naked capitalism Thu 2010-09-30 08:22 EDT

Why Backstopping Repo is a Bad Idea

The normally sound Gillian Tett of the Financial Times endorses an idea that is both dangerous and unnecessary, namely, government backstopping of the system of short-term collateralized lending called repo, for ``sale with agreement to repurchase.''...But the real problem is that the only securities that were once considered to be suitable were those of the very highest quality, namely Treasuries. The real problem is in widening the market beyond that. If you have absolutely impeccable collateral, you don't care if your counterparty goes belly up if you aren't at risk of losses on the assets you hold...the real problem is the use of low quality collateral...why would we possibly WANT a system that might down the road encourage the pledging of less than stellar instruments as repo?...we need to go back and look hard at why the need for repo has risen since 2001, and how much is related to legitimate activity. The fact that it grew much more rapidly than the economy overall suggests not...official efforts should proceed...to shrink the repo market (as we've recommended for a market that has contributed to the growth of repo, credit default swaps)...our efforts NOT to restrain banks leads to a tremendous tax on all of us...a banking industry that creates global crises is negative value added from a societal standpoint. It is purely extractive...

Backstopping Repo; Bad Ideas; naked capitalism.

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.

Money Game Wed 2010-09-01 10:53 EDT

Why Ben Bernanke's Next Round Of Quantitative Easing Will Be Another Huge Flop

There is perhaps, no greater misunderstanding in the investment world today than the topic of quantitative easing [QE]. After all, it sounds so fancy, strange and complex. But in reality, it is quite a simple operation...The Fed simply electronically swaps an asset with the private sector. In most cases it swaps deposits with an interest bearing asset...The theory behind QE is that the Fed can reduce interest rates via asset purchases (which supposedly creates demand for debt) while also strengthening the bank balance sheet (which entices them to lend). Unfortunately, we've lived thru this scenario before and history shows us that neither is actually true. Banks are never reserve constrained and a private sector that is deeply indebted will not likely be enticed to borrow regardless of the rate of interest...The most glaring example of failed QE is in Japan in 2001. Richard Koo refers to this event as the ``greatest monetary non-event''...Since Ben Bernanke initiated his great monetarist gaffe in 2008 there has been almost no sign of a sustainable private sector recovery. Mr. Bernanke's new form of trickle down economics has surely fixed the banking sector (or at least bought some time), but the recovery ended there. ..The hyperventilating hyperinflationists and those investors calling for inevitable US default are now clinging to this QE story as their inflation or default thesis crumbles before their very eyes...With the government merely swapping assets they are not actually ``printing'' any new money. In fact, the government is now essentially stealing interest bearing assets from the private sector and replacing them with deposits...now that the banks are flush with excess reserves this policy response would in fact be deflationary - not inflationary...

Ben Bernanke's; Huge Flop; Money game; Quantitative Easing.

zero hedge - on a long enough timeline, the survival rate for everyone drops to zero Wed 2010-08-25 10:47 EDT

Illinois Teachers' Retirement System Enters The Death Spiral: AIG Wannabe's Go-For-Broke Strategy Fails As Pension Fund Begins Liquidations

Two few months ago we disclosed how the Illinois Teachers' Retirement System (TRS) was doing all it can to become the next AIG. In addition to, or maybe precisely due to, its deplorable fundamental condition, which can be summarized as being 61% underfunded on its $33.7 billion in assets, with a performance record of down $4.4 billion in 2009 and 5% in 2008, the fund, courtesy of a detailed analysis by Alexandra Harris of the Medill Journalism school at Northwestern, was found to be on its way to trying to become a veritable self-made TBTF: as was described then, "TRS is largely on the risky side of the contracts, selling and writing OTC derivatives, including credit default swaps,..."

AIG Wannabe's Go; Broke Strategy Fails; Death Spiral; dropped; Illinois teacher; long; Pension Fund Begins Liquidations; Retirement System Enters; survival rate; Timeline; zero; Zero Hedge.

PRAGMATIC CAPITALISM Mon 2010-08-23 19:11 EDT

SAY IT AIN'T SO JOHN....

TPC

I am saddened to say that John Hussman is worried about inflation and default in the USA. I guess the inflationistas and defaultiastas have made a substantial mid-season pick-up. Unfortunately, however, Mr. Hussman makes all the same claims that have driven these worrywarts astray for so many years. Specifically, Mr. Hussman is now discussing the inevitable ``collapse'' of the U.S. dollar due to Quantitative Easing...There is substantial historical evidence showing that QE is nothing more than an asset swap and has little to no impact on the real economy, inflation rates or currencies. Japan is again the best historical precedent...there is a long-term threat of inflation or that we have attempted to paper over many of our mistakes, however, there is very strong evidence showing that QE will not be the cause of a collapse in the dollar...

ain't; John; PRAGMATIC CAPITALISM; says.

Satyajit Das's Blog - Fear & Loathing in Financial Products Thu 2010-08-19 16:16 EDT

Grecian Derivative

Satyajit Das

...In the 1990s, Japanese companies and investors pioneered the use of derivatives to hide losses...Since then, the use of derivatives to disguise debt and arbitrage regulations and accounting rules has increased...Italy used a currency swap against an existing Yen 200 billion bond ($1.6 billion) to lock in profits from the depreciation of the Yen. The swap was done at off-market rates...the swap was really a loan where Italy had accepted an off-market unfavourable exchange rate and received cash in return...A key element of the recent Greek debt problems has been the use of derivative transactions to disguise the true level of its borrowing...More recently, similar structures have emerged in Latvia...This follows a series of revelation regrading the use of derivatives by municipal authorities in the U.S., Italy, German, Austria and France where complex bets on interest rates were used to provide funding or cosmetically lower borrowing costs. Many of these transactions resulted in substantial losses and are now in dispute...Normal commercial transactions can be readily disguised using derivatives exacerbating risks and reducing market transparency. Current proposals to regulate derivatives do not focus on this issue...

fears; financial products; Grecian Derivative; loath; Satyajit Das's Blog.

naked capitalism Tue 2010-08-17 12:40 EDT

Guest Post: Why Clearninghouses Are a Maginot Line Against Systemic Risk

Warren Turbeville

As discussed in ECONNED and on this blog, clearinghouses are not a solution to the systemic risk posed by credit default swaps, since there is no way to have a CDS counterparty post adequate margin and have the product be viable (to put it more simply, adequate margin make CDS uneconomic). ..I am one of the few people around who knows something about the clearing business and theory and is not employed by an investment bank or clearinghouse. At the end of my career on Wall Street, I was hired to perform a financial autopsy of the special purpose derivatives clearinghouse set up by California as part of an innovative power market structure. It had failed in the state's power crisis of 2001-02. Observing the tremendous systemic risk generated by using conventional clearing techniques for all but straightforward derivatives, I embarked on a seven year quest. I formed a company that designed a mathematical, IT and legal structure to provide a transparent and orderly system to manage the risks of those derivatives which shouldn't be cleared conventionally. Imagine my surprise when the banks decided against using the system...

Clearninghouses; Guest Post; Maginot Line; naked capitalism; systemic risk.

Mon 2010-08-16 13:54 EDT

Could The US Become Another Ireland? >> The Baseline Scenario

Peter Boone and Simon Johnson

As Greece acts in an intransigent manner, refusing to act decisively despite deep fiscal difficulties, the financial markets look on Ireland all the more favorably. Ireland is seen as the poster child for prudent fiscal adjustment among the weaker eurozone countries...Ireland's perceived ``success'' is partly due to its draconian fiscal cuts...Ireland's difficulties arose because of a massive property boom financed by cheap credit from Irish banks...Today roughly 1/3 of the loans on the balance sheets of banks are non-performing or ``under surveillance''...The government...guaranteed all the liabilities of banks and then began injecting government funds...it is planning to buy the most worthless assets from banks and pay them government bonds in return. Ministers have also promised to recapitalize banks than need more capital. The ultimate result of this exercise is obvious: one way or another, the government will have converted the liabilities of private banks into debts of the sovereign (i.e., Irish taxpayers)...The government is gambling that GDP growth will recover to over 4% per year starting 2012 -- and they still plan further major expenditure cutting and revenue increasing measures each year until 2013...The latest round of bank bailouts (swapping bad debts for government bonds) dramatically exacerbates the fiscal problem...

Baseline Scenario; Becomes; Ireland.

Wed 2010-08-04 20:48 EDT

Janet Tavakoli: Stranguflation: Deflation and Inflation Where it Hurts America Most

Janet Tavakoli

The U.S. is suffering from high unemployment combined with too much consumer debt in a weak economy...our bloated financial sector has been sucking the life-blood out of the U.S. economy for years, and recent decisions insure it will continue to feed off taxpayers, while the host economy struggles for life...The bailouts were a perversion of capitalism and the principles upon which The Republic was founded. This was the result of influential interested parties reaching into the U.S. Treasury with no accountability. Capitalism doesn't call for bailouts, instead investors take losses. Shareholders in failed financial institutions should have been wiped out, debt holders would have had to accept discounts combined with debt for equity swaps, and financial institutions would have then been recapitalized without taxpayers footing the bill. Instead banks lobbied for relaxed accounting and ineffective "financial reform." No one, including bank managers, can tell how much capital is truly needed, and taxpayers' ongoing heavy subsidies give these financial institutions the appearance of stability.

deflation; hurting America; Inflation; Janet Tavakoli; Stranguflation.

naked capitalism Sun 2010-07-25 16:28 EDT

The Irish mess

Richard Smith

The Irish banks got in a big mess with duff RE loans. The government swapped discounted bad loans for government-issued bonds...the whole thing is the usual dump onto taxpayers...loans to no more than ten or a dozen of these developers account for EUR 20Bn of the EUR70Bn face value of the debts exchanged...The extra national debt incurred (so far) equates to EUR25,000 per taxpayer. And EUR6,500 of that goes to repair damage inflicted by just a dozen well-placed spivs. Then go for some fairly brutal austerity to sort out the new debt/GDP ratio (Irish unemployment was 13.5% the last time I looked). You will have some pretty discontented citizens, and the debt/GDP ratio will stay the same, or get worse, so you cut again...

Irish mess; naked capitalism.

New Deal 2.0 Sun 2010-07-25 16:20 EDT

Will Criminals Exploit Cap and Trade?

Marshall Auerback

...the carbon trading proposals embodied in the Obama Administration's cap and trade proposals are misguided. Money laundering is very easy when you have an opaque pricing structure with little in the way of regulatory protections. It's the environmental equivalent of credit default swaps. Worse, the cap and trade system doesn't work...Carbon Trading Schemes amount to nothing more than a privatization of the atmosphere...the criminals can have a field day...

0; Criminals Exploit Cap; new dealing 2; trading.

Rajiv Sethi Tue 2010-06-15 14:25 EDT

Defenders and Demonizers of Credit Default Swaps

Rajiv Sethi

The recent difficulties faced by Greece (and some other eurozone states) in rolling over their national debt has let some to blame hedge fund involvement in the market for credit default swaps...Leaving aside the question of whether naked CDS trading has been good or bad for Greece, it is worth asking whether there exist mechanisms through which such contracts can ever have destabilizing effects. I believe that they can, for reasons that Salmon and Jones would do well to consider...such contracts allow pessimists to leverage (much more so than they could if they were to short bonds instead). The resulting increase in the cost of borrowing, which will rise in tandem with higher CDS spreads, can make the difference between solvency and insolvency. And recognition of this process can tempt those who are not otherwise pessimistic to bet on default, as long as they are confident that enough of their peers will also do so. This clearly creates an incentive for coordinated manipulation...

Credit Default Swap; defending; demonic; Rajiv Sethi.

Sat 2010-05-22 20:00 EDT

"Drop Dead Economics": The Financial Crisis in Greece and the European Union

Michael Hudson

Financial lobbyists are using the Greek crisis as an object lesson to warn about the need to cut back public spending on Social Security and Medicare. This is the opposite of what the Greek demonstrators are demanding: to reverse the global tax shift off property and finance onto labor, and to give labor's financial claims for retirement pensions priority over claims by the banks to get fully paid on hundreds of billions of dollars of recklessly bad loans recently reduced to junk status. The Greek bailout should be thought of as a TARP for German and other European bankers and global currency speculators. Almost $1 trillion is being provided by governments (mainly Germany, at the cost of its own domestic spending) into a kind of escrow account for the Greek government to pay foreign bondholders who bought up these securities at plunging prices over the past few weeks. They will make a killing, as will buyers of hundreds of billions of dollars of credit-default swaps on the Greek government bonds, speculators in euro-swaps and other casino-capitalist gamblers. (Parties on the losing side of these swaps now will need to be bailed out as well, and so on ad infinitum.) This windfall is to be paid by taxpayers -- ultimately those of Greece (in effect labor, because the wealthy have been untaxed) -- to reimburse Euro-governments, the IMF and even the U.S. Treasury for its commitment to predatory finance. The ³sanctity of debt -- sacrificing the economy to pay bondholders -- is to be used as an excuse to slash Greek public services, pensions and other government spending...

Drop Dead Economics; European Union; Financial Crisis; Greece.

zero hedge Sun 2010-05-09 09:25 EDT

Dissecting The Crash

Here are two accounts dissecting in detail the events from yesterday. One is from Dan Hinckley at Wild Analytics, the second from Dan O'Brien. ...The idea that it was a 'fat finger' error is ludicrous; unless the fat finger hit every market in the world virtually simultaneously. Liquidity simply left the world financial markets for about four minutes this afternoon. The bids just vanished...In one second more or less someone (and yes, under these circumstances, human beings take control of the machines) made the decision to pull the bids on every equity in the S&P, every financial futures contract, every FX contract in every market in the world. This kind of thing just doesn't happen in a pure auction environment; there just isn't a tight enough communication link between the parties to allow the decisions to propagate within the same second -- even with HFT algorithms. No. Some human made the decision to pull the bids; all of them, all at once. If that is not a condemnation of the concentration of financial power and the systematic risk it engenders I don't know what is...How does all of this happen? Well, you can thank the Federal Reserve... 1) The Fed prints fake money out of thin air... 2) Large banks and hedge funds borrow money from the Fed at near-ZERO interest rates... 3) These institutions buy Treasuries with a guaranteed 4% return, thus guaranteeing the banks massive and risk-free profits on the backs of the middle class (remember, you're not allowed to earn an interest rate on your savings accounts!)... 4) These institutions then swap Treasuries with the Fed for cash... 5) These same institutions (banks) then take the cash and gun the stock market higher with its FREE MONEY from the government...I meant free money from you. By the way, were you asked to vote on this? Frankly, it's better than free money - they're being PAID to do this... 6) Banks pay the very clown-posse that cause the 2008 crash (and today's) the largest bonuses...EVER...with your tax dollars.

Crash; dissecting; Zero Hedge.

naked capitalism Thu 2010-04-22 18:21 EDT

Guest Post: Are Interest Rate Derivatives a Ticking Time Bomb?

Washington's Blog

...Most economists and financial institutions assume that interest rate derivatives help to stabilize the economy. But cumulatively, they can actually increase risky behavior, just as portfolio insurance previously did. As Nassim Taleb has shown, behavior which appears to decrease risk can actually mask long-term risks and lead to huge blow ups. Moreover, there is a real danger of too many people using the same strategy at once... Given that the market for interest rate derivatives is orders of magnitude larger than credit default swap market -- let alone portfolio insurance -- the risks of a ``black swan'' event based on interest rate derivatives should be taken seriously...

Guest Post; Interest Rate Derivatives; naked capitalism; ticking time bomb.

Jesse's Café Américain Mon 2010-04-12 18:11 EDT

Most Wall Street Banks Using Lehman Style Accounting Trickery Enabled by the Fed to Hide Their Risk

Jesse

This analysis from the Wall Street Journal indicates that most of the big US Banks are engaging in the same kind of repo accounting at the end of the quarter that Lehman Brothers was doing to hide their financial instability until deteriorating credit conditions and liquidity problems made them precipitously collapse, as all ponzi schemes and financial frauds do when the truth becomes known. The basic exercise is to hold big leverage and dodgy debt, but swap it off your books with the Fed at the end of each quarter for a short period of time when you have to report your holdings...

Fed; hide; Jesse's Café Américain; Risk; Wall Street Banks Using Lehman Style Accounting Trickery Enabled.

Fri 2010-04-02 17:25 EDT

Looting Main Street: How the nation's biggest banks are ripping off American cities with the same predatory deals that brought down Greece

MATT TAIBBI : Rolling Stone

...In 1996, the average monthly sewer bill for a family of four in Birmingham was only $14.71 -- but that was before the county decided to build an elaborate new sewer system with the help of out-of-state financial wizards with names like Bear Stearns, Lehman Brothers, Goldman Sachs and JP Morgan Chase. The result was a monstrous pile of borrowed money that the county used to build, in essence, the world's grandest toilet -- "the Taj Mahal of sewer-treatment plants" is how one county worker put it. What happened here in Jefferson County would turn out to be the perfect metaphor for the peculiar alchemy of modern oligarchical capitalism: A mob of corrupt local officials and morally absent financiers got together to build a giant device that converted human shit into billions of dollars of profit for Wall Street -- and misery for people...And once the giant shit machine was built and the note on all that fancy construction started to come due, Wall Street came back to the local politicians and doubled down on the scam. They showed up in droves to help the poor, broke citizens of Jefferson County cut their toilet finance charges using a blizzard of incomprehensible swaps and refinance schemes -- schemes that only served to postpone the repayment date a year or two while sinking the county deeper into debt. In the end, every time Jefferson County so much as breathed near one of the banks, it got charged millions in fees. There was so much money to be made bilking these dizzy Southerners that banks like JP Morgan spent millions paying middlemen who bribed -- yes, that's right, bribed, criminally bribed -- the county commissioners and their buddies just to keep their business...

American cities; brought; Greece; Looting Main Street; nation's biggest bank; predatory deals; RIP.

Jesse's Café Américain Tue 2010-03-09 17:42 EST

Are Traders Demanding US Credit Default Swaps Payable in Gold?

Jesse

...I have a great deal of respect and admiration for Janet Tavakoli and her knowledge in this area. If she is seeing a new demand for Credit Default Swaps on the US payable in gold I would credit it since this is her area of expertise and industry connections...if the existence of CDS on the default or downgrade of US sovereign debt payable in gold bullion be true, who would be in a position to stand behind these Credit Default Swaps with any reliability, and what buyer would be in a position to make such a demand of a credible source?

Credit Default Swaps Payable; gold; Jesse's Café Américain; Traders Demand.

The Full Feed from HuffingtonPost.com Tue 2010-03-09 17:30 EST

Janet Tavakoli: Washington Must Ban U.S. Credit Derivatives as Traders Demand Gold

Janet Tavakoli

Congress should act immediately to abolish credit default swaps on the United States, because these derivatives will foment distortions in global currencies and gold. Failure to act now will only mean the U.S. will be forced to act after these "financial weapons of mass destruction" levy heavy casualties. These obligations now settle in euros, but the end game is to settle them in gold. This is so ripe for speculative manipulation that you might as well cover the U.S. map with a bull's-eye...

Ban U.S. Credit Derivatives; com; full Feeds; HuffingtonPost; Janet Tavakoli; Traders Demand Gold; WASHINGTON.

Sun 2010-02-28 13:43 EST

"Sultans of Swap" by Gordon T Long, FSU Editorial 02/24/2010

...When asked why there are $605 Trillion derivatives outstanding (1) how do you articulate an answer to this horrendous and almost unimaginable number? The US is the largest economy in the world but tallies only 2.3% in comparison. Global bank reserves amount to only 1.2% of this accumulation. The gargantuan size appears to defy all logic...we discover the Sultans of Swap. The Bond Vigilantes are of a previous era. They are dead -- RIP. Through the magic mix of Credit Default Swaps, Dynamic Hedging and Interest Rate Swaps the Sultans of Swaps effectively control interest rate spreads. Through Regulatory Arbitrage they extort tremendous political sway globally. They live in the world of risk free spreads. Low interest rates simply attract more volume for their concoctions. We have had an explosion in Money Supply globally as the charts (right) indicate. The parabolic rise matches the increase in these derivative products along with their ability to turn Interest Rate Swaps into high powered bank lending...Everything is based on tax payers paying, GDP expanding and interest rates staying low...

FSU Editorial 02/24/2010; Gordon T Long; sultans; Swap.

naked capitalism Fri 2010-02-05 11:06 EST

FDIC Proposes Tough-Minded Securitization Reforms; Industry Howls

...the FDIC presented a cogent and tough-minded plan for securtization reform at the American Securitization Forum...The driving element is that the FDIC is proposing to change the requirements for a securitization to be treated as a true sale, meaning that when the originator sells the mortgages to a securitization vehicle (say a trust), the investors in that vehicle cannot go back to the originator for recourse...The FDIC included various proposals to insure transparency for investors, including a requirement that all deals be arms length, to third party investors (no affiliates or insiders). They would exclude derivatives (excluding interest rate swaps) and would not permit re-securitizations...a clever effect of this proposal was that it solved the problem of ``what to do with rating agencies'' by making them irrelevant

FDIC Proposes Tough-Minded Securitization Reforms; Industry Howls; naked capitalism.

naked capitalism Wed 2010-01-13 11:54 EST

William Black'' ``Anti-Regulators: The Federal Reserve's War Against Effective Regulation''

...This essay focuses on Chairman Bernanke recent appointment of Dr. Parkinson to lead the Fed's examination and supervision. My central point is that Dr. Bernanke appointed Dr. Parkinson because he shared Dr. Bernanke's anti-regulatory ideology and has never changed those views, even in the face of the Great Recession. The anti-regulator policies that Bernanke and Parkinson championed were the principal drivers of the fraud epidemic that have produced recurrent, intensifying crises...First, Dr. Parkinson was a leading proponent of the obscene (and successful) effort to prevent Commodity Futures Trading Commission Chair Brooksley Born from taking regulatory action to prevent destructive credit default swaps (CDS). Second, Dr. Parkinson, like Greenspan and Bernanke, subscribed to the naïve view that fraud was impossible in sophisticated financial markets and that credit rating agencies were reliable. Third, Dr. Parkinson endorsed the international ``competition in regulatory laxity'' that Dr. Bernanke (belatedly) warned has degraded regulation on a global basis...

anti regulators; effectively regulated; Federal Reserve's War; naked capitalism; William Black.

naked capitalism Mon 2009-12-28 17:16 EST

Guest Post: Princeton Economist and Computer Scientists Show that Derivatives Are Inherently Vulnerable to Fraud

Washington's Blog

...the main default risk model for credit default swaps -- the ``Gaussian copula function'' -- was inherently flawed. Now, Princeton University economists and computer scientists have demonstrated that financial derivatives are also inherently vulnerable to fraudulent pricing. PhysOrg summarizes Princeton's findings: ...sellers of these investments could purposefully include pieces of bad risk that no buyer could detect even with the most powerful computers... the problem arises from asymmetric information between buyers and sellers, and goes against conventional wisdom in economic theory, which holds that derivatives reduce the negative effects of such unequal information.

Computer Scientists Show; derivative; fraud; Guest Post; inherently vulnerable; naked capitalism; Princeton economists.