaving themselves in the chains of political correctness, and all other synonyms providing for abstractions and contortions of brutal truths.

Here's a simple example:
I have a webpage on brutal honesty, titled
Lebed Dofenism :: Practicing Radical Honesty, the url is
lebed-dofenism.co.nr and has been submitted to various search engines.

However, if you go to the search engines and do a search on lebed dofenism, you will find ZERO, on Altavista and Yahoo, and on Google, you will find ONE PAGE -- THE INCORRECT PAGE!!, Search under lebed-dofenism.co.nr (submitted to Google!!), you will find ZERO!!

COMPUTERS ARE NOT ALLERGIC TO BRUTAL HONESTY, and DO NOT PROGRAM THEMSELVES TO AVOID BRUTAL HONESTY, VIA HUMAN PSYCHOLOGICAL EMOTIONAL CORPSE LIKE BEHAVIOUR. Accordingly, I doubt computer search engines got involved in such a conspiracy to protect their kool aid search children from -- in this case -- finding the webpages to lebed dofenism (agreed an obscure term, but even if only 20 people in the world are interested, why restrict those twenty people from searching for, and finding a webpage dedicated to lebed dofenism????????)

Interesting questions...

Posted by: JMCSwan | Oct 15 2008 10:11 utc | 49

ahq @ 23:

jeff I don't see any difference between AIG (or in fact their unregulated reinsurers) writing too much fire insurance versus too many CDSes. Do we have any idea whether there collectively is too much fire insurance written in the world?

who is "we"?

By law, in US (at least prior to Bush admin... who knows now) the answer was yes.

of course we dont but no one is calling for banning insurance altogether. why are actuarial models more robust than CDS models?

AIG (and WS's) CDS models were not actuarial: they "spread risk", rather then accounting for it and capitalizing guarantees. Your question answers itself, unless of course it's posed to an audience that doesn't know what's going on and trusts you, as a professional, to provide professional services.

jony no one is asking you to trade derivatives if you dont understand them. If you feel exposed to them, get unexposed: find out what stocks you own that invest in them and sell those stocks. just dont be surprised if people who are willing to take risks you dont like or understand push back when you try to ban what they're doing, even when its none of your business.

Rating agencies exist for a reason: to provide honest assessment of value. Just like mass media, (eg. having become centralized distribution of non-critical text-filler promoting scams as patriotic mumbo jumbo, all in the service of "maximizing profit" at the expense of delivering product value) rating agencies told the world these things were AAA. They clearly weren't, and those few fund/asset managers who pulled back the covers and took a look said so... but practically nobody was listening.

Why is there no public questioning and subsequent investigation into the precise mechanisms by which rating agencies were corrupted?

If institutions public & private abandon their purpose, confab w/schemers to promote fraud, your assertion: "willing to take risks you don't like or understand" becomes part of the scam. AAA means nothing. "Guaranteed" means obscured risk. It's a deliberate sale of what-you-see-is-not-what-you-get: buyer beware, but don't tell buyer that!!!

AFAIC what's happened is alchemy has replaced fiduciary responsibility: when it comes to money, you can't make something out of nothing. Whether you (your industry) knows/knew it or not (clearly many, many did but just went along for the ride anyway) just doesn't matter 'cause the result remains the same: depletion of investor assets.

Where I live, many...
* contractors now out business
* real estate reps/brokers out of business
* land speculators now out of business
* mortgage companies now out of business
* (etc. etc.)
... are polled by our local "paper of record" asking: why the slowdown? A very large % of them reply w/stuff like:
* a) too much bad news
* b) a) has scared off buyers
* c) all the CRA bullshit being pushed by right wingers afraid of losing their cash cow.

It goes on & on.

Seems to me ENRON was only a beta test. Did US gov. learn any meaningful lessons there? Not so much, rather tweaked the model just a tad and ramped up the global distribution.

As your comments attest, IMO one of the biggest problems facing us now is taking the air out of your crowd... a very big crowd w/a very big megaphone and a lot of other people's money to amplify that megaphone, and informing affected global publics just exactly what the hell has happened here. I see little evidence this process had begun. The obfuscation & entirely non-illuminating Paulson statement I hold up as exhibit A.

Until (if?) an accurate reconstruction of how this thing was executed is put before the public, this shit's gon'a rinse and repeat again and again while focused economic energy & resources directed towards unsolved problems the world drastically needs addressed gets diverted and consumed by ponzi schemes.

This blog's host has asserted repeatedly for some time now a failure of (US in particular) citizenship 101. I emphatically agree. And the huge body of evidence (just for starters, electing GWB twice with a trail of unbelievably stupid/corrupt schemes repackaged and marketed as consumer-friendly) agrees as well.

I don't think we're going to solve anything until we, somehow, get serious about driving a dagger through the heart of mass-marketing of stupid.

Posted by: jdmckay | Oct 15 2008 10:53 utc | 50

I'll try to come up with some policy ideas over the next days. Any suggestions are welcome. What are your's?

It's almost an incomprehensible mess.

If it were up to me, I'd simultaneously...

* a) begin forensic econ/accounting effort
* b) use a) to deliver unvarnished map of it all to public
* c) convene "Manhattan Project" for econ, as many have suggested. And in case it goes w/out saying, don't invite IMF/CATO and all the other think tanks responsible for selling the model that got us here.
* d) same suggestion for energy.
* e) communicate value of all this to to global publics... measure value, and have major punishment for those who attempt to corrupt the process.
* f) take results of c/d, devise means by which to focus human energy/resources in laser beam fashion while (by whatever means necessary) directing economic resources in support of the same.

Posted by: jdmckay | Oct 15 2008 11:08 utc | 51

"We have placed the first foundation stone of a new financial order," said chancellor Angela Merkel, underlining that nothing would ever be the same again in banking.

Bottom line..

"If you are not at the table, you are on the menu."-Robert Wenzela>.

ENRON was only a beta test

indeed..

and I also doubt that @47 is worth responding to

jony_b_cool #49, whoever this wanker is, I suspect S/he and posse are merely grooming the board...

Posted by: Uncle $cam | Oct 15 2008 13:06 utc | 52

ahq @47 - I'd like to preface my remarks by saying that I work at a hedge fund that has both quant and fundamental funds. I am in the front office and I am a CFA Charterholder (not trying to show off, but I'm not about to have someone call me out as lacking in knowledge of how the game works).

0% interest is only on the short end of the yield curve. Funny how the yields continue to blow out on the long-end (which is where people's mortgages get priced - you know the TNX). I realize a lot of the money raised recently was CMB (cash management bills) which are of a short nature. BUT - you and I both know that the Treasury is going to have to keep rolling it over. As time goes on, the yields will move up - as the Treasury keeps dumping more supply on the market. This is not going to have a happy ending. Any sentient being who takes a step back knows that. I've been watching the Treasury moves for about a year now. It's shocking what's been going on since February of this year - almost every week the estimates of what Treasury supply was going to be have been off. They've been too low by billions.

And to that honest quant guy. Many of the quants I know are lovely people. They also don't worry about things that have happened outside of a specific historic time period (ie anything before 1987 - I have asked and the answer is: the data isn't good enough. Oy.) When it comes to equities they also seem to have an odd blind spot when it comes to sell-side information. Anyone alive and in asset management in 2001 knows that sell-side is no good for anything.

And anyone even aware of ratings in the industry knows that they were piles of shit. I knew that in 2004 when the marketing people browbeat S&P into giving certain funds specific ratings. Why? They said: We pay them for it. So extrapolating from that, you have the rating problems on all that crap MBS. But, when it comes to MBS, I thought it was rather obvious in 2006 that the prices were rubbish. I had to learn how to manually price MBS and was surprised to learn that every single input was either an assumption or the interest rate that the income into the bonds pays. Yikes. Nothing real goes into those prices. You just change assumptions.

So, I guess I'm saying - anyone who didn't drink the kool-aid in finance understood quite well the issues and that all this would blow up. By why give a shit when you're making 2/20 (2% annual management charge/20% performance fee) on those suckers in the hedge funds. No one can claw back your bonus...

Posted by: InTheCity | Oct 15 2008 13:06 utc | 53

@52 above: Yup.

Regarding energy use in buildings, there is a modest push to require publishing all electrical and fuel use for all buildings, monthly. The data is already there. Public utility commissions would simply need to impose the publishing rule on utilities.

There’s no sense developing policy blind. Put effort where it is needed—exactly where it is needed. There would be an immediate 30% energy savings, just from having the public know what each property uses. Great Britain and Germany have energy labeling requirements for rental property (and other buildings?) What would underpin such a step is the recognition that energy is a common good such that energy purchases can no longer remain as a private transaction between a utility and a customer.

Meanwhile, I’d like to see the last five years of accounting published on the web for any corporation or institution that partakes of taxpayer funds. And a google engine that would permit the public to analyze them.

Posted by: Browning | Oct 15 2008 13:14 utc | 54

jdmckay@52,

one downside to the FDIC is that it eliminates account-holder interest in bank accountability.

one suggestion would be to provide each account-holder in a bank with x number of designate points proportional to their average annual deposits. Each account-holder then makes a choice out of a number of independent account holder designate companies (AHD's). Whichever AHD receives the most designate points get a seat on that banks governing board as well as full access to the banks books. In addition, FDIC coverage would be reduced from 100% to 80%.

Posted by: jony_b_cool | Oct 15 2008 13:38 utc | 55

So, I guess I'm saying - anyone who didn't drink the kool-aid in finance understood quite well the issues and that all this would blow up. By why give a shit when you're making 2/20 (2% annual management charge/20% performance fee) on those suckers in the hedge funds.

more or less what my friend whose a 20 year Wall St quant told me.

Posted by: jony_b_cool | Oct 15 2008 13:50 utc | 56

ITC @ 54

Good post. I didn't mean to demean entire industry, and take you @ your word as I know asset managers who lifted the covers and accurately determined value as you (in general) describe. There is a place for derivatives... just not as CDOs in this "meltdown" executed as fraud.

So, I guess I'm saying - anyone who didn't drink the kool-aid in finance understood quite well the issues and that all this would blow up. By why give a shit when you're making 2/20 (2% annual management charge/20% performance fee) on those suckers in the hedge funds.

well said.

No one can claw back your bonus...

I'd advocate mandatory "re-investment" of earnings in the CDO products they sold.


jbc @ 56

one downside to the FDIC is that it eliminates account-holder interest in bank accountability.

Ya, but the entire global "re-capitalization" is dealing w/a nearly incromprehensable downside that makes the Grand Canyon look like a tee divot.

Trying to stabilize this is one thing. Corrective measures is quite another. And I've seen +/- 0 from FED, TREASURY, WH, McCain or Obama even attempting to define corrective measures. In fact, I know very few people here that comprehend the fact the USA is broke... completely, totally broke. "Rude awakenings" doesn't begin to describe what USA'sians have to look forward to economically.

The fact our neo-con econmists/pundits still are giving their all to lipstick their pig economics, in spite of dire circumstances... I du'know.

... I would add to my modest suggests @ 52: education. And I mean nuts and bolts, thorough (across disciplines: science/basic phyics, econ, math, and in particular, english (or whatever is native tongue)). On the matter of competency in language, I would emphasize linguistics... eg. at minimum, the ability to make distinctions and articulate them w/the language at hand using commonly understood meaning of the words.

The co-opting of words for illegitimate purposes has been central to not only mobilizing a bigoted/red neck bubba class here, but masking true actions and intents. That "freedom fries" became a "patriotic" rallying cry, or torture becomes "enhanced interrogation techniques", or Fed gov endorse/enabled/sanctioned fraud to favored industry becomes "defense of free markets"... sheesh, we've got a loooong ways to go AFAIC.

Or to paraphrase Robin Williams (from memory):

How did we get from the Crucifixion and Resurrection to chocolate bunnies and painted eggs?

And after all this, in the midst of our (US) prez election, a wake-up-call public discussion that even approximates problems & corrections is reduced to energy-expert Sarah Palin, inability to distinguish voter registration issues from "voter fraud" (ACRON dustup) while GOP is rolling out racially tinged voter roll db's exactly like Florida 2k, etc., etc., etc...

Heaven help us.

Posted by: jdmckay | Oct 15 2008 15:33 utc | 57

Don't recall if I saw it here, on another blog, or just stumbled across it... but given AHQ's defense of these "financial instruments" I'm reminded of the depravity of the industry exhibited in this little blurb:

THE Lehman Brothers board signed off on more than $100m (£59m) in payouts to five top executives just three days before the bank went bankrupt leaving thousands of employees out of work in London.

The payoffs, approved on September 12 by the Wall Street giant’s compensation committee, included over $24m in severance packages to the collapsed firm’s top three London executives.

The committee agreed a $16.2m pay-off for Benoit Savoret, chief operating officer for Europe. This payment had been guaranteed by the firm after Savoret had turned down an approach to join a rival firm. Andy Morton, the fixed-income business head, was set for a $2m golden goodbye.

Both were forced out in a shake-up orchestrated from New York in the waning days at the troubled bank. A $5m package for Jeremy Isaacs, the European chief executive who also left, was approved as well.

I also get rubbed every time I read one of these things, of the "free market" neocons complaining about "income redistribution". I mean they steal huge volumes of money, say they're "creating value" or "creating wealth", then cry like crocodiles at even the suggestion some of their pile should go back to cleaning up the wasteland they stole from "fair and square".

Those demanding equitable redistribution of their spoils then are chastised as advocating a "welfare state", and summarily contextualized as freedom hating, terra'ist luv'n libearls.

And these guys own our (US) media.

How do you fight this shit?

(sorry for the rant... verbalizing this stuff today seems to be putting me in a foul mood. :( )

Posted by: jdmckay | Oct 15 2008 15:53 utc | 58


jdmckay & InTheCity are exactly the kind of guys the psychopaths want to keep away from key power & authority.

Posted by: jony_b_cool | Oct 15 2008 17:02 utc | 59

0% interest is only on the short end of the yield curve.

I think by "effective yield" that means net of inflation. Treasury yields are at 4.5% flat across most of the curve, so yes the effective borrowing cost to the government is almost free.

Any sentient being who takes a step back knows that.

Long term (2017, 2018) ED futures are pricing in no meaningful short rate rises for the next ten years. EDU8 closed at 93.98.

I dont think Mr. Quanto is saying the ratings were good, or that CDOs were well priced or anything else. But it's absolutely ridiculous to go from this truism to doing away with currency and interest rate hedging altogether!! Anyone who has worked in finance is aware of this (and a split MBA is definitely not "working in finance" -- sorry!) hedging is vital to ANY well managed corporate treasury. and there's nothing scary about generic exchange traded interest rate derivs like eurodollar futures and currencies, with netting and margining and all the rest of it. Its really apples and oranges.

Posted by: vaudois | Oct 15 2008 18:03 utc | 60

jdmackay @58 Oh, I hope you don't think I wouldn't degrade large parts of the finance industry. I have a mate who works on an infrastructure fund. He used to do internal M&A - meaning Mergers/Acquistions for the company he works for (which is a very large financial company with an investment bank that has killed them). He recalled to me how he met this one guy who was telling him about - hey don't worry this thing makes money. It's free money. Yes, this supposedly educated person said "free money". My mate was horrified. It is amazing how many people bought into the crap.

Personally I'd be happy if finance was no longer in charge of the economy. In a capitalist system, finance should really just be a bit helpful. Not the main part. But that's also assuming I like the capitalist system!

Posted by: InTheCity | Oct 15 2008 18:09 utc | 61

The campaign to liquidate hedge funds seems to won got an unlikely candidate:

Why hedge funds are crying

It may be a case of shutting the stable door after the thundering herd has bolted, but law and order is being brought to the wild wild west of global financial markets...
...In an message to Lehman's General Counsel, Thomas Russo, Fuld summarised a conversation he had over dinner with the US Treasury Secretary Henry Paulson.
According to Fuld, Mr Paulson said he wanted to "kill the bad HFnds + heavily regulate the rest."

http://tinyurl.com/537xt9

I thought G-S suckled half the world's hedge funds on its very own breasts.

Posted by: johnf | Oct 15 2008 18:12 utc | 62

And anyone even aware of ratings in the industry knows that they were piles of shit.

Absolutely true, and the people making the most noise about ratings in public throughout this runup were hedge funds shorting the hell out of the ABX (like Paulson & Co.)

Posted by: vaudois | Oct 15 2008 18:12 utc | 63

@ #50

Actually your site isn't visible to search engines because you're using frames and pulling content from another domain. From the search engine's perspective, the "lebed-dofenism.co.nr" domain has no content of its own, it's all coming from "farmer-greean.blogspot.com". You may have more luck submitting that domain for indexing, however the massive amount of links on the page are probably also going to hurt your rankings.

Hope that helps... Search engine optimization can be pretty complicated.

Posted by: Chemmett | Oct 15 2008 19:13 utc | 64

Search engine optimization can be pretty complicated

if it's that complicated, then search engines should be banned.

Posted by: Powder Fresh | Oct 15 2008 20:19 utc | 65

if it's that complicated, then search engines should be banned.

har

Posted by: vaudois | Oct 15 2008 21:16 utc | 66

here's an funny exchange ..Rolling Stone's Matt Taibbi and NRO's Byron York argue..

live on the radio, NRO's york gets a blistering takedown.

MT: Do you even know how a CDS works? Can you explain your conception of how these derivatives work? Because I get the feeling you don't understand. Or do you actually think that it was a few tiny homeowner defaults that sank gigantic companies like AIG and Lehman and Bear Stearns? Explain to me how these default swaps work, I'm interested to hear.

Because what we're talking about here is the difference between one homeowner defaulting and forty, four hundred, four thousand traders betting back and forth on the viability of his loan. Which do you think has a bigger effect on the economy?

B.Y.: Are you suggesting that critics of Fannie and Freddie are talking about the default of a single homeowner?

M.T.: No. That is what you call a figure of speech. I'm saying that you're talking about individual homeowners defaulting. But these massive companies aren't going under because of individual homeowner defaults. They're going under because of the myriad derivatives trades that go on in connection with each piece of debt, whether it be a homeowner loan or a corporate bond. I'm still waiting to hear what your idea is of how these trades work. I'm guessing you've never even heard of them.

I mean really. You honestly think a company like AIG tanks because a bunch of minorities couldn't pay off their mortgages?

B.Y.: When you refer to "Phil Gramm's Commodities Future Modernization Act," are you referring to S.3283, co-sponsored by Gramm, along with Senators Tom Harkin and Tim Johnson?

M.T.: In point of fact I'm talking about the 262-page amendment Gramm tacked on to that bill that deregulated the trade of credit default swaps.

Tick tick tick. Hilarious sitting here while you frantically search the Internet to learn about the cause of the financial crisis — in the middle of a live chat interview.

B.Y.: Look, you can keep trying to make this a specifically partisan and specifically Gramm-McCain thing, but it simply isn't. We've gone on for fifteen minutes longer than scheduled, and that's enough. Thanks.

M.T.: Thanks. Note, folks, that the esteemed representative of the New Republic has no idea what the hell a credit default swap is. But he sure knows what a minority homeowner looks like.

B.Y.: It's National Review.

Posted by: annie | Oct 15 2008 21:21 utc | 67

michael hudson again on kpfa's program guns and butter this week - the bailout's new financial oligarchy - tough words for a tough situation

Posted by: b real | Oct 15 2008 21:34 utc | 68

b real

splenidi interview

dr hudson is singing along with me ô down, down, down we go

bring out the tumbrils

Posted by: remembereringgiap | Oct 15 2008 23:31 utc | 69

b real

splenidi interview

dr hudson is singing along with me ô down, down, down we go

bring out the tumbrils

Posted by: remembereringgiap | Oct 15 2008 23:39 utc | 70

b @ 60:

Interesting interview (and curious you hear KPFA "over there"). IMO some of it insightful, some very speculative, and some wrong.

I do agree w/his point US is already broke, a point I mentioned previous and the utter lack of acknowledging this publicly in US which irks me to no end. Ok, scares the shit out of me.

In addition to stats/graphs depicting this "condition", a couple from Barry Ritholtz reinforce the point:
Adjusted Reserves
Adjusted Monetary Base.

His assertion that Paulson is "emptying the treasury" just before the election could very well be true. As best I can tell, however, it a speculative assertion... supporting evidence is sparse. And IMO, this point doesn't suggest solutions/corrective measures, which is what's most needed.

Personally, I don't think Paulson's a crook. I do think he's in way over his head, and obviously he/Bernacke are way behind the curve. I think he's doing what he knows, he just doesn't know enough.

I watched a Bernacke speech today on C-SPAN today delivered to The Economic Club of New York. Aside from dire statements from Bernacke, the body language of nearly everyone there looked like they were getting a last meal before being taken to the gulag.

I think Bernacke's in same boat as Paulson... over his head and myopically informed.

Anyway, back to Hudson: he asserts foreign govs don't trust us in financial/market matters: true!!! Another point lost on most USA'sians. He says in particular, however, citing Germans as example, they want to run from US investment. I don't know about that... reason I asked you the other day about "decoupling". And from what I saw from Germany's support for G7 goals, looks like he's got this one wrong. But for sure, the underlying sentiment (they don't trust us) is true and, in the long run, what I'm most concerned about here. I've made the point everywhere I can that this is a unique window to drive a dagger through the heart of neocon/"free-market" economics... the truth is on the side of doing that. I don't see it happening at all.

Beyond that, EU is not region covering US debt or in 1st postion to cash out and send us into ruin: that's CHINA/RUSSIA/JAPAN/KOREA/SINGAPORE etc. And in fact, Russia/China have indeed sold off significant treasuries in recent months... Russia +/- $300b just a couple weeks before shit hit the fan here and Paulson went to congress "for help". I've wondered if that wasn't real reason Paulson tapped Barney Frank on the shoulder.

But maybe Hudson's right... maybe EU will go it's own way? He talks of FED/Treasury attempting to strongarm London/EU banks to bail out Euro held US investments gone bad, and they said no. I haven't read/seen evidence of this, but it wouldn't surprise me. He even says Europe discussing how to move away from the $USD. Again, wouldn't surprise me but I haven't seen evidence of that.

Anyway, it's a worthwhile listen. Maybe they'll play/discuss it on FOX news, 'ya think?

...

Again, what I really want to hear is serious, honest corrective measures. I hear none here in the circles of power that matter. Frankly, I'm not sure US is up to having that conversation/realization. I worry a critical mass of our population has been so dumbed down & un/mis-informed that the will & capacity to deal w/this has been effectively mushed.

Posted by: jdmckay | Oct 15 2008 23:49 utc | 71

annie @ 66:

sigh. I see BY behavior in that transcript over again amongst his neocon/conservative breathren. It's disheartening.

Posted by: jdmckay | Oct 15 2008 23:53 utc | 72

jdmckay,

those neonuts, they get a script and they stick to it.

Posted by: annie | Oct 16 2008 0:03 utc | 73

What I find most interesting about this dialogue is the way that even the reasonable people have been tricked into the "who has got the most arcane jargon" game.
The original quant creature started it but everyone else joined in. Mostly because knowing all of this unlyrical, frequently imprecise, occasionally redundant and always deliberately obscure language of the 'market experts' has become a rite of passage for bourgeois amerikan males.
I can see the alcohol lubricated social gatherings in my minds eye. This is where middle aged, middle class amerikans indulge in there favourite dick measuring contest of "who can best pretend to be a market insider". This may seem unnecessarily harsh and I'd be lying if I pretended that middle aged middle class males in other parts of the world thrust together at social gatherings with little in common outside of their respective partners insistence that "we are all family here" don't also get into pissing contests.

They do but not about financial markets to quite the same extent.

This stuff is more dangerous to the people playing the game than they are usually prepared to acknowledge.
Firstly because the syntax used carries with it a number of unproven, probably wrong assumptions. The first of those is the inevitabilty of the capitalist way. The second is that massed human behaviour can be as accurately predicted as if one was calculating the maximum v velocity of m mass subjected to f force for t time.
The third and most dangerous assumption is that the artificially constructed lexicography of these debates accurately describes the artificial constructs they are assumed to.

I doubt that this vocabulary of capitalist connivance really exists for any other purpose than to deceive the bulk of the players - from Joe Familyman trying to adopt a hunter gatherer understanding of his childrens' education savings, his family housing finance and his retirement plan, across to the corporate shit kickers charged with selling these scams to Joe Familyman.

Sure the vocabulary is most frequently invented by academics who all the other academics describe as brilliant, innovative, even genius, but what does that mean in a world where even academics in the real sciences have argued in favour of intelligent design or some other equally corrupt mumbo-jumbo cause they thought it would advance their career or earn them an extra dollar.

As soon as normal, honest human beings begin using the language of the spruikers, spivs and shills of the modern finance industry, they have practically conceded defeat. They have given all the territorial advantage to the wall st con artists.

If you get up close to some derivatives and they seem more like one of those crazy useless systems claimed to allow anyone to win the lottery, than an insurance policy, then that is how you should think about and talk about that derivative.

Posted by: Debs is dead | Oct 16 2008 0:10 utc | 74

DID@75
I doubt that this vocabulary of capitalist connivance really exists for any other purpose than to deceive the bulk of the players

Yes, we are slaves to "conventional wisdoms"
Sigh

Posted by: jony_b_cool | Oct 16 2008 0:46 utc | 75

What did Trichet mean, talking about discipline and invoking Bretton Woods?

Posted by: ...---... | Oct 16 2008 0:47 utc | 76

ahq, I wasn't trying to indicate a distaste for derivatives. They are obviously a form of hedging that could benefit real industry. I was questioning your example of coal pricing being evidence of the value of derivatives. I doubt that is a good example. I suspect it would show that hedging merely delayed a recent price increase until the hedges ran out. So what? What evidence is there that a bunch of traders would not have made the recent price increases worse? If Enron was still here those increases likely would have been worse.

Posted by: dacorilitter | Oct 16 2008 2:10 utc | 77

Hmm. Since I'm a babe in the woods when it comes to high finance (and thank the goddess, I'm also a very conservative investor), I had to look up "quant" to find out a little bit about our honest friend above.

Found an interesting website here.
You want jargon, here's yer website. Dark pools, DarkSweepTM, assets under management = AUM (shiva save us)

Key characteristics of alpha generation platforms include: an ability to integrate seamlessly with leading data sources and databases for rapid data capture, transformation and storage for analysis; ease of use in creating rigorous back-testing and simulation environment; availability of prepackaged operations, routines, strategies and factors; detailed documentation of model creation process; charting, reporting and visualization tools; a codeless environment for rapid strategy development; and a straight-through processing feature that enables quants to go from idea generation to order generation in a drastically reduced time frame.

The demand for quants and their quantitatively driven alpha discovery strategies will persist as the current march toward cross-asset-class trading continues to increase, and trading narrows even more. In this incredibly competitive environment, technology can give a quant a leg-up on the competition.

If these guys (and I agree with DiD about the testosterone factor) wanna play quantum physics poker, they shouldn't oughta be doing it with the same stuff that people use to buy rice, beans, and houses. Moral hazard, my ass. They're playing WoW with the real world. Who's gonna be Jeezus and throw the money-lenders out the temple?

Yeah, yeah, I don't know shit about this stuff. Forgo the flaming, please.

Posted by: catlady | Oct 16 2008 2:18 utc | 78

catlady

i couldn't agree more

it is the metaphysics of morons

except it is the world that pays the price

Posted by: remembereringgiap | Oct 16 2008 2:54 utc | 79

Debs @ 75:

Felt I ought to say how much I value your contributions and especially your passionate eloquence. Thanks as always.

Catlady @ 79:

"thank the goddess:" I think She just put the Ma back into market...

Posted by: Tantalus | Oct 16 2008 3:19 utc | 80

Thank you Did, catlady,r'giap for bringing some much needed code-breaking into this topic. The Grover 'drown the govt in the bathtub' Norquist-sque New double speak and framing is quite manipulative and serves the class uppers always and foremost. Just as George Lakoff lectures on how conservatives use language to dominate politics, so to does this form of stratagy work on wallstreet and other institutions and in most money issues, to sucker people out of their money.

I haven't the time of late nor energy nor knowledge to navigate the octopus ink of verbal distraction to sift through to be able to even begin to find anything constructive to add as our new friends dominate this discussion. But I do know it is meant to burn people out. It, being the jargon of the snake oil used car sales pitches of the already living well.

Posted by: Uncle $cam | Oct 16 2008 3:42 utc | 81

für r'giap, b, und ahq:

Lied des Lotterieagenten

Was zahlen Sie fur einen Rat, wie man sen Geld anlegt mit Nutzen?

Hast du Geld, lass es nicht bei dir im Sack,
geh' zu den Menschen und säe es aus.
Das ist ein Akker, der düngt sich mit Blut,
da wächst etwas, da kommt etwas heraus,
das produziert die Krone des Gewinns: Zins und Zinseszins.

Zuerst kommt das und dann kommt nichts danach.
Für dich schliesst sich des Lebens Bilderbuch.
Du schlägst nur pünklich den Kalender auf
und liest Termine und du liest genug.
Das kalkuliert die Krone des Gewinns: Zins und Zinseszins.

Trägst du ein Herz von Fleisch, erhärte es zu Stein
und wund're dich nicht gleich gelingt.
Sei einmalhart vor einer grossen Not,
bald siehst du zu, wenn wer ins Wasser springt;
das garantiert die Krone des Gewinns: Zins und Zinseszins.

Bau einen Turm von Quadern um dich,
du hörst nicht wie sie draussen kläglich schrein.
Sei blind, sei taub, erlasse leine Schuld,
du büsst ja Geld und Geldes Nutzen ein,
verleugne nei die Krone des Gewinns: Zins und Zinseszins.

Darum lerne, wieman's macht, dass einem Zinseszins und Zinsesfreude lacht.

So sind jetzt ein reicher Mensch. Sie haben viel Geld auf Ihrem Konto....
Sie sind ein Millionär....
Dann können Sie machen, was Sie wollen....


-Kaiser/Weill

Posted by: catlady | Oct 16 2008 3:44 utc | 82

What a real financial collapse looks like. An hour long video on Argentina, with strong lessons for any American who looks around right now and sees "business as usual" in the neighborhood.

Found over at Stan Goff's Feral Scholar, one of DeAnander's haunts. Haven't seen any posts from DeA for a while, nor at Eurotrib, which I seldom read. Hope the boat's floating snugly.

Posted by: catlady | Oct 16 2008 4:18 utc | 83

catlady - scroll up to #36 ;-)

Posted by: b real | Oct 16 2008 4:55 utc | 84

echoing DiD's adept assessment, I've been trying out my training-wheel understanding of the derivative dance these gambling addicts are forcing us to confront with my friends and coworkers, and by simply uttering befuddling terms like credit default swaps i feel i am virally spreading the unspoken validation of utter bullshit.

jdmckay@72:Frankly, I'm not sure US is up to having that conversation/realization. I worry a critical mass of our population has been so dumbed down & un/mis-informed that the will & capacity to deal w/this has been effectively mushed.

I've been trying to establish a presence at a local, left-leaning blog, focused on local politics and culture, and like other intelligent, obama supporting people i've conversed with, my initial criticisms of B.O. being a pro AIPAC, Afghan war expanding, domestic spying, free trade enabling bailout champion of naked corporatism were at first ignored, but today i was told by an official contributor that my nihilism hurt his head.

a compliment?

see, i want to establish a presence at this site because these people are civically engaged citizens from my community who attend and report on city council meetings where zoning laws are hashed out and developers are forced to plead their case. as it gets worse, these are the people who matter where i live, so i consider it prudent to say, in the most polite way a bitter dissident can muster, wake the fuck up!

i'm saying this because people trump financial instruments, and humans have basic needs that are not only not met, but thwarted every day by people like me, brought up on the unrealistic expectations of sustaining an unsustainable lifestyle that i was encouraged to consider was my birth right.

but who cares that this is not just the sickness of amerika? it's so easy to throw it all on US. we are by far the most grotesque manifestation of the elite lurching toward "global order" but focusing too intently on this devolving nation narrows attention from other players eager to place their bets.

god, i fucking hate gambling.

Posted by: Lizard | Oct 16 2008 5:44 utc | 85

"who has got the most arcane jargon"

There's nothing arcane about any of the jargon so far. If you think its arcane you should study it more. You certainly shouldn't be offering opinions on things you don't understand.

Posted by: vaudois | Oct 16 2008 9:55 utc | 86

What evidence is there that a bunch of traders would not have made the recent price increases worse?

I can give you a reaosn: derivative markets make volatility lower by distributing risk. Hedge funds, banks etc are by and large both long and short. Their collective market making holds prices within reaosnable bounds. IN markets like coal etc where there are no funds or banks, moves are much spikier and scarier. It isnt "manipulation" just illiquidity, and has always been thus in any physically settled instrument with a thin underlier.

The evidence is everywhere: look at any market with a futures curve, and compare it to a similar one without a futures curve. The volatility of the hedgeable one is always going to be lower. Equities are a great example but it also applies to bonds, currencies commodities, everything.

There's also the argument that no one seems to have touched that bond dealers would have a monopoly on rates with no derivs market. Do we want that?

Posted by: vaudois | Oct 16 2008 9:59 utc | 87

You certainly shouldn't be offering opinions on things you don't understand.

Are you serious? So you have to understand something before you can talk about it or have an opinion on it?

What kind of pedigogy does that arrive from?

Sounds like the war between Kant and Hegel to me.

Posted by: Uncle $cam | Oct 16 2008 10:09 utc | 88

So you have to understand something before you can talk about it or have an opinion on it?

You can certainly talk about it, but it seems wiser to ask questions than to spout opinions if you don't get the basics.

What kind of pedigogy does that arrive from?

Epictetus: We have two ears and only one mouth.

Truly, nothing that's been discussed is that esoteric. If you have any questions, maybe I or someone else can answer them, or point you toward some source material.

Posted by: vaudois | Oct 16 2008 10:21 utc | 89

Truly, nothing that's been discussed is that esoteric. If you have any questions, maybe I or someone else can answer them, or point you toward some source material.

Well, perhaps...lol

However sometimes, the esoteric and arcane is exactly what we are dealing with. Sleight of hand, verbal simulacra etc..

Tom Robbins (often times): Answers can't be giving, they can only be received.

Signal noise and all that...lol

Posted by: Uncle $cam | Oct 16 2008 11:00 utc | 90

U$,

Everything viewed up close is complicated. Especially concepts from disciplines where we have no training. Legal regulation is immensely complicated and confusing to the unschooled (of course I can speak only for myself), which is why it confuses me to see people running to the arms of legislators and regulators for protection from derivatives -most of which can be explained in 10 or 15 seconds. Whereas laws often run to 500 pages plus, a derivative "term sheet" is typically two pages long. In fact the most toxic categories of derivatives are usually a reply to some byzantine regulation, and it's not unheard of to see legal training as a prerequisite for structured finance roles.

I'm unsure why it makes sense to trust lawmakers and law enforcement more than markets to ensure "fairness." In principle it seems that the more transparent, liquid and broadly traded something is, the closest to "fair" its value, and that most derivatives fall well within this description. Not CDSes perhaps (yet, although a central clearing mechanism and greater standardization of terms would change this as well.)

Posted by: vaudois | Oct 16 2008 11:21 utc | 91

A guy in m+a at a major institution tells me the following: going into a deal, we know the elements, and we know the ways in which those elements and their connections can be described (if you know any less, you don't belong in the room, let alone at the table). This, for him, is where "jargon" has its indispensable place.

Fun starts when descriptions get complex, and the transactions proposed even more so. Keeping the picture opaque is often the name of the game. Again, the fun is not in the jargon, but in the depth of the play (bluffs included)--much as in chess, where the winner sees ten moves ahead, and the loser only nine.

This guy, who doesn't do trades, has spent the last three years in a state of perpetual dread over the accelerating growth of the markets, because, as he puts it, no one knew the rules. For him, deregulation has been the problem, not the instruments themselves.

Posted by: alabama | Oct 16 2008 11:22 utc | 92

http://www.frbatlanta.org/news/CONFEREN/07FMC/07FMC_Weithers.pdf

a good (and short, and accessible!) piece on credit derivatives.

Posted by: vaudois | Oct 16 2008 11:32 utc | 93

Indeed, Alabama, indeed.

Two words: Delphi Technique

The Delphi technique was developed by the RAND Corporation in the late 1960's as a forecasting methodology. Later enhanced, The delphi method became a proven scientific form of propaganda, to control group dynamics. The Delphi Technique and consensus building are both founded in the same principle - the Hegelian dialectic of thesis, antithesis, and synthesis, with synthesis becoming the new thesis. The goal is a continual evolution to "oneness of mind" (consensus means solidarity of belief) -the collective mind, the wholistic society, the wholistic earth, etc.

In thesis and antithesis, opinions or views are presented on a subject to establish views and opposing views. In synthesis, opposites are brought together to form the new thesis. All participants in the process are then to accept ownership of the new thesis and support it, changing their views to align with the new thesis. Through a continual process of evolution, "oneness of mind" will supposedly occur.

In group settings, the Delphi Technique is an unethical method of achieving consensus on controversial topics. It requires well-trained professionals, known as "facilitators" or "change agents," who deliberately escalate tension among group members, pitting one faction against another to make a preordained viewpoint appear "sensible," while making opposing views appear ridiculous.

There is a need of those in power to preserve the illusion that there is "community participation in decision-making processes, while in fact lay citizens are being squeezed out. Edward Benays would be proud.

Posted by: Uncle $cam | Oct 16 2008 12:32 utc | 94

vaudois@88,

if someone has a need today to hedge a commodity (coal, crude, gasoline, corn, copper, ...) by far the best way to do so has always been via long-term physical contracts, not via derivatives. This is what the refineries & power utilities prefer to do. These industries can survive & thrive without a derivatives market. If oil futures did not exist, the entire oil derivatives market would be instantly replaced by an informal "spot market" (like back in the old days). And prices would most likely fall and remain stable.

I cannot speak in depth about the pro/cons of derivatives wrt stocks & bonds but just wanted to point out that whatever the case, pricing commodities is generally a very different animal. What we have seen in recent years is a highly successful (for the traders/Wall-Street/Big Oil) effort to impose a (stocks/bonds like) derivative system for pricing oil. And to convince the public that it is sacred gospel.

Posted by: jony_b_cool | Oct 16 2008 12:59 utc | 95

Uncle $pam,

That's nothing new, so the Rand Corporation can't claim discovery of that concept...it's been going on since the advent of Civilization. The only thing Rand did was bottle, brand and label it. As you must know, such practices are not the sole propriety of the Elite. Any group is capable of, and often engages in, such behavior, including the clique here at MOA, of which you are part. If you're going to cast stones it's best to make sure you are practicing what you preach, lest you are them against whom you preach, just another flavor.

Posted by: Joe The Plumber | Oct 16 2008 13:06 utc | 96

Joe the Plumber,

Are you hurt and angry? Angry? Hurt? Angry and hurt? Are you mad because someone wants to spread your wealth?

I think you should audition for the Sarah Palin porno

"Something need plunging, ma'am?"

"Ooh, you big moose! Is that a pair of channel locks in your pocket or did I just blink? Come over here and spread the wealth!"

"I'm hurt and angry. Angry. Hurt. Angry and hurt."

"Aww. Let mommy kiss it better... mind the lipstick..."

Posted by: Tantalus | Oct 16 2008 13:18 utc | 97

hmm - "Joe The Plumber" in 97 is also "bee" in 10 and Powder Fresh in 66

Obviously someone trolling under various names. As the usual netiquette applies here, such behavior leads to being banned.

Posted by: b | Oct 16 2008 13:23 utc | 98

@vaudois @87 - You certainly shouldn't be offering opinions on things you don't understand.

Now that is the really 'democratic' opinion. Only experts should vote?

@88 - derivative markets make volatility lower by distributing risk. Hedge funds, banks etc are by and large both long and short. Their collective market making holds prices within reaosnable bounds.

Nonsense. The recent spike in oil was obviously a lot of hedgies trading all in the same direction. Was that holding market prices within reasonable bounds? Just as now in stocks. Everyone is shorting as hell. Makes sense as an individual decision. You assume that derivative markets are balanced and distribute risk. They can also behave very unbalanced and increase the risk.

But the most important argument against them is that they obviously have external costs that have to be carried by the society. If the external costs of a product becomes too big, the society should and usually does, ban that product, or at least regulates it.

That goes for drugs, dirty cars, guns and lots of other issues too. It applies to financial products just as well.

@94 - a good (and short, and accessible!) piece on credit derivatives.

Now that hit is far outside the ballpark - 54 pages from a University of Chicago free-market preacher is short and accessible?

Let's see the conclusions (page 43+) of this genius:

The probability of systemic risk in the banking industry attributable to credit derivatives stemming from macroeconomic events is probably much lower than in the past ...
As is currently demonstrated?
For the financial system as a whole, recognizing that hedge funds, on balance, supply/demand comparable magnitudes of credit derivatives to/from the market, these would appear to provide a buffer for traditional lending institutions. One caveat here is the potential for concentration risk if hedge funds all end up taking on the same (losing) positions.
Which of course they seem to have done. And not only the hedgies, but also the investment banks.
Recent developments in the settlement procedure, reductions in operational risks, and other advances to improve the clearing, transparency, and liquidity of the market bode well for the continued success of these products.

The "continued success of these products" brought AIG down and threatens to bring down the world's financial system.

Such is the wisdom of an April 2007 paper by some UoC financial "expert."

Thanks - I do not need such "experts" to tell me how derivatives work.

Posted by: b | Oct 16 2008 13:47 utc | 99

wallerstein: The Depression: A Long-Term View

The depression has started. Journalists are still coyly enquiring of economists whether or not we may be entering a mere recession. Don't believe it for a minute. We are already at the beginning of a full-blown worldwide depression with extensive unemployment almost everywhere. It may take the form of a classic nominal deflation, with all its negative consequences for ordinary people. Or it might take the form, a bit less likely, of a runaway inflation, which is simply another way in which values deflate, and which is even worse for ordinary people.

Of course everyone is asking what has triggered this depression. Is it the derivatives, which Warren Buffett called "financial weapons of mass destruction"? Or is it the subprime mortgages? Or is it oil speculators? This is a blame game, and of no real importance. This is to concentrate on the dust, as Fernand Braudel called it, of short-term events. If we want to understand what is going on, we need to look at two other temporalities, which are far more revealing. One is that of medium-term cyclical swings. And one is that of the long-term structural trends.

...

Posted by: b real | Oct 16 2008 16:18 utc | 100

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