The Village Voice: What Cooked the World's Economy?

[marmar]

What Cooked the World's Economy?
It wasn't your overdue mortgage.

By James Lieber
Tuesday, January 27th 2009 at 2:46pm


It's 2009. You're laid off, furloughed, foreclosed on, or you know someone who is. You wonder where you'll fit into the grim new semi-socialistic post-post-industrial economy colloquially known as "this mess."

You're astonished and possibly ashamed that mutant financial instruments dreamed up in your great country have spawned worldwide misery. You can't comprehend, much less trim, the amount of bailout money parachuting into the laps of incompetents, hoarders, and miscreants. It's been a tough century so far: 9/11, Iraq, and now this. At least we have a bright new president. He'll give you a job painting a bridge. You may need it to keep body and soul together.

The basic story line so far is that we are all to blame, including homeowners who bit off more than they could chew, lenders who wrote absurd adjustable-rate mortgages, and greedy investment bankers.

Credit derivatives also figure heavily in the plot. Apologists say that these became so complicated that even Wall Street couldn't understand them and that they created "an unacceptable level of risk." Then these blowhards tell us that the bailout will pump hundreds of billions of dollars into the credit arteries and save the patient, which is the world's financial system. It will take time—maybe a year or so—but if everyone hangs in there, we'll be all right. No structural damage has been done, and all's well that ends well.

Sorry, but that's drivel. In fact, what we are living through is the worst financial scandal in history. It dwarfs 1929, Ponzi's scheme, Teapot Dome, the South Sea Bubble, tulip bulbs, you name it. Bernie Madoff? He's peanuts. .........(more)

The complete piece is at: http://www.villagevoice.com/2009-01-28/news/what-cooked-the-world-s-economy/

[Hardrada]

1. I don't buy the collective blame crap. I've been trying to fuck up

capitalism since 1968. It just so happened that the genius money lords fucked it up worse than I could or even the entire old radical Movement. But we didn't come with their garbage economic theories.

[Phoebe Loosinhouse]

2. If I could rec this a thousand times I would.

It's like Poe's purloined letter. It's really not all that complicated. Just think like a crook.

[alfredo]

3. K&R

[Still Sensible]

4. Basically the money folks had run out of ways to make more

so they created derivatives, which gave them a way to make money out of thin air every time they changed hands. Instead of "cutting out the middle man" they reversed it and added more middlemen... and viola!

And this wouldn't have been as easy without the help of a real estate market that inflated prices and values far beyond reason. The real estate crash of the 80s should have told them it would eventually bust, but they were making so much money!

And then, of course, there are the banks and credit card companies. First they took advantage of GOP power to eliminate a bunch of regulations... and they too, having run out of ways to make money, decided that ARMs was one way... and issuing credit cards to people who have no business with credit cards is another... heck, the rate of default was predictable, but acceptable to them... because...

They lobbied to get tightened bankruptcy laws so when their house of cards began to fall, they would be protected.

Did I miss anything?

[terisan]

7. Yes you left out that Joe Biden was responsible for much credit card/bankruptcy legislation and

Larry Summers as previous Treasury Sec was opposed to regulating derivatives---now one is VP and the other is appointed head of Nat. Economic Council and planning the bailouts.

Dems fully participated and are the people now in total power and they want more bank bailouts.

The money we hand them is going to be on our backs for decades. and our finance sector is moving to China anyway.

I don't argue with your role ascribed to Repubs---but the bank bailout is right now almost totally a result of Bush/Democratic members of Congress.

Only pressure on this administration and this congress can keep us from becoming very poor suckers.

[gopbuster]

5. K&R Excellent Article...I am printing this out and passing it along to everyone I know

Including the "blame the victim" Republican's I know who STILL DON'T GET IT

[leftstreet]

6. "a morass of white-collar sociopathy"

another snip >>

About $2 trillion in credit derivatives in 1989 jumped to $8 trillion in 1994 and skyrocketed to $100 trillion in 2002. Last year, the Bank for International Settlements, a consortium of the world's central banks based in Basel (the Fed chair, Ben Bernanke, sits on its board), reported the gross value of these commitments at $596 trillion. Some are due, and some will mature soon. Typically, they involve contracts of five years or less.

Credit derivatives are breaking and will continue to break the world's financial system and cause an unending crisis of liquidity and gummed-up credit. Warren Buffett branded derivatives the "financial weapons of mass destruction." Felix Rohatyn, the investment banker who organized the bailout of New York a generation ago, called them "financial hydrogen bombs."

Both are right. At almost $600 trillion, over-the-counter (OTC) derivatives dwarf the value of publicly traded equities on world exchanges, which totaled $62.5 trillion in the fall of 2007 and fell to $36.6 trillion a year later.

:wow:
600 TRILLION !!

[marmar]

17. Yep. Those graphs will drive you to the liquor cabinet.....

:beer: :scared:

[creeksneakers2]

75. The author misunderstands

The $596 trillion figure is based on hypothetical numbers that never were money or never going to be. They figures were just hypotheticals used in deciding fees to the derivative issuers. The actual money at stake was only a tiny fraction.

Not all that money was lost either. And of what was lost, I don't see how it can cause a depression, since most of the derivatives were sold to those who had no insurable interest. Say I buy a lottery ticket and it turns out to be a $10 million winner. Then the lottery doesn't pay me the $10 million. Have I lost $10 million? I'd say what I lost was the dollar for the lottery ticket, which I lost anyway.

In 2007 the mortgage foreclosure total was at 2 million with an average loss of $60,000. Lets say its 3 million foreclosure's now with an average loss of $100,000. That's only $300 billion. That's lots of money but we've already given far more than that in bailout and there's more bailout money on the way.

Recessions are caused by the attitudes and decisions of the general public. People aren't buying stuff now. So people are getting laid off. So more people don't buy stuff. That's what is causing the recession. When some people start to believe things will get better they'll buy stuff again. Then things will get a little better. Then more people will buy stuff and then it will all be over. When the stock market starts going back up a little it will then recover much of what it lost. Economic growth on the backside of recessions is usually fantastic.

Meanwhile, the public has been convinced the whole system is crumbling and they have to pay for demands made by those who are milking the supposed crisis. Its all a scam. The worst thing is, all that bailout money is being borrowed from the general investment pool, where investors would have been forced to make more risky investments and would have led us out of all this already. Bill Clinton's theory, that deficits cause economic decline proved true once. Unfortunately, it will probably prove itself again. And nobody is talking about it.

[Raksha]

8. K & R - I read the whole thing.

Most comprehensible article on "this mess" I've read yet.

[JDPriestly]

9. This should be mandatory reading for anyone who wants to

understand why the economy is in trouble.
My favorite excerpts:

Will Obama re-criminalize these financial weapons by pushing for repeal of the CFMA? This should be a no-brainer for Obama, who, before becoming a community organizer in Chicago, worked on Wall Street, studied derivatives, and by now undoubtedly knows their destructive power.

. . . .

The second most shifty bailout went to Citigroup, a money sewer that won last year's layoff super bowl with 73,000. Instead of being parceled to efficient operators, Citi received a $45 billion bailout and $300 billion loan package, at least in part because of Robert Rubin's juice. While Treasury Secretary under Clinton, Rubin led us into the derivatives maelstrom, deported jobs with NAFTA, and championed bank deregulation so that companies like Citi could mimic Wall Street speculators. After he joined Citi's leadership in 1999, the bank went long on mortgages and other risks du jour, enmeshed itself in Enron's web, tanked in value, and suffered haphazard management, while Rubin made more than $100 million.

Rubin remained a director and "senior counselor" at Citi until January 9, 2009, and is an economic adviser to Obama. In truth, he probably shouldn't be a senior counselor anywhere except possibly at Camp Granada. Like Greenspan, he should retire before he breaks something again, and we have to pay for it. (Incidentally, the British bailout, which is more open than ours and mandates mortgage relief, makes corporate welfare contingent on the removal of bad management.)

http://www.villagevoice.com/2009-01-28/news/what-cooked-the-world-s-economy/5

Incredible

[JCMach1]

10. 600 trillion (this may be a conservative number) in derivatives

which could possibly be at risk...

No bailout will fix that. :(

[leftstreet]

11. That figure just blows me away

If this is true, that's something that basically destroys the system.

[JCMach1]

12. That's the conservative figure 1.2 Quadrillion is probably closer to the actual number

http://www.youtube.com/watch?v=PSTt3wEDSbU

600 was from the OP article

Essentially, the world has turned the hose of money on the problem... think of it as a MASSIVE devaluation of all currencies at the same time with all the excess liquidity...

Economic meltdown and dislocation... NO SHIT... we are deep in it.

[leftstreet]

13. Ah, the Holy Hose of Money

[creeksneakers2]

77. There isn't 1.2 quadrillion in the world

US GDP is about 12 trillion. So we would have to have lost 100 years worth of all the money made in the US in a year. Where did all that go? Who got it?

Those huge numbers getting kicked around are based on money that never existed and was never going to.

[HamdenRice]

26. Why not fifty google-zillion? If we're just making up numbers I can make up a bigger one than yours

Why not seventy google-zillion-gazillion?

[Warren Stupidity]

59. My infinity is bigger than your infinity

really it is. In fact it is infinitely bigger.

[csziggy]

43. It's a Ponzi scheme - the "total" is an imaginary figure

Like the Madoff $50 billion. He never had that much money in the scam - that was the amount that is investors thought they had with the invented "profits" added to initial investments. If everyone was honest and just claimed the amounts they originally invested, it would be a fraction of the billions now making headlines.

Derivatives are another imaginary item. The amounts claimed are based on imaginary accruement of imaginary profits. On paper everybody loved them since they seemed to given terrific gains. "Terrific" gains have now become "terrifying" losses for the rest of us who can only deal with the real world.

[SoCalDem]

61. Any child who has every played musical chairs could understand our "mess"

or hot potato.. eventually all but ONE loses:(

[creeksneakers2]

76. It isn't that much money or anywhere even close

The author doesn't understand he's using a hypothetical amount that never existed and was never going to.

[Oilwellian]

14. Excellent article

This part was interesting:

Credit derivatives—those securities that few have ever seen—are one reason why this crisis is so different from 1929.

Derivatives weren't initially evil. They began as insurance policies on large loans. A bank that wished to lend money to a big, but shaky, venture, like what Ford or GM have become, could hedge its bet by buying a credit derivative to cover losses if the debtor defaulted. Derivatives weren't cheap, but in the era of globalization and declining American competitiveness, they were prudent. Interestingly, the company that put the basic hardware and software together for pricing and clearing derivatives was Bloomberg. It was quite expensive for a financial institution—say, a bank—to get a Bloomberg machine and receive the specialized training required to certify analysts who would figure out the terms of the insurance. These Bloomberg terminals, originally called Market Masters, were first installed at Merrill Lynch in the late 1980s.

Subsequently, thousands of units have been placed in trading and financial institutions; they became the cornerstone of Michael Bloomberg's wealth, marrying his skills as a securities trader and an electrical engineer.

It's an open question when or if he or his company knew how they would be misused over time to devastate the world's economy.

(snip)

As for Bloomberg, its business side, Bloomberg L.P., has been less than forthcoming. Requests to interview someone from the company—and Michael Bloomberg, who retains a controlling interest—about the derivatives trade went unanswered.

There's something about this picture:

[justaregularperson]

15. Obama had better bring this to public conciousness and indict the masterminds or he will be blamed

Obama had better not think that he can go light on this. I would be preparing for a massive indicting and education campaign. There is no way to get out of this during the next 4 years and it will all be blamed on him if the real story does not get out to the public.

[DCKit]

16. Don't give up the house until *they* prove *they* own it..

Best advice EVER.

[coalition_unwilling]

18. A must read! Paulson meets his successor

at Goldman Sachs. Successor warns Paulson that GS stands to lose $20 billion if AIG busts. Lo and behold, AIG gets its bailout.

Lehman Bros., by contrast, is allowed by Paulson&Co. to go belly up.

And they dare to blame minority homebuyers for this collapse
???? Where are the fucking indictments????

I have lost my capacity for outrage after 28 years of this bullshit! And yet here I rant :)

[KharmaTrain]

19. The Speculation Games...

I saw them in many forms...tech bubble, dot com bubble, housing bubble, oil bubble and so on...the market had long detached from reality and it had become a gambling casino using Monopoly money. Companies rolled up massive debts and kicked them down the road...twisting that new load as a positive and milking it on higher stock prices. I'm sure we'll find that earnings statements and other assets were overvalued to keep the stock price high and hide both poor revenues and growing debt.

Here's the deal...Repugnicans LOVE debt. It's free money. You lend it on a house or business or from China...handle it through a "friendly bank" (who makes all sorts of fees) and then they collect the interest. It got that the worst customers were the ones with a zero balance...they were the deadbeats since so much money could be made for not only the lending but the lack of both regulation and any real rate protection. For many years, the debt grew slowly...people were squeezed quietly...but with the passing of the Bankruptcy Bill in '05, it opened up the door to 30 percent interest rates and the ensuing defaults and bad junk. The game started to collapse on itself and with it, a lot of other easy money schemes are sure to come forth. Sadly...for many, the money they thought they had was just numbers...not real assets...and with the market crash, not only were their gains wiped out but their initial investments as well.

It's why Keith Olbermann keeps calling his reports on this issue "why daddy went to jail".

[bklyncowgirl]

20. Move over Stephen King--if this doesn't scare you nothing will.

The fact that there are an estimated $600 trillion of these unregulated credit default swaps and other instruments out there waiting to blow up as the economy worsens is terrifying.

[SpiralHawk]

21. The k and the r

eom

[fishnfla]

22. Unfortunatly, it looks like the Clinton Admin is partly to blame

People may not want to face this, but what the hell, everyone was making money at the time.

It is important to look at this scandal from this perspective, it shows that it was a long time developing, was broad and far-reaching into various economic sectors, and a huge mountain to move.

Its gonna take a long time to clean up this mess

[burythehatchet]

24. neo-liberals (DLC) are as harmful to fiscal policy as neo-cons are to foreign policy

that's a sad fact that many simply refuse to embrace because they still cling to the idea of corporate power as a good thing.

[datasuspect]

29. the clinton years were an orgasm of free market cowboyism

[havocmom]

65. During those years, I took Prozac for sever depression. I stopped when I got too giddy and reckless

Seems some corporate cats did not notice they were flying too high without a net. How much prozac was being consumed? Makes some feel so good they think they are invincible. I knew I wasn't and stopped taking when I noticed I was taking too many risks.

The clinton years were prozac days too.

[Baby Snooks]

69. Partly?

http://www.motherjones.com/news/feature/2008/07/foreclosure-phil.html

Bill Clinton signed the legislation that in essence completely deregulated our economic system. And turned Wall Street into a casino.

Even the casino is broke at this point.

[ShortnFiery]

23. I take it back. However, those mortgages should never been offered.

Legislation should prevent greedy lenders from "feeding off" the poor, elderly and ill-informed underclass. We should take care of the "least of us."

[HamdenRice]

25. It's sad when well meaning lefties write about finance and get everything wrong

There have been a lot of really bad articles about the financial crisis, but this is probably the worst of the worst.

The writer doesn't seem to have the slightest clue about what he's talking about and mixes up all kinds of securities, derivatives and kinds of investment firms.

It's kind of like explaining baseball by saying, "the pitcher pitches the football to the center, who can either dunk or make a penalty kick. If he makes a penalty kick then that's a hole in one, but if he misses the penalty kick, then he has caught the largest bass and is called a bass master ..."

Sorry, but that article is just financial word salad.

[MadHound]

27. Not surprising that you would say that

The question becomes who does one believe, an Ivy league educated lawyer/author with a quarter century of experience, or an anonymous internet chatboard poster who claims to have laundered money, been a witness to bribing, and other nefarious activities all the while being a player on Wall Street and development banking <http://www.democraticunderground.com/discuss/duboard.php?az=show_topic&forum=125&topic_id=137886#188664>

Somehow the lawyer/author with twenty five years of experience comes across as the more credible one in this case. But hey, that's just me:shrug:

[HamdenRice]

30. At least I'm an anonymous internet poster who gets his facts right

Didn't you predict that the US Treasury would default on its t-bills? Actually, no, you said they had already defaulted, right?

And didn't you say that the Treasury wouldn't be able to attract buyers for its bonds? How do you reconcile that with the fact that there is effectively zero yield on Treasuries?

And you raise the issue of what posters should and should not be believed?

And you point to a post in which I explain my first hand background in international relations and finance -- including, yes, nefarious things I've witnessed -- to show why I don't know what I'm talking about?

Your posts are getting increasingly :silly: :crazy: :silly: :crazy: :silly:

Do you have anything substantive to say about the VV article?

No?

What a surprise!

[MadHound]

33. Wow, your memory is going

I stated that nothing of what you claim, rather that US Treasury bonds would be downgraded within 3-6 months, sometime around May or before. Oh, and I did link to an article showing a trading house that had done just that, simply on the announcement of the bail out bill. Hmmm, selective memory there eh? Just like your supposed experience.

In that post of yours that I linked to, you didn't claim that you merely witnessed nefarious deeds, but rather than you had actually done nefarious deeds: "My Brief Career as a Money Launderer -- in which I was tasked with closing out a small (by this firm's standards) Wall Street transaction that had occurred a few years before I came to the firm, in which about $26 million had been moved from a certain Latin American country to a Cayman Islands bank via a fictitious company to avoid certain currency restrictions in that country,"

In other words you are either a self admitted criminal, in which case why should we believe a crook, or simply a bullshit artist, because really now, would somebody doing the crimes you claim really brag about them on an anonymous internet chat board. Either way, it simply adds up to the fact that your credibility on virtually any issue is highly suspect.

You're correct, I'm not addressing the OP's article, I'm addressing your high-handed attempt to belittle that article, since you're presenting yourself as some sort of financial genius, when the truth of the matter is that you're either a self admitted criminal or merely another bullshit artist roaming the internet. Which is it?

Either way, your credibility is zip, zero, zilch, nada.

[HamdenRice]

37. Too bad you can't read

My post, the title of which was intended to be sarcastic (I know, you have no sense of humor, so it's lost on you) said, "closing out a small (by this firm's standards) Wall Street transaction that had occurred a few years before I came to the firm..." In closing it out, I was able to understand what they had done.

The larger point, which also went over your head, is that the scandal is that this transactions was entirely legal. In fact, it's sadly routine. So obviously, I wasn't confessing to a crime. In case you haven't been reading about the current financial crisis (or if you were but it went over your head), the systemic problem has been what's legal, what bankers are perfectly able to get away with, not with criminality.

But this sort of thing is doomed to go right over the head of anyone who is both a complete financial illiterate and who has no sense of humor or irony.

[Cronopio]

56. "... a complete financial illiterate ..."

Considering that this economic meltdown was invented and implemented by financial literates, that insult just doesn't have the string it used to.

Add to that the fact that most of the financial literates are now claiming ignorance about how far their game could go, and you start to question their definition of the term "literate".

BTW, K&R to da OP.

[glitch]

32. Not just you. nt

[Vinnie From Indy]

51. LOL! Touche!

[fishnfla]

34. Thats funny, because I've heard and read the exact same explanation

heard it on NPR and read it in Vanity Fair. 600 trillion scam makes sense to me

[HamdenRice]

38. NPR did a terrific job, but it wasn't the same explanation

I think the OP article is well meaning because there is a big problem. It's just that most writers can't identify what the problem is. The best reporting on this was done by NPR's "This American Life," oddly enough, even though they're not generally business gurus.

I just wish that someone would do good reporting that gets to the bottom of the issue. The VV article just gets everything wrong and confused.

For example, the volume of derivatives is simply misunderstood by most writers and readers. The VV article confuses and lumps together everything from mortgage backed securities to collateralized debt obligations to credit default swaps and calls them "derivatives." That's like calling footballs, golfballs and footballs are all "baseballs." It's just not true and confuses people about what's really going on.

The real issue is credit default swaps (not derivatives in general) -- and not even the scale of cds or their existence is the problem.

As far as I can tell there are only four people who actually get why they are bad -- one left wing blogger, one right wing gold bug blogger, one New York Times reporter and Andrew Cuomo, the attorney general of New York.

And to make a long story short, because cds are not backed up by assets like a normal insurance policy, the issuer of cds protects his position by engaging in dynamic hedging according to computer programs -- which in turn "burns down" the very "house" that is being insured against for fire.

[Stephanie]

40. Is this the blogger? This is the article that first alarmed me about credit default swaps

http://www.dailykos.com/storyonly/2008/9/21/9322/74248/245/602838

Three Times is Enemy Action
by Devilstower

Sun Sep 21, 2008 at 06:03:41 AM PST

==excerpt==

The encouragement and "safety" that credit default swaps provided made the sub-prime mortgage market possible. Just as with the deregulation of S&Ls in the 1980s, the market was suddenly flooded with easy credit. The result was a real estate boom, soaring home prices, and a plague of "Flip that House!" shows on cable.

As the banks piled up crappy mortgages, they heaped on ever more of the credit default swaps -- and they still had no idea how to value the things. Worse, they began to trade the swaps themselves as if they were an investment, treating them like something worth holding instead of a big bundle of cartoon bombs whose fuses were already lit. Since very few loans were falling into default at the time, owning a default swap seemed like a way to collect fees without ever paying out. Banks wanted more, and more, and more.

A secondary market for trading swaps exploded into existence, and swaps were traded with absolutely no consideration for the nature or quality of the underlying investment. Swaps changed hands a dozen or more times, growing in "value" as they went. Worse still, no one regulated who could buy a swap, so it was (and is) perfectly possible for a company to acquire swaps that theoretically cover billions of dollars in loans, even if that company doesn't have a red cent on hand to cover those swaps should the loans default.

How big did this market become? Here's business correspondent Bob Moon and host Kai Ryssdal on American Public Media's Marketplace from back in the spring.

BOB MOON: OK, I'm about to unload some numbers on you here, so I'll speak slowly so you can follow this.

The value of the entire U.S. Treasuries market: $4.5 trillion.

The value of the entire mortgage market: $7 trillion.

The size of the U.S. stock market: $22 trillion.

OK, you ready?

The size of the credit default swap market last year: $45 trillion.

KAI RYSSDAL: That's a lot of money, Bob.

As in three times the whole US gross domestic product, Bob. And the truth is that Moon probably underestimated. The unregulated and poorly reported credit default swaps may have actually passed $70 trillion last year, or about $5 trillion more than the GDP of the entire world.

So, are you starting to get an idea of just how big a genie Phil Gramm and his pals unleashed?

With some regularity over the last eight years, fiscal whistle blowers have tried to raise their hands and register a protest. Um, sirs? Is it altogether a good idea to run up debts exceeding all the assets it's even possible to hold? But so long as no one actually had to pay off on the swaps, the party went on. Even usually conservative (in the fiscal sense) companies like AIG started to worry that they were being left behind and leapt headlong into the swap pool.

Shortly after Greenspan's departure in 2006, the Federal Reserve took the unusual step of issued a joint statement along with the SEC to warn about the risks associated with credit default swaps. But by that point, the damage was already severe. If swaps lost their value, most of those who had played the game would find their giant firms abruptly valued in pocket change. The only solution was to cover the problem with still more swaps and keep moving.

Then a funny thing happened. After years in which banks had handed out loans willy-nilly, guarded by the indestructible swap, people and companies started to really default on those loans. Credit slowed, home prices fell, and the whole snake started to eat itself tail first. Suddenly, credit default swaps were not sources of limitless cash. It turns out that an insurance policy -- even a secret, unregulated policy -- is occasionally expected to pay. Speculators started to look at the paper they were holding and for the first time realized it could all be worthless. Worse, it could (and did) represent a massive debt; one that no one had the funds to cover.

[HamdenRice]

41. No it was someone crazier

I think I read the Kos piece when it came out. It's another one concerned with size, but not connecting it to dynamic hedging.

[fishnfla]

54. I'm sorry it was not this american life

it was fresh air, and it was credit default swaps they were talking about, just as the article in the OP indicates, they are part of the problem

So maybe more people know about it than you and the 4 wise men

[creeksneakers2]

78. That's what I thought too

I'm no expert but I can spot some major errors in the work.

[mod mom]

28. MSM compares "the mess" w a recession in '82 but here we hear the truth:

"...we are living through is the worst financial scandal in history. It dwarfs 1929, Ponzi's scheme, Teapot Dome, the South Sea Bubble, tulip bulbs, you name it. Bernie Madoff? He's peanuts."

[Stephanie]

31. That $600 trillion in derivatives - please explain to me what happens next

That's the black hole that's sucking all the TARP money, right? It's an amount that could never possibly be paid off, so what's the solution? Shouldn't investors who got swindled by derivatives salesmen just eat the losses? Shouldn't the salesmen who couldn't pay off the bets go to jail? Are taxpayers expected to be on the hook for this unresolvable debt?

[Earth_First]

35. re: Are taxpayers expected to be on the hook for this unresolvable debt?

I'm pretty sure you know the answer to this semi-rhetorical question...

[Stephanie]

36. I actually don't

Surely Washington knows that the debt is unpayable. What do you actually expect will happen?

[HamdenRice]

39. No, they simply expire

There is a lot of hysteria about derivatives. The problem isn't derivatives, it's credit default swaps.

Here's why derivatives aren't the problem. Take for example a put option. I would buy a put as protection when I buy a share. Let's say I buy 1 share of IBM at $100. I hope it will go up -- maybe to $110. But in case it goes to $90, I buy a put that entitles me to sell it at $100. That put could be really cheap -- maybe only $1. I have literally "hedged my bets." These puts are traded on an exchange.

The stock can go up or go down.

If it goes down, I exercise the put and force the issuer of the put to purchase my share at $100, even though it's only worth $90.

But if the stock goes to $110, then I just let the put expire, and the issuer has made $1.

From this example you can see two things about the hysteria over derivatives.

1. Many derivatives expire. They just go away because they aren't needed. So of that big number a huge portion of it will just disappear, unused.

2. There are a lot of confusing numbers thrown around about this put. What amount of this put goes into that big scary number? Is it the cost of the put ($1)? Is it the exercise price ($100)? Is it the liability of the issuer ($10 -- $100-$90)? Is it the trading volume of the put (eg, if the put is traded 50 times, then that racks up a volume of $50 on that $1 put)?

The international settlements institution wrote an article a few months ago about these numbers and said that all of these various numbers in (2) are lumped together to get these huge numbers like $600 trillion. It's a completely meaningless number. In my example, that one put would add to the $600 trillion number:

$1 + $100 + $10 + $50 = $161

even though the cost of the put is $1 and the liability it created is $10 and the chance that it will just go away is 50/50.

So no, the TARP money is not going into the derivatives black hole. The TARP money is going to banks to make up for the loss of value of their asset backed securities, which were their major assets.

[Stephanie]

42. thanks for the info

now what about the credit default swaps?

[HamdenRice]

44. OK, here's the short version of why credit default swaps are destroying the financial system

I'm about to re-launch my blog with a long article about this. The problem is that it's hard to explain anything without explaining everything, and I've been working on this for a few months now. You kind of have to understand a hedge, hedge funds and dynamic hedging to understand what cds are doing, not to mention what cds are themselves.

But here goes, the super short, down and dirty version:

A cds is a derivative that an issuer sells that "insures" a bond or other debt instrument. If the bond is say a $1,000 bond from IBM, the issuer of the cds says, if that IBM bond goes into default, and because it's in default, the only thing anyone will pay you for it is $300, I'll make up the difference of $700 -- the difference between the face value of the bond and what it's worth.

So it's basically bond insurance.

Thanks to Phil Gramm, a cds was legally not treated like insurance, however. If it were insurance, then the issuer would have to put aside "reserves" to make sure he had the $700 if the bond went bad. Thanks to Gramm, cds were treated like derivatives, rather than like insurance.

It was not considered risky to issue cds because very, very few bonds default in normal times. Obviously that's not true now.

Hundreds of billions of bonds are in default now, and cds issuers are on the hook for that money -- the difference between the face value of bonds and what they are worth.

Most people are completely distracted by the fact that cds issuers are on the hook for so much money. Actually that's a pretty trivial problem. The issuer is usually a subsidiary of a bank or investment bank that has limited liability. So the issuer will either pay up or that division goes bankrupt. Either the bank takes the loss or the buyer of the bond and the cds insurance takes the loss. It's bad, but no biggie in terms of systemic risk -- risk to the system. At any rate, it makes no difference to the issuer of the bond, in this case, IBM.

The real catastrophe of cds is that the issuers are using a particular method to protect themselves that actually hurts the issuer of the bond. Think of it this way. If you issued a cds against the IBM bond in my example (it was $1,000), before the company defaulted when the IBM bond was still selling for $1,000, what would you do? At first nothing. But let's say you start reading bad news about IBM.

What could you do to protect yourself as the IBM bond goes down in value, from $1,000 to $900, to $800, to $300 and so on?

Sounds like nothing, right? You're screwed right?

Actually there is one thing you could do: When the bond is at $1000 but might go down, you can short the IBM bond.

That's called a "dynamic hedge."

That means you borrow one IBM bond you don't own (from an investment bank) and sell it. You have $1,000 in the bank and you owe someone an IBM bond. That's classic short selling. If the bond goes to $300 and the buyer of your cds wants his $700, you have shorted the bond, so you have $1000 in the bank. You give the buyer of the cds $700, and buy back that different IBM bond that is now only worth $300. It's a wash to you.

Because it's hard to find bonds to short, the cds issuers seem to have been using complex formulas to short the other securities (the stocks and preferred stock) of bonds they insured to mimic the shorting of the bond. So the cds issuer short IBM stock to protect itself against the decline of IBM bonds. But shorting IBM stock scares other IBM investors, who dump their stock, and eventually you can put IBM into bankruptcy by destroying the value of its stock.

So here's what's happening: Issuers of cds are shorting the very bonds (or stocks) of the companies that they are supposed to be insuring. It's like an insurance company issuing a fire insurance policy on a house and when he suspects the wiring might be bad, he burns down the house.

It's insane.

The executives of every bank that has gone bankrupt and Iceland's central bank has complained about shadowy hedge funds engaged in ferocious short selling that put them under. In some cases, these companies need not have gone bankrupt. It appears that it's issuers of cds who are protecting themselves that are destroying company after company, bank after bank.

[Stephanie]

52. Thank you very much

And do we know who these cds issuers are? And is there any way to stop them from doing this?

[fishnfla]

55. enlighten us all

what is this difference between this post and what is written in the OP you are calling wrong?

[relayerbob]

64. Probably a dumb question ...

Why not simply freeze the assets and disallow trading/shorting of CDS? Seems to me the losers are the issuers of the CDS, and the underlying stock would not be hit, since there would be little/no incentive to sell. I mean most of this is funny money anyway, as in there isn't really $600 trillion out there to be lost, never was, the gains are (or were) all theoretical based on leveraged profits (and losses). I know, grossly oversimplifed, but...

[Baby Snooks]

70. Insane but legal...

You forgot to add that it's legal. Nothing like legal fraud, is there?

[SOS]

57. Oh, that's just another $15 trillion catastrophic meltdown....

"Any honest assessment must include the role that credit-default swaps have played in this mess: it’s the elephant in the room, the $30 trillion market that people do not want to talk about.
Credit-default swaps are insurancelike contracts that Wall Street created in the early 1990s.
While the amount of credit insurance outstanding is around $30 trillion, Robert Arvanitis, chief executive of Risk Finance Advisors in Westport, Conn., says he believes fully half that amount isn’t problematic because it consists of winning and losing stakes that offset each other.
But that still leaves $15 trillion worth of contracts that may be in need of triage."

http://www.nytimes.com/2009/01/25/business/25gret.html

[creeksneakers2]

79. Its nothing like that bad

The $600 trillion is just a hypothetical number. Nobody lost anything like $600 trillion. Here are figures from the International Monetary Fund on all the US losses from everything. They total $1.405 trillion. That's a ton of money, but only about a 10th of GDP. There's enough bailout money out there to reimburse everybody.

Dept up to October 2008 - type/total outstanding/ amount lost (in billions)

Subprime residential/300/50
Alt-A residential/600/35
Prime residential/3,800/85
Commercial real estate/2,400/90
Consumer loans/1,400/45
Corporate loans/3,700/110
Leverage loans/170/10

Total losses all loans to October 2008: $425 billion


Securities losses to October 2008 in billions (calculated by loss of market value)

Asset backed securities/210
Collateralized debt obligations/290
Prime mortgage backed securities/80
Commercial mortgage backed securities/160
Consumer asset backed securities/0
High grade corporate debt/130
High yield corporate debt/80
Collateralized loan obligations/30

Total losses on securities up to October 2008: $980 billion.

Total of all losses: $1.405 trillion

http://www.imf.org/external/pubs/ft/gfsr/2008/02/pdf/chap1.pdf

[jazzjunkysue]

80. OK. I should have read YOUR post before I went to bed and shook for an hour.

lesson learned. Read the whole thread, if it matters.

I can't tell you how relieved I am to hear this.

I swear, I'm not going through one week of the rest of my life without DU.

[Waiting For Everyman]

45. Anybody who made a killing in swaps, and also pushed subprimes

is WAAAYYYY GUILTY. The article makes that clear - that without the mortgage defaults there would've been no big payoff in swaps. So what did they do? They went out and looked for a whole bunch of likely defaults! This mess was CAUSED for all of us, on purpose, so that a few could make a huge illegal windfall. It's just like the mafia burning down a business to get the insurance - only a LOT BIGGER. And yes, I'd use Rico against them.

We should be going after those who set up and made the killing, prosecuting them, and clawing back the profits ASAP.

And I don't care what anybody says, the up-and-up homeowners who lost their homes over this, should get compensated in the form of help buying another home. Also people still trapped in exorbitant mortgages and other absurd consumer debts (because those were part of this scam too) should have them written down to affordable rates. That's the least that should be done to compensate the damage of this.

The banks should be forced to eat the loss, which they caused, and besides, instead of being treated harshly for this fiasco they have been showered with money to cover the write downs anyway. They're getting off easy, and not even doing that much. I know why too...

When these mortgages are looked at closely - either in modifications or bankruptcies or asset evaluations, more criminality on the banks' part is going to be noticed, AND they don't have the underlying notes.

The didn't even do this con correctly by form. None of it is legal.

[Stephanie]

53. Who profited?

Where are the records to be found? Do they have to report the profits to the SEC?

[jazzjunkysue]

81. There's GOT to be a paper trail. Money is all digital. Obama's gotta do it.

[slipslidingaway]

46. Notional values and actual dollar values...

....Let's get one thing straight, one must draw a clear distinction between notional values and actual dollar values. The whole premise of derivatives transactions is that a few real dollars can be spent to control a large amount of notional dollars. Hence the leverage..."

More here...

http://www.democraticunderground.com/discuss/duboard.php?az=show_mesg&forum=103&topic_id=351988&mesg_id=351988

[NashVegas]

47. You Often May See Me Post About the Perils of Over-Specialization and De-Skilling

via automated tasks. It's interesting to note this article traces the beginnings of derivatives to a machine designed to do an analyst's job.

I also think hyper-specialization of education and skills has played a part in that it's left the highest offices of a company as vulnerable to missing the forest through the trees as the bottom floor is. We don't expect our CEOs to know how widgets are made or even sold, we just want them to make deals among other CEOs who don't know either, but have people who know how they are made and sold, working under them. While we we *hope* they know what they're doing.

Then, the article touches on "entrepreneurial culture" which I think is interesting, although not in the way the article does. Starting a company and then selling it became all the rage - even after the dot.com bubble burst, people still wanted to do start-ups and sell. How about investors fund money to people who want to start up companies and then stick around and run them?

Oh and FYI, you should read Michael Lewis's December 2008 article in Portfolio, along with this. Some choice quotes:

As an investor, Eisman was allowed on the quarterly conference calls held by Moody’s but not allowed to ask questions. The people at Moody’s were polite about their brush-off, however. The C.E.O. even invited Eisman and his team to his office for a visit in June 2007. By then, Eisman was so certain that the world had been turned upside down that he just assumed this guy must know it too. “But we’re sitting there,” Daniel recalls, “and he says to us, like he actually means it, ‘I truly believe that our rating will prove accurate.’ And Steve shoots up in his chair and asks, ‘What did you just say?’ as if the guy had just uttered the most preposterous statement in the history of finance. He repeated it. And Eisman just laughed at him.”

“With all due respect, sir,” Daniel told the C.E.O. deferentially as they left the meeting, “you’re delusional.”
This wasn’t Fitch or even S&P. This was Moody’s, the aristocrats of the rating business, 20 percent owned by Warren Buffett. And the company’s C.E.O. was being told he was either a fool or a crook by one Vincent Daniel, from Queens.

....

That’s when Eisman finally got it. Here he’d been making these side bets with Goldman Sachs and Deutsche Bank on the fate of the BBB tranche without fully understanding why those firms were so eager to make the bets. Now he saw. There weren’t enough Americans with shitty credit taking out loans to satisfy investors’ appetite for the end product. The firms used Eisman’s bet to synthesize more of them. Here, then, was the difference between fantasy finance and fantasy football: When a fantasy player drafts Peyton Manning, he doesn’t create a second Peyton Manning to inflate the league’s stats. But when Eisman bought a credit-default swap, he enabled Deutsche Bank to create another bond identical in every respect but one to the original. The only difference was that there was no actual homebuyer or borrower. The only assets backing the bonds were the side bets Eisman and others made with firms like Goldman Sachs. Eisman, in effect, was paying to Goldman the interest on a subprime mortgage. In fact, there was no mortgage at all. “They weren’t satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn’t afford,” Eisman says. “They were creating them out of whole cloth. One hundred times over! That’s why the losses are so much greater than the loans. But that’s when I realized they needed us to keep the machine running. I was like, This is allowed?”

[Waiting For Everyman]

48. You're soooo right!

And the whole credit reporting system is another example of automating judgements that should be done by human evaluation... just to MASS PUSH a task to enable banks to be too big.

And any automated/numerical system, such as risk evaluation, is only as good as it's premises... which are never looked at... only the number-conclusions spit out by it.

The specialization you mentioned provides plausible deniability. IMO, it's purposely that way - to give cover to the guilty participants in these scams.

[Tierra_y_Libertad]

49. So, congress is "bailing out" the crooks and giving us the shaft.

Crime doesn't pay. WE pay for the crimes...for our own good, according to the politicians.

[Better Believe It]

50. K & R

[Irish Girl]

58. K & R

"The bottom line in this scandal is that fantastically wealthy entities positioned themselves to make unfathomable fortunes by betting that average Americans—Joe Six-Packs and hockey moms—would fail."

A must read.

[Silver Gaia]

60. Yup. That one line really leapt out at me, too.

And then they did everything in their considerable power to ensure that the failure of average Americans could, would--and DID--happen, so that they could feed on the misfortune of millions. Set aside all the fancy financial buzz words, and this is the very simple heart of the matter. The bottom line. :grr:

[Joanne98]

62. MUST READ! A $600 trillion in credit derivative bubble. Who pays?

Nobody can pay off something this big and if they even try we'll KILL THEM!

Get your pitchforks and nooses ready. We may have to send a message!

[Maven]

63. K/R

[OwnedByFerrets]

66. The most important question, however, is

does ANYONE in the universe have a CLUE as to how to fix this farking mess???????

[Sarah Ibarruri]

67. Looks like the DLC's Clinton bears responsibility in the deregulation that caused this disaster nt

[Octafish]

68. The BFEE

A sampler:

Know your BFEE: Goldmine Sacked or The Best Way to Rob a Bank Is to Own One

Know your BFEE: Phil Gramm, the Meyer Lansky of the War Party, Set-Up the Biggest Bank Heist Ever

Know your BFEE: They Looted Your Nation’s S&Ls for Power and Profit



What's even worse, they also are warmongers and traitors.

Know your BFEE: Money Trumps Peace. Always.

[jazzjunkysue]

82. I almost can't believe we got the presidency back from these thieves.

[Octafish]

83. Wait until the investigations hit high gear.

The rats and their cockroach gangs will become claw-scarred
as they climb over each other, scurrying for the nearest rock to hide under.

Know your BFEE: America’s Ruling Gangster Class

May their ill-gotten gains be tracked and used as evidence against them all.

[bonito]

71. Kick n/t

[NM Independent]

72. A rather chilling quote from the article about our new AG

"After leaving the Clinton era's Justice Department, Holder went to work for Covington & Burling, a D.C. firm that represents corporate heavies including Big Tobacco. He defended Chiquita Brands in a notorious case, in which it paid a $25 million fine for using terrorists in Columbia as security. Holder fits well within the gaggle of elite D.C. lawyers who move back and forth between government and defending corporate criminals. He doesn't exactly have the sort of résumé that startles robber barons."

:scared:

I don't see the hope in this situation.

[readmoreoften]

73. What is a "semi-socialist" economy? When did Marx suggest a bailout of the rich?

Most capitalists want nothing more than the socialization of the losses.

[Greyhound]

74. Well that was certainly depressing.

We need to recognize what has and is happening.
:kick: & R