77 thoughts on “Monday Message Board (on Tuesday)

  1. Socrates @ 35 –

    The CDO and CDS market were designed to diversify risk. It allowed banks, hedge funds et al to then take on more risk. Take a step back and look at the issue. The products are not individually to blame but the increase in systemic risk that they helped cause.

    Mohammed El-Erian wrote “When Markets Collide” which is a very good primer for looking at this whole issue from a macro POV. The issues regarding savings in Asia flowing into the west.

  2. SeanG: the CDS market was a casino. It was not insurance, it was not regulated, you could (and it happened) take out a CDS on another organisation’s bonds. You could apparently bet on just about anything, even credit re-grades. Heck if the market had continued for long enough there would have been CDS’s issued on 2 flies crawling up a wall.

    Bit like taking out life insurance on someone else. And just like that example the temptation to game the system and make a default/regrade/etc happen was irresistable.

    There was no insurance accouting (e.g. estimate costs, have sufficient reserves, etc, etc). It was opaque, there was no clearing house. Heck you have to even question the legality of at least some of the contracts (I’m sure the court cases will go on for decades). And there is still trillions outstanding in contracts at this very moment.

    So the problems are more than just increasing and ignoring systemic risk, the actual contracts themselves were rediculous and should have been illegal right from the beginning.

    These, and other reasons, are why I personally advocate cancelling the whole market (note Scholes agrees with me). Announce (with due secret preparation of course) that at 12:00 GMT on x date all CDS contracts are null and void.

    Then on a following period, send in the police (in every country) to shut down every hedge fund.
    Get some use out of all that ‘national security’ powers and legislation that every Govt has now.

  3. Sean G at 33 says
    “The Japanese Government (which you conveniently ignored) spent trillions of yen on white elephant projects and bailouts – Keynesian policies in action and nothing gained.”

    Sean, better the white elphant fiscal projects thanks than the massive monetary bail outs of banks (the latter hardly a Keynesian remedy – the tax handout to individuals is as close as you will get to a Keynesian remedy – these massive liquidity injections are being pumped straight in at the top and not being lent (just held so they can use it takeover other banks or businesses that fail later ie a profit making opportunity, a “cash in on the crisis” opportunity) IF anything the monetary bailout is closer to the last resort Monetary policy remedy (dont intervene but if you have to it should be Monetary policy) – but for a last resort style monetary intervention its been rolled out pretty damn fast which a) kills that idea and b) just makes me skeptical that the large financial moguls have more say than Keynesian policy or MOnetary or any other economic idea in this mess.

    Futhermore, for an intervention that is supposedly designed to protect free markets (cough loudly)…. if individual freedom of choice was really what mattered the Obama admin with the agreement of MOnetary Policy and monte pelerin style advocates would have put the monetary bailout straight into individuals hands and let them choose. Isnt that what matters? The individual and his freedom to choose? (Cough loudly again)

    The whole thing is a joke, not a bailout, not a Keynesian remedy and nor if you subscribe to the spin is it a free market remedy. Its a handout to banks so they get away with minimum losses and unemployment (labour) – and small business (too small to object) bears the cost, like it always is in these collapses.

    Power gets protection and hides behind ideology. Its a sham.

  4. Plus they are making the bad mistake that people will actually want to take on loans right now. Better the government does for its building because not may other people will want to. When inflation rises next because of the value of the US dollar plunging – the interest rates will kill people off.

    These massive monetary bailouts are a damn waste of firepower.

  5. What happens next – the US dollar plunges – how about all those countries still sitting on US dollar reserves?? (like China – it wants a new reserve currency). So the money bailout depresses the USD and then does everyone else sell into it? Maybe the US should resign as reserve currency to maintain some dignity ??? (before there is a forced redundancy). Inflation runs wild in the US?

  6. oldskeptic – you are so right. The insolvency lawyers and accountants arec already raking it in…as we speak. The court cases will feed sectors of the legal industry for years. Shame so few legal firms are public companies……nothing nicer than a partnership in times like this.

  7. Peter M #41
    Oh just what I suspected(the rentiers in action and getting away with it.)

    You said
    “But if history teaches us anything at all it is that these guys (bankers) require constant adult supervision. If this is present they have the capability to destroy large parts the economies productivity.”

    I presume you meant “not present.” Its what has been missing (but where are the adults ????- if there can be a slip of the first draft of the bailout legislation for AIG between getting to congress – that enabled AIG to give those bonuses out who did it (the damn amendment – the late, last minute amendment)?

    Who slipped the legislation amendment in? Who understood it (the late amendment)? Probably only AIGs and Goldman. Who advised the amendement (answer – same as prior question). Who slipped the pen? (Geithner). On whose advice (PPS – same?).
    Who is running who and what? (govt or financial moguls).??

    I am more than cynical.

  8. Oldskeptic,

    Tthe CDS market is insurance. Insurance is about probabilities that an event or payoff will occur. Whether you want to compare it to a casino is not a bad description.

    However, the CDS market was efficient when the nominal value was $2 trillion (the netted value is considerably lower than that). The problem is excessive use. If you have a CDS taken out over a CDO for instance, then if the CDO blows up and the CDS comes into force then there must be systemic problem because the CDO is a collection of debts from multiple sources that must be in serious problems.

    The questions regarding legality are going to be the next big issue because banks, insurance companies et al have poor documentation so these things, if tightened, will flow through to the front office traders who will not be allowed to execute those trades once the details are known (credit sanctioning committee will restrict them).

    Alice @ 53,

    This is fundamentally a monetary issue. If we do not clear the system of bad debt then no amount of fiscal stimuli will ever work. I cannot understand why you jump to such irrational opinions (re: my view of the market) but bailouts will be necessary as well to create stability. Once these are established then reduced interest rates will flow into the economy and fiscal measures will have a greater impact.

    That is one reason by the Keynesian-inspired fiscal measures taken in Japan never worked. Have you ever read Keynes?

    One other thing – AIG is an insurance company, not a bank. That makes it’s actions worse because it has a duty to manage the premiums prudently while investment banks can be the cowboys.

    Quick question – have either Alice or Oldskeptic worked in the finance industry?

  9. Sean – dont give me “irrational”. You just stick to your dream – you need to keep people thinking your industry is OK. Thats fine but its not.

  10. Oh and they didnt even get the fiscal guns out until the interest rates were close to zero in Japan anayway – and MP hadnt worked…Sean go read history. You are starting to annoy me. You work in the finance industry – you are duty bound to maintain confidence. Its a prerequisite of your employment. Its self interest. Its not fact. The finance industry has become the new rentier class of aristicrats – no better, no worse than any other class of manipulative rentiers.

  11. Oh and lets talk about the ratings agencies shall we?
    Aig says “you guys at S&P – we want this crap we are bundling and selling – CDOs – rated AAA??? Is that Ok with you? because if it isnt Moody’s gets our business. Do we make ourselves clear???

    S $ P responds “crystal. AAA – no problem.”

  12. In a communist nation with no free markets anything can be had for a price also. The fact that everything has a price is not a product of freedom. It is a product of human values and priorities.

    Of course the term free markets generally implies a reasonably black and white set of rules in relation to property. So one should not use the term “free markets” as a euphemism for chaos.

  13. And Sean

    For such a deregulation no governemnt intervention proponent your hypocrisy is amazing….but not unexpected.

    “but bailouts will be necessary as well to create stability.”

    Wow. Am I surprised? No. Government intervention when it suits your interests in the finance industry in which you are productively employed, but no government intervention when it suits the finance industry’s need to gamble, extract profits from productive industry and maintain their mandarin status over all it reigns…at the peak of flogging CDOs..

    Hypocrisy with a capital H Sean. Its a good thing Oldskeptic and I dont work in the finance industry. Kid, we can both tell it to you like it really is…something you are unlikely to get from your employers.

    Your choice to battle against the evidence but in terms of economic health, who are you really helping – the rentiers or the producers?

    You dont need our views Sean. They may help you in the long run but not now, in the short run. We dont need your views either Sean. We arent interested in financial sector recovery (and we dont rely on the industry to feed us) to its peaks of the recent short run – overinflated and speculatively priced.

    We have quite different objectives you see..

  14. Is it with a gun that property rights are enforced in a free market (after all private negotiations have failed)???

    No one has quite explained to me who the enforcing body of law is in a free market?

    How is peace and order kept? The government? Pricate security firms ( if you are rich enough to pay for mercenaries?)

    Or what?

    Private what keeps the peace??

    Private lawyers ? (if you can afford them?)

    Looks like a recipe for a bloody civil war to me.

  15. Andrew,
    Sure the people who took out the home loans did not take on the risk, but other banks and investment vehicles such as hedge funds were sold the risky debt. The originators were not forced to wear at least some of the risk that they created.

    There were a lot of naive people who were sold loans that they did not understand – (both investors and borrowers). I heard stories of people who believed that they would be paying the teaser rates for the life of their loan, and would pay off their home loans in 20 or 30 years. They had no concept of what negative amortisation meant, and they had no idea that the interest rates on their loans would reset.

    It was the height of irresponsibility on the part of the mortgage brokers, bankers and regulators to allow people that ill-informed to take out historically extravagant loans that they clearly did not understand.

    So in summing up I think some sort of regulation that forces mortgage originators (including mortgage brokers) to wear some of the risk that they create, seems like a good idea.

  16. And i heard of people who were “prime loans”m converted by salespersons to “subprime” because the (exploding arms) nature of the interest rate re sets would make the financial firm sellers more (which the buyers did not understand).

    Its Amadios case in law – selling sophisticated loan structures to people who just didnt understand (and probably were not meant to understand…accidentally on purpose…it was all in the fine print which no one can understand).

  17. I dont beelive loan customers were that “uninformed” either (of their own nature – ie were not intellectually challenged) Smiley. I believe the commissions being paid to mortgage brokers gave them incentives “not to inform” and to “hide the facts” in small print (very small if at all).

  18. Alice, from their own statments I believe that some sub-prime mortgage holders had been explicitly lied too. However, I believe that a majority of them were not sophisticated enough to even ask the right questions.

    Actually it reminds me a bit of the situation with Storm Financial. In a recent story on the 7:30 Report, one investor claimed that he had asked a broker if he could lose his house and he was assured by the broker that that could not happen. I guess that’s the risk you take when you rely on a verbal statement from someone in the finance industry.

  19. Alice,

    A free market is simply a market where exchanges are conducted free of coercion (whether from government or otherwise). It is a place where people exchange things freely as opposed to exchanging them in a context of coercion.

    A free market is an idealisation that will never exist but it is a useful relative term. We can talk of one market scenerio being more free than another. And you might rightly argue that minimising coercion within a market might require some degree of functional government.

    In the real world in which we live there is no such thing as a perfectly free market, just as there is no such thing as a perfectly round wheel. However it is still quite reasonable to say that things might travel better if a particular wheel was rounder or a particular market was more free, especially so if you articulate specifically how the wheel might be made more round or the market more free.

    You asked how property rights are enforced in a free market. This is a somewhat problematic question because free markets are without coercion by definition so defending yourself against those that would acquire your property in an unfree manner is unrequired by definition. However given that free markets are merely an idealisation we might ask what circumstances allow us to approximate a free market. The usual position of free market advocates is that a sound framework of property rights needs to be enshrined in law and defended by the judicial branch of government. However they would also note that governments, particularily the executive branch, often turn predator. So the question is then about how can we achieve the benefit of a government, that we see as necessary to provide an approximation of a free market, whilst not suffering at the hands of a tyrant. And the usual answer lies in systems of limited government (ie government which is constrained). The first and most obvious restraint being the rule of law.


  20. John, today it was reported that Defence is investigating the Fitzgibbon spying case, but something sounds fishy. Defence Signals Directorate conduct intelligence on a daily basis and the collated information is analysed and assessed for security risks and reports passed on. But in this case ‘if’ it is found that a classified document has found its way into the public domain then those involved, be it in Defence, the public service and/or a member of parliament caught up in the scandal have not only abused their powers and office, but were involved in the commission of a crime.

  21. Yes,

    What on earth is going on in defence? Its so strange…could it be they just dont like the reforms? Could it be there were elements too attached to the large budgets under the prior government? Could it be the top brass need a clear out or could it be that top brass dont like taking orders from someone who seems to have been receiving large donations from a Chinese property developer. I will suggest the Labour Party in NSW, but Im less certain at federal level are too close to developer donations (both parties too close to influence of donations) and NSW Labour needs an updated broad spectrum anti corruption disinfectant.

  22. I agree with TerjeP, except where he/she says:

    “A free market is an idealisation that will never exist … [because] …free markets are without coercion by definition so defending yourself against those that would acquire your property in an unfree manner is unrequired by definition.”

    A free market can exist, where coercion (by theft or fraud or governmental force) is banned. The fact that the process of banning force involves the use of force doesn’t negate freedom. You don’t infringe political and economic freedom by using (retaliatory) force to defend yourself against (initiated) force.

    How can force be banned? By subordinating ones right to defensive retaliatory force to the government. As TerjeP says, this involves: “a sound framework of property rights … enshrined in law and defended by the judicial branch of government.” But since “governments, particularily the executive branch, often turn predator… a systems of limited government (ie government which is constrained)” is required. “The first and most obvious restraint being the rule of law”, within a constitution, protected by checks and balances.

    First, however, we need to ensrine the moral/political principle that we each have the right to our own life, liberty and property, for use as we see fit, in pursuit of our own (greedy) happiness – no one has a right to take by force one hour of any innocent citizen’s life nor one dollar from his pocket. In other words we must reject slave-master, or parasite-host relationships, and approach each other as free traders.

  23. John, I don’t buy the denials and conflicting messages coming out of the intelligence community concerning the Fitzgibbon spying case. My nose tells me that the airing of the case may have compromised an ongoing investigation.

  24. I am someone who is quite pro free trade, though i think using the Burma, North Korea as examples against autarky is fecicious. There are clearly a few other things wrong with the way those nations are governed.

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