naked capitalism Wed 2010-09-08 17:27 EDT

Economic consequences of speculative side bets -- The case of naked CDS

Yeon-Koo Che and Rajiv Sethi

...We argue that the existence of naked credit default swaps has significant effects on the terms of financing, the likelihood of default, and the size and composition of investment expenditures. And we identify three mechanisms through which these broader consequences of speculative side bets arise: collateral effects, rollover risk, and project choice...the existence of zero-sum side bets on default has major economic repercussions. These contracts induce investors who are optimistic about the future revenues of borrowers, and would therefore be natural purchasers of debt, to sell credit protection instead. This diverts their capital away from potential borrowers and channels it into collateral to support speculative positions. As a consequence, the marginal bond buyer is less optimistic about the borrower's prospects, and demands a higher interest rate in order to lend. This can result in an increased likelihood of default, and the emergence of self-fulfilling paths in which firms are unable to rollover their debt, even when such trajectories would not arise in the absence of credit derivatives. And it can influence the project choices of firms, leading not only to lower levels of investment overall but also in some cases to the selection of riskier ventures with lower expected returns...

Case; economic consequences; naked capitalism; Naked CDS; speculative side bets.

zero hedge Fri 2010-01-29 16:36 EST

Guest Post: Government Spending, Bank Lending And Inflation

Submitted by Kletus Klump In his latest weekly commentary, Inflation Myth and Reality, Dr. John Hussman makes the argument that changes-in federal government spending dictate the future path of inflation. As shown below, his data set covers the period from 1951 through 2008 and there appears to be a decent correlation. However, his data set is incomplete in 2 respects: 1. It does not include the Great Depression years and 2. It does not include data on bank lending. The relationship between government spending and future inflation was vastly different during the years of 1932 to 1941. The correlation between the 2 series for this time period is negative 0.25. The factor causing this is change in mortgage-loan growth...fears of government-spending-induced extended inflation in terms of time and magnitude are not a concern until the lending mechanism improves.

bank lending; government spending; Guest Post; Inflation; Zero Hedge.

naked capitalism Mon 2009-12-21 15:58 EST

Obama's demand that fat cats lend is no ode to Samuelson

Edward Harrison

...to-do about President Obama's fat cat remarks and his meeting with bankers exhorting them to lend...we are getting a bunch of populist rhetoric which is pure politics to induce banks to lend recklessly and save the economy when basic economics would tell you that there is a deficit of lending capacity and demand for credit. It is the absurd kabuki theater of depression economics...David Rosenberg...sees something altogether more cynical -- an orchestrated campaign to shame and bully banks into going against their fiduciary responsibility and lending irresponsibly again!...Easy money is not the solution, it is the problem. Jobs are the solution...fiscal policy is more effective than monetary policy in a depressionary environment. Quantitative easing is overrated.

fat cats lend; naked capitalism; Obama s demands; Ode; Samuelson.

zero hedge Tue 2009-11-03 19:57 EST

Guest Post: Systemic Risk is All About Innovation and Incentives: Ed Kane

Edward J. Kane vi Chris Whalen

...we present the views of our friend and mentor Ed Kane of Boston College, who argues that the problem with the financial regulatory framework is not the law, regulation nor even the regulators, but rather the confluence of poorly aligned incentives and financial innovation... The financial crisis of 2007-2009 is the product of a regulation-induced short-cutting and near elimination of private counterparty incentives to perform adequate due diligence along the chain of transactions traversed in securitizing and re-securitizing risky loans (Kane, 2009a). The GLBA [Gramm-Leach-Bliley Financial Modernization Act of 1999] did make it easier for institutions to make themselves more difficult to fail and unwind. But it did not cause due-diligence incentives to break down in lending and securitization, nor did it cause borrowers and lenders to overleverage themselves. Still, the three phenomena share a common cause. Excessive risk-taking, regulation-induced innovation, and the lobbying pressure that led to the GLBA trace to subsidies to risk-taking that are protected by the political and economic challenges of monitoring and policing the safety-net consequences of regulation-induced innovation. These challenges and the limited liability that their stockholders and counterparties enjoy make it easy for clever managers of large institutions to extract implicit subsidies to leveraged risk-taking from national safety nets (Kane, 2009b)...To reduce the threat of future crises, the pressing task is not to rework bureaucratic patterns of financial regulation, but to repair defects in the incentive structure under which private and government supervisors manage a nation's financial safety net.

Ed Kane; Guest Post; incentives; innovation; systemic risk; Zero Hedge.

Credit Writedowns Fri 2009-10-23 09:00 EDT

The next crisis is already under way

Wolfgang Munchau of the Financial Times wrote a very important comment piece in today's Financial Times. In it he said that central banks are targeting asset prices to avoid the brunt of cyclical downturns. This policy is inducing asset bubbles and creating a more volatile real economy with unpredictable negative consequences...Munchau invokes Hyman Minsky's model of financial instability to help explain how this sets us up for a volatile future because traditional macroeconomic theory is inadequate for understanding what got us to this point. In essence, the idyllic state of economic and price stability we know as ``the Great Moderation'' is really just a financialization of the economy. However, a large financial sector leads to excessive dependence on asset prices to fuel growth, which in turn leads to an accumulation of debt...

credit writedowns; Crisis; way.

naked capitalism Thu 2009-10-15 17:12 EDT

Hyperinflation, national bankruptcy, dollar crash and other exaggerations

Edward Harrison

Marc Faber, Martin Wolf... George Soros' comments on dollar weakness: ``The dollar is a very weak currency except all the others.'' Right now, there is no alternative to the dollar. Some people are fleeing U.S. assets if they can. But the alternatives are limited and this limits how far the dollar will fall. And this is unfortunate because the monetary system now in place is in need of change. Without it, we are likely to see nationalistic policy responses to economic weakness, which will induce conflict.

dollar crash; exaggerated; Hyperinflation; naked capitalism; nationalized bankruptcy.

Tue 2009-06-16 00:00 EDT

naked capitalism: Guest Post: The Fake Recovery

``he underlying systemic issues in the financial sector are being papered over through various mechanisms designed to surreptitiously recapitalize banks while monetary and fiscal stimulus induces a rebound before many banks' inherent insolvency becomes a problem''

Fake Recovery; Guest Post; naked capitalism.

Mon 2008-12-08 00:00 EST

Winter (Economic & Market) Watch >> Boom-Bust Speculator Induced Maladjusted Roller Coaster Economy

Winter (Economic & Market) Watch >> Boom-Bust Speculator Induced Maladjusted Roller Coaster Economy

Boom-Bust Speculator Induced Maladjusted Roller Coaster Economy; economic; Market; watch; winter.

Thu 2008-07-03 00:00 EDT

Faustian economics:

Hell hath no limits--By Wendell Berry (Harper's Magazine); "Our true religion is a sort of autistic industrialism"; "our 'identity' is located not in the impulse of selfhood but in deliberately maintained connections"; "in the phrase 'free market,' the word 'free' has come to mean unlimited economic power for some, with the necessary consequence of economic powerlessness for others"; "we confuse limits with confinement...our human and earthly limits, properly understood, are not confinements but rather inducements to formal elaboration and elegance, to _fullness_ of relationship and meaning"; "we want to make our economic landscapes sustainably and abundantly productive, we must do so by maintaining in them a living formal complexity something like that of natural ecosystems. We can do this only by raising to the highest level our mastery of the arts of agriculture, animal husbandry, forestry, and, ultimately, the art of living."

Faustian economics.

Wed 2008-03-26 00:00 EDT

Winter (Economic & Market) Watch >> Rebuttal of GaveKal's Bully ``Wealth & Platform Theory''

Winter (Economic & Market) Watch >> Rebuttal of GaveKal's Bully "Wealth & Platform Theory"; platform companies "outsource American jobs to safe production locales like China and Thailand, who then pollute the global environment and fail to account for the negative externalities (true costs) of their production...the peculiar slash and burn notion that the US can just eat its young by outsourcing jobs to foreign polluters, while failing to invest in capex and just merrily borrowing from foreigners against its Bubble induced wealth."; 2006-12-26

economic; GaveKal's Bully; Market; Platform Theory; Rebuttal; watch; wealth; winter.