While reviewing this post from 2002, foreshadowing a derivatives crisis like the current one, I found the following:

“At the end of 2002’s first quarter, the notional value of derivatives contracts involving U.S. commercial banks and trust companies was $45.9 trillion, according to the Office of the Comptroller of the Currency’s bank derivatives report. ”

The bulk of the exposure is in interest rate swaps, which are fairly well understood and seem to pose only modest risks in themselves. But there’s still around $1 trillion in more recent derivatives involving securitisation of various kinds of debts. This securitisation is sound only if the credit rating agencies have got their risk assessments right, which in turn requires that the accounts on which those assessments are based should be valid. A few years ago, when the market in debt derivatives was starting up, this assumption seemed safe enough, but now it looks a lot more dubious. The big danger is that defaults in the debt derivatives market could spread to the much larger interest rate derivatives markets.

As an update, the $1 trillion in credit derivatives has exploded to around $50 trillion. While less dramatic in proportional terms, the growth in interest rate swaps is actually more alarming, having reached around $300 trillion in notional values.[1]

It now seems pretty well certain that, as the quote above suggests, the chaos in debt derivatives will shortly spread to interest rate swaps.

Update Unless that is, all normal calculations are rendered irrelevant by a US government asset purchase on a scale that will make all past nationalizations look puny. How that will play out I have no idea. For example, will US-based ratings agencies take the step (automatic if it were anyone else) of downgrading US government debt? End Update

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I don’t think even the most alarmist of doomsayers could have anticipated the pace of events in financial markets over the past couple of weeks. In that time, the casualties (bankrupt, nationalised or firesale) include Fannie and Freddie, Merrill Lynch and Lehman, AIG and HBOS and probably others I’ve missed. And the new names on the list are even more startling: Goldman Sachs, Morgan Stanley, Macquarie Bank, GE, even the Federal Deposit Insurance Corporation.

As late as last week, columnists were asking (and answering in the negative) the question “Should I take my money out of the stock market and put it in a money market fund”. Now the question is “If I pull out of the money market funds before they shut down redemptions, what’s the safest alternative: a bank account, T-notes or gold?”.

No doubt, this too will pass. But it’s just about impossible to see things returning to the status quo ante. A severe recession now seems inevitable. And when it ends, we’ll be looking at a greatly contracted financial sector, with governments deeply enmeshed in both ownership and regulation. Among the likely consequences, a huge decline in the economic importance of New York City, as the firms that defined Wall Street disappear. London may gain relative to New York, but is still likely to suffer badly, as will Switzerland. And that will have implications for the national economies that depend heavily on playing a central role in the financial systems.

Politically, even allowing for the incredible triviality of US election campaigns, it’s hard to see McCain surviving once the implications of this sink in. From the Keating Five to deregulation in the 90s, he’s been in the pockets of the financial sector throughout his career.

No doubt there’s lots more I’ve missed. Jump in and comment.

I was at a seminar the other week on inequality in US household income, and I asked the speaker about something that’s puzzled me for a while. I didn’t really get an answer, so rather than do a lot of work myself, I thought I’d try this crowdsourcing all the cool kids are talking about. Here’s the puzzle.

Over the past 40 years or so, real median US household income has risen by about 30 per cent.

but real US GDP per person has more than doubled. How can this be ?

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That’s when credit default swaps (CDSs) with a notional value somewhere between $500 billion and $1.4 trillion will have to be settled as a result of the (re)nationalization of Freddie Mac and Fannie Mae, which has been deemed to constitute a default event on their bonds. Paradoxically though because the government guarantee of the bonds is now explicit, they are actually safer than before which means that the net payments required in settlement will be very small, and sometimes go to the party who offered protection against default. Don’t worry too much if none of this makes sense, the main point doesn’t depend on it, but you can read a bit more from The Economist.

As The Economist notes, most participants are expecting all this to go smoothly. But one thing about the longrunning credit squeeze is that unexpected (bad) things tend to happen. So what could go wrong?
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Measured by the dollar amount involved, the nationalisation of the mortgage guarantors Fannie Mae and Freddie Mac, announced today by the Bush Administration, is the largest in history. No less than $5 trillion of assets and obligations have been taken over by the US government in one hit.

Of course, that debt had long been regarded as having an implicit government guarantee and the companies involved were quangos (in the original sense of quasi-NGOs) rather than genuine private firms. Fannie was a government agency privatised in the 1960s, and Freddie was created to provide competiion for Fannie. So even though the US government will now guarantee virtually all new mortgages, this is more an admission of existing reality than a big step towards socialism.

While the quasi-governmental status of Fannie and Freddie was always problematic, this wasn’t the reason for their failure. Rather, they were pushed to accept increasingly bad loans made by the private sector. And when their difficulties became acute, the most satisfactory solution, under normal conditions, would have been to formalise the government guarantee of the existing loan book, then put them into run-off mode, writing no new business. But given the failure of the private sector, that would, mean, in effect, making it impossible for anyone to write a mortgage contract.

The fact that the credit crisis has reached this point marks the failure of the central claim of the neoliberal program, namely that private capital markets, free from intrusive government regulation, can enable individuals and households to handle the risks they face more flexibly and efficiently than a social-democratic welfare state.

In the boom that created this crisis, every part of the financial system (retail banks and mortgage businesses, major Wall Street banks, the financial engineers who designed new securitisation assets, investment funds, ratings agencies and bond insurers) had a major role to play. All have failed miserably, even though most will get to keep the rich rewards they received when things were going well.

Further update As various commentators point out, the failure here is one of actually existing neoliberalism. The “unknown ideal” of a perfect free market system remains pure and unsullied by empirical experience.

More seriously, the significance of the event is not in the marginal change in the status of Fannie and Freddie from quasi-private to quasi-public, but in the abandonment of the pretence that the normal operations of financial markets are capable of cleaning up the mess they have created, even with the liberal helpings of public money that have already been dished out.

I’ve been to some great sessions at the Melbourne Writers Festival, most recently meeting and listening to Andrew Davies who’s written of the lot of the great BBC adaptations of classics like Pride and Prejudice, not to mention Bridget Jones’ Diary.

My first session last night was about blogging, under the title “Who are the Gatekeepers” with Margaret Simons and Antony Loewenstein, both of whom, unlike me, had an actual book to talk about. I read both The Content Makers (made even more relevant by the Fairfax job cuts and strike happening as the Festival got under way) and the Blogging Revolution and both are well worth it.

The topic led me to think about the gatekeeping function of the mass media (this is cultstud jargon for deciding what’s important and who’s authoritative). My assessment, based on recent experience was fairly negative. I see three ways in which the old media gatekeepers have failed, and in which bloggers have been effective critics.

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I’ve only been to a couple of events at the Melbourne Writers Festival so far[1], but already this statement from Nobel Prize winner Peter Doherty has been worth the trip for me. Responding to a rant against Darwinism as religious orthodoxy, coming not from a creationist but from a neo-Lamarckian viewpoint[2], Doherty said:

Science is revolutionary, which is why George W. Bush and John Howard hate it so much

Well said!

I’ll be talking about blogging and gatekeepers at the BMW Edge, Federation Square this evening at 5:30 and on Parched, the Politics of Water tomorrow (nearly sold out, so hurry if you’re interested). More details here.

fn1. I had to go to a climate change symposium in Canberra en route which made for a hectic trip, but also allows meant I could do the Canberra gig while minimising extra CO2 emissions.

As I mentioned a couple of posts back, the claim that mainstream science is totally wrong about global warming is an orthodoxy that is almost universal among commentators, bloggers and thinktanks on the political right in Australia, even though the great majority of ordinary Australians, including Coalition supporters, believe the science.

The great majority of Australian take the view that, while scientists aren’t always right, it’s much better to act on the basis of the best available science than to assume that the scientists are wrong. For this, they are attacked by rightwing commentators as religious fanatics or, at best gullible innocents.

One limited exception to this appeared to be the Centre for Independent Studies. A while back Andrew Norton got stuck into Clive Hamilton for listing CIS in the delusionist camp on the basis of some fairly tenuous links. As Norton observed, the CIS had never published much on the topic (though what it did publish was in line with delusionist orthodoxy) and had published nothing since 2003.

CIS has made up for it now, with this piece by Arthur Herman (also published, less surprisingly, in the Oz). It’s got everything – “global warming as a religion”, Al Gore conspiracy theories, Godwin’s Law violations on eugenics, the Spanish Inquisition and so on, backed up by some typically dodgy Internet factoids. As with much in this genre, it’s important to note the call for the replacement of science, as it currently exists, with “real science” in which people like Herman (self-described as “an historian and author”) will lay down the rules.

What’s striking here is the contrast between the willingness of just about everyone on the political right to sign up to a set of beliefs that are dictated entirely by political tribalism and their self-perception as brave heretics, spelt out in more than usually ludicrous fashion by Herman.

Tim Lambert does garbage pickup on Herman’s “facts”. Strikingly, given that he’s supposed to be an (sic) historian, Herman seems to have a lot of trouble with dates and references. And there’s more from Nexus 6 and Gary Sauer-Thompson.

Update: In a comment from Jennifer Marohasy it was announced that Michael Duffy was willing to give $1000 to anyone who would nominate ““Some work/some research results that have been published in reputable scientific journals that:

1. examine the causal link between anthropogenic carbon dioxide and warming, and

2. quantify the extent of the warming from anthropogenic carbon dioxide. ”

Several people provided responses and, after coming back from my hiatus I wrote to Duffy asking the status of my offer. He replied “I asked Jennifer Marohasy about this, because she’s the one who needs to be satisfied. ” and appended a response from her indicating that she was, in fact, not satisfied.

From the original statement, I didn’t realise that Duffy meant to include “satisfactory to Jennifer Marohasy” as a term of the offer. Now that we’ve cleared that up, I think we can regard the offer as in line with the Socratic irony approach to scientific discussion.
There seems to have been something of a meltdown chez Marohasy, so I think we can take this offer as being off the table for all practical purposes

Via BitchPhD (69F, 31M) I found this fun site which checks (but doesn’t save) your Google cache, and looks at the popular sites you visit to predict your gender. The comments suggest both some striking hits and some big misses. I got 51 per cent probability female, 49 per cent male.