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.

naked capitalism Fri 2010-07-16 16:15 EDT

What is Simon Johnson Smoking?

Simon Johnson...incorrectly celebrates a toothless provision in the Dodd-Frank bill as being tantamount to an anti-trust act for too big to fail banks...If we believed this bill was meaningful, action be taken against these banks immediately upon signing. Odds of that happening? Zero...The problem is it not merely the size of these firms, but the fact that they control infrastructure that is deemed critical to modern commerce. I'll get into specifics in short order, but in some cases the firm owns critical plumbing outright; in other cases, it is so tightly networked to other firms that mucking with it very much runs the risk of taking down the rest of the grid...Citi runs a big corporate cash management/reporting system called GTS...And no one is going to dare tamper with JP Morgan's clearing business...The problem is that it would take a radical restructuring of the very biggest banks, the critically placed dealer firms, and the most important payment and clearing operations to make a real dent in systemic risk. The officialdom the political lacked the will to do so at the peak of the crisis, and there is no basis for fantasizing that it will suddenly develop more nerve now.

naked capitalism; Simon Johnson Smoking.

zero hedge Sun 2010-05-09 09:42 EDT

Themis' Take: May 6, 2010 -- The Day That Will Change Market Structure

...The story is not a key-punch error. The story is a failed market structure. The market failed today. The market melted down and ``liquidity providers'' quickly pulled all bids. According to today's Wall Street Journal, high frequency firm, Tradebot, closed down its computer systems completely, as did New Jersey's own Tradeworx,...To make matters worse, while some high frequency firms shut down yesterday and pulled their bids, as we warned they would do for over a year and a half, other high frequency firms turned from being liquidity providers to liquidity demanders, as they turned around and indiscriminately hit bids...The market action of May 6th has demonstrated that our equity market has major systemic risks built into it...The price discovery process ceased to exist. High frequency firms have always insisted that their mini-scalping activities stabilized markets and provided liquidity, and on May 6th they just shut down. They pulled the plug, as we always said they would, and they even admit it in the papers this morning...This is not an isolated incident, and it will happen again.

2010; 6; Change Market Structure; day; take; Themis; Zero Hedge.

Jesse's Café Américain Wed 2010-05-05 16:22 EDT

Market Manipulation, Systemic Risk and Fraud, Pure and Simple, And It Continues Today

Jesse

This article by the Financial Times should remove any doubt in anyone's mind that Goldman Sachs was willfully selling fraudulent financial instruments. It appears that they were working in conjunction with Ratings Agencies, Mortgage Origination Firms, and Hedge Funds to cheat investors...Tom Montag, then a senior Goldman executive and now head of corporate and investment banking at Bank of America, was quoted as describing the deal in an e-mail as follows: ``Boy that timeberwof (sic) was one shi**y (sic) deal,'' according to the Senate subcommittee...Within five months of issuance, Timberwolf lost 80 per cent of its value...

continued; fraud; Jesse's Café Américain; Market Manipulation; Pure; simple; systemic risk.

zero hedge Tue 2010-01-19 12:18 EST

Guest Post: The Banker Bonus Diversion

I am so tired of the absolute nonsensical and foolish approach in regards to Banker Bonuses taken by both the Obama administration as well as the bankers themselves. Here's what is really going on and what should should be going on if we lived in a world that was dependent on telling the truth, prudent financial management, reduction of systemic risk, and if a cure to our banking system malady is genuinely being sought...This is a total and epic failure of the banking regulatory authorities in the U.S...The bankers should have taken every nickel of profit and allocated it to capital accounts to provision for loan losses: past, present, and future. The regulators should force every nickel on to the balance sheet irrespective of the menagerie of FASB FAS 157. The government should not be taking this needed capital from the banking system.

Banker Bonus Diversion; Guest Post; Zero Hedge.

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.

The IRA Analyst Thu 2009-09-17 10:22 EDT

Back to Basis for Securitization and Structured Credit: Interview With Ann Rutledge

To get some further insight into the world of securitization and cash flows, we spoke last week to Ann Rutledge of RR Consulting...The difference between a futures contract for T-bonds and a credit default swap is that the former is a real contract for a real deliverable, whereas the CDS trades against what people think is the cash basis, but there is no cash market price to discipline and validate that derivative market. Rutledge: a contract or structure without a cash basis should not be allowed at all. You cannot have a derivative that is honest and fair to all market participants without a true cash basis. ...derivatives markets such as CDS and CDOs that have no cash basis tend to magnify speculative excesses, while derivative markets where there is a visible cash basis market to discipline investor behavior seem less unstable in terms of systemic risk. Rutledge: If the cash market were visible and could be examined by all participants, then it would give away the ability of the dealer banks to tax participants in the market and extract these abnormal returns. So how do we fix the problem... Rutledge: These originators play this game over and over again and they don't get caught, in part because we do not have a common, standardized set of definitions for governing the most basic aspects of the securitization process. The buyers don't do the work and the accounting framework is a counterparty-oriented framework, not one that is focused on the underlying assets. So banks like Countrywide and WaMu originated and sold some truly hideous structures during the bubble, but the buyers only diligence was reliance upon recourse to these banks. It costs maybe 50bp for a buyer to get the data and grind the numbers to really diligence a securitization based on cash flows, even a complex CDO. But the cost to the buyer and the system of not doing the diligence is an order or magnitude bigger. If the Congress, the SEC and the FASB, and the financial regulators only do one thing this year when it comes to reforming the world of structured credit, then it should be to impose by law and regulation common standards for the definitions used in the marketplace.

Ann Rutledge; basis; interview; IRA Analyst; securitizations; structured credit.

Bruce Krasting Sat 2009-09-12 12:10 EDT

SSTF Shocker - $6B August Deficit

Bruce Krasting

The Social Security Trust Fund reported an August net deficit of $5.865 Billion. This is the largest monthly deficit in nineteen years...This deficit is now the seventh in the past twelve months. That pace has never been seen before...Social Security is the mother of all systemic risks. Even the debate on this topic brings risk. It will expose an additional $7 trillion unfunded liability. Another reason for holders of dollars to worry.

6B August Deficit; Bruce Krasting; SSTF Shocker.

Bruce Krasting Fri 2009-09-04 19:11 EDT

Debt Repudiation -- On the Table

Bruce Krasting

In the Week in Review section the NY Times had a piece by David Streitfeld titled ``When Debtors Decide to Default''. I thought it was an important story. The NY Times put the issue of Debt Repudiation on the table. Exactly where it belongs. The author also contributed a new adjective to describe many of America's troubled borrowers, ``Ruthless Defaulters''. This definition comes to us from the ``lending'' side of the equation. I think that is a misguided definition by the industry. I don't think they know what they are up against. Yet...Debt repudiation is the biggest systemic risk we face...the default rate on mortgages in excess of $500k is going to explode this fall...the CC numbers would follow. Broad based debt repudiation is a distinct possibility.

Bruce Krasting; Debt Repudiation; table.

Bruce Krasting Fri 2009-09-04 18:29 EDT

FHFA Report on Restructurings -- Everything is Going Fine

Bruce Krasting

The FHFA released a report on their refinancing activity for the year to date. As usual it was cast in glowing terms. It is clear that FHFA is doing something. In my view that `something' is consistently the wrong thing...No private lender in their right mind would make a 125% loan. These are just losses to be. The FHFA is perpetuating the cycle of default. They are making things worse, not better...No single entity should have this much exposure to the credit market. It defines systemic risk.

Bruce Krasting; FHFA reported; going fine; restructuring.

Tue 2009-04-21 00:00 EDT

naked capitalism: Guest Post: Some More Thoughts On FDIC And The "Systemic Risk Exception" Clause

Tyler Durden

clause; FDIC; Guest Post; naked capitalism; Systemic Risk Exception; thought.

Wed 2008-04-16 00:00 EDT

Institutional Risk Analytics

Large OTC Markets + Excessive Leverage + Fair Value Accounting = Systemic Risk, by The Institutional Risk Analyst; FAS 157; JPMorgan "an uncapitalized, $76 trillion OTC derivatives exchange with a $1.3 trillion asset bank appendage"

Institutional Risk Analytics.

Wed 2008-03-19 00:00 EDT

naked capitalism: Systemic Risk From an Outsized Fannie and Freddie?

Freddie; naked capitalism; Outsized Fannie; systemic risk.