"Derivatives are financial instruments whose value derives from something else, such as a mortgage-backed security or a commodity like oil. The allure of the over-the-counter derivative, as opposed to those swapped on exchanges, is that it can be individually negotiated and tailored to meet the specific needs of the buyer.
Geithner said the ease with which derivatives were bought and sold in an era of easy credit encouraged financial institutions and investors to take on too much risk. At the same time, government regulators weren't given the proper tools to mitigate those risks and protect the American consumer, he said.
"The complexity of the instruments overwhelmed the checks and balances of risk management and supervision," he said.
The administration's proposal, part of a broader overhaul package, has run up against much of the financial industry, which says it would raise costs and squash innovation." Yahoo News
For me, the best were the Credit Default Swaps that were sold by financial houses to people who did not own the underlying asset. These "insurance" intruments allowed the same asset to be insured as many times as desired. As a result, the same asset could be "insured" fifty or a hundred times. An analogy would be that everyone on your block might insure your life if they wished, and without informing you as well.
Monte Carlo? Las Vegas? The Mississippi coast casinos in the pre-Katrina days? This whirlwind of fraud was ridden by people so arrogant or foolish as to believe that they could "time" the collapse and escape. Some of them managed to do that. "Into the valley of death rode the six hundred…" Madness. pl
One of the great things about SST for me is becoming aquainted with history and culture in the context of current events.
This is probably old stuff
to most, but to me it’s brand new. Thanks for creating this site, Col.
That snip you had at the end of a recent post set me off looking at Kipling, and I am surprised no one has used this gem to describe our current troubles.
The Gods of the Copybook Headings
AS I PASS through my incarnations in every age and race,
I make my proper prostrations to the Gods of the Market Place.
Peering through reverent fingers I watch them flourish and fall,
And the Gods of the Copybook Headings, I notice, outlast them all.
We were living in trees when they met us. They showed us each in turn
That Water would certainly wet us, as Fire would certainly burn:
But we found them lacking in Uplift, Vision and Breadth of Mind,
So we left them to teach the Gorillas while we followed the March of Mankind.
We moved as the Spirit listed. They never altered their pace,
Being neither cloud nor wind-borne like the Gods of the Market Place,
But they always caught up with our progress, and presently word would come
That a tribe had been wiped off its icefield, or the lights had gone out in Rome.
With the Hopes that our World is built on they were utterly out of touch,
They denied that the Moon was Stilton; they denied she was even Dutch;
They denied that Wishes were Horses; they denied that a Pig had Wings;
So we worshipped the Gods of the Market Who promised these beautiful things.
When the Cambrian measures were forming, They promised perpetual peace.
They swore, if we gave them our weapons, that the wars of the tribes would cease.
But when we disarmed They sold us and delivered us bound to our foe,
And the Gods of the Copybook Headings said: “Stick to the Devil you know.”
On the first Feminian Sandstones we were promised the Fuller Life
(Which started by loving our neighbour and ended by loving his wife)
Till our women had no more children and the men lost reason and faith,
And the Gods of the Copybook Headings said: “The Wages of Sin is Death.”
In the Carboniferous Epoch we were promised abundance for all,
By robbing selected Peter to pay for collective Paul;
But, though we had plenty of money, there was nothing our money could buy,
And the Gods of the Copybook Headings said: “If you don’t work you die.”
Then the Gods of the Market tumbled, and their smooth-tongued wizards withdrew
And the hearts of the meanest were humbled and began to believe it was true
That All is not Gold that Glitters, and Two and Two make Four
And the Gods of the Copybook Headings limped up to explain it once more.
As it will be in the future, it was at the birth of Man
There are only four things certain since Social Progress began.
That the Dog returns to his Vomit and the Sow returns to her Mire,
And the burnt Fool’s bandaged finger goes wabbling back to the Fire;
And that after this is accomplished, and the brave new world begins
When all men are paid for existing and no man must pay for his sins,
As surely as Water will wet us, as surely as Fire will burn,
The Gods of the Copybook Headings with terror and slaughter return!
In Las Vegas at least the casinos are very heavily regulated. The Nevada State Gaming Control regulates who works for you, where you buy your equipment, how and when you empty your slot machines, who you can have as a business partner, the amount of cash you must keep on hand, how many tables and slot machines you can have. It may be gambling, but it’s nothing like the free for all that characterized the derivatives market.
As Matt Taibbi wrote in his outstanding Rolling Stone Article about Goldman-Sachs….The whole enterprise was akin to buying and selling a watermelon after some else had thrown it off off a tall building …the whole point was to move it onto someone else’s books before the inevitable …”splat!”
Selling CDSs by a financial house offers limited profit and practically unlimited risk (see AIG), but the sheer destructiveness of CDSs is that by going short on bonds by purchasing a CDS contract carries limited risk and almost unlimited profit potential (see GM). GM bondholders owned CDS and they stood to gain more by bankruptcy than by reorganisation. (You hear much about the unions’ drag on GM profit-potential, true, by that’s not the whole story of GM bankruptcy)
Soros and Maxine Waters have both called for banning Credit Default Swaps, described by Soros as the most toxic of all derivatives. May I add you to those strangest of bedfellows on this issue?
As for Geithner – his call for more future regulation is all well and good (if anything positive ever comes of it) but it doesn’t help the mess we’re (still) in now. Still lots of off-book bank derivatives losses to be dealt with.
Every person in America should listen to this recording in the series to understand what Col PL wrote above. “Another Frightening Show About the Economy”
You can download it for a fee or click on “Full Episode” on the left and listen to it via your computer. It is invaluable. About an hour. Also highly entertaining.
P.S. or should I say B.S. After you listent to this show, I can guarantee you will understand Credit Default Swaps. And all this malarkey that they are ‘too difficult to understand’ and that they are so rarified that they can’t be regulated will become apparent to you as just that: rank nonsense.
Because guess what? You’ll be able to understand what they are.
We have been conned by thieves. But you need to understand how the thieving works before you can complain intelligently about it.
It is at times and circumstances like these that the language of the streets becomes the only vehicle that will convey adequately the destructive impact that these kinds of financial manipulations have generated at all levels of our society.
Geithner’s statement limits our understanding of how bad this really is because to explain it he relies on a kind of financial cant which can only be understood by the initiated.
IMO, your attempt at explaining this evil via analogy fails for the same reason. And, because analogies, like cant, can seriously attenuate the affective component of the communication its true meaning can become even more obscure.
Still, I’m unwilling to accept that words fail me. The words, I would use, however, you would be reluctant to print.
Yes, CDOs can be sold many, many times over – and in a global marketplace where huge sums are constantly changing currency, location, and ownership in the flicker of an eyelash, how are these to be tracked? A currency shift, on top of a CDO, must be more powerful than meth to whoever clears what are fundamentally obscene profits.
By ‘leveraging’ (ie, borrowing) at ratios where a $1 bet can ‘win’ the CDO owner $29 in return, these credit derivatives are profoundly destabilising.
But why the US honored them is, to my mind at least, very suspicious. They were basically fluffed up ‘insurance contracts’ sanctified by attitudes about wealth that have no basis in the actual lived experience of any human.
Short of reinventing electricity, it’s hard to argue that these CDO’s ‘created wealth’.
They created instability.
They fed arrogance.
And they were basically the Enronization of the US economic system at several levels.
I thank you, Col. Lang, for this post, but would quibble with one point:
If the investors had taken on the risk, I could live with it. It’s my view that they OFFLOADED the risk onto the rest of us, via their control and influence over US regulatory mechanisms, a cowed, ignorant Congress, and a socially malignant over-production of MBAs and Business School grads.
When 1 in 126 people grows the food that the rest of us eat, that leaves 125 looking for productive work. Too many of them ended up in ‘investments’ and ‘banking’ and overinflated their own self-importance.
Geithner needs to spend a few months volunteering for Habitat for Humanity; it might help him see that his views about just who actually took the ‘risk’ need to be completely overhauled. He blames us, rather than the creeps who actually offloaded their risk on the rest of us — with Geithner acting as their handmaid.
With excuses like Geithner’s, and the slow action in D.C., I am personally extremely pessimistic about ‘economic recovery’.
Registration is what is needed. The market will self regulate if every derivative created by or purchased by a public company is registered with a government agency and fully described. Then any investor in the public company can see if there is adequate capital to back up the risk. Then the market will treat companies that assume too much risk in the same manner as they do for companies that assume too much debt.
Wednesday, July 9, 1930:
here’s a review in the 1930 Journal … of an 1830 book … about events in 1720 … and it still could have been written today!]
Washington Irving’s book “The Great Mississipi Bubble” republished by Random House. “The story was written about a hundred years ago and the actual event occurred more than two hundred years ago, but the narrative … will interest many who witnessed the recent debacle of stock prices.” A couple of quotes from the book: The boom – “Every now and then the world is visited by one of those delusive seasons when the ‘credit system,’ as it is called, expands to full luxuriance; the broad way to certain and sudden wealth lies plain and open … “; The bust – “a panic succeeds, and the whole superstructure built upon credit and reared by speculation crumbles to the ground, leaving scarce a wreck behind.”
“I was just wondering, where do you think your plan went wrong?” asked Rep. Bill Posey, R-FL
I would say in the run up to that $1 Trillion and counting war in Iraq, which had no nuclear weapons and no connection to 9-11. But at least it was all off budget and we got all 5 of Tom Delay’s most important things in time of war, ‘tax cuts’.
“The market will self regulate…” , of course it will it’s called an economic collapse, that’s how free (un-regulated) markets work.
“Frank also said he would call for a ban on so-called naked credit default swaps, a type of derivative where buyers have no risk of exposure.” Why hasn’t this happened yet and why isn’t Geitner pushing this.
Jamzo, there’s a couple of good books referring to the Mississippi Bubble on the Wiki post about the architect: http://en.wikipedia.org/wiki/John_Law_(economist)
Anyoue who wants to understand how financial derivatives relate to security regulators should watch Beverly Hills Cop.
Derivatives are basically fast talking, flashy Axel Foley ( Eddie Murphy who spins circles around the straight-laced Rosewood and Taggart regulatory types. Ultimately, overwhelmed and feeling the need also to be cool, Rosewood and Taggard join up with Foley.
Unfortunately, this is real life and not the movies; so things have ended up with a crash rather than with a bang.
About that bailout:
Securitization of various loans led the pathway to destruction. Once sold and resold no one really had any idea what was in the package and certainly no one accoutable for it. That package became a vehicle however for more lending and leverage. Leading ultimately to the slicing and dicing of the packages of loans or whatever underlay the securitization and thus to derivatives. All signed off on by the legal and accounting profession and in existence since the 70’s but no one or no org or no politician wanted to regulate this expansion of debt and credit. Now the great unwinding occurring and will take years because the business plan of the entire FIRE sector is shattered and only more bailouts by government will sustain it. In the meantime, job losses mean demand is falling not growing and basically the trickle down TARP and stimulus package have failed and will failed as the need to redesign an economy with other than a debt/highly leveraged foundation must occur. NO STRAIGHT TALK FROM THE ECONOMISTS OR FIRE SECTOR because they hope the swindle will get them home even though they know they must continue with fraud, waste, and abuse in order to gain their own security. Finally, the real joke is the US thinks it is in control of its own fate. NO WAY! If not the Islamic World, the BRIC nations now realize that they must short the US econonmy to survive just as Japan and Germany have been doing since WWII.
I am surprised Geithner doesn’t try to go to china again. The chinese is practically panicky and trying to find ways to ditch dollar without crashing the planet economy. 5 years from now, all these is going to end in tears.
they better quit joking around and start implementing industrial strength economic surveillance measure.
btw, UK economy is ready to go kaboom soon. The pound is very unattractive.
# The Chinese are no idiots! They know what is coming. Incessant Quantitative Easing amounts to USD devaluation. Can the US fulfill all their debt obligations? I doubt so. Social security and Medicare liabilities amount to anywhere between US$60T and US$100T. With tax revenues collapsing, America is going the way of California. California will default on its debts soon. It is effectively defaulting now by paying with IOUs.
# I have my doubts that the western central banking cartel, the shadow government, will allow the Chinese to take over their financial and banking system without a fight. They will never give up their control over fiat money. How will they maintain control? War? Blackmailing? Coercing? Co-opting? Corrupting? No doubt all methods will be used!
# The Chinese are accumulating gold surreptitiously. Gold is real money. They know it. There is no way any government can print, out of thin air, quantities of gold! Jennifer Barry explains :
China now has the fifth largest official gold reserve, 1,054 metric tons, surpassing Switzerland. While this was a 76% jump in gold holdings, the yellow metal is still only 1.6% of China’s foreign reserves. Just to reach the global average of 10.5%, China would have to grow its gold hoard to nearly 7,000 t.
This announcement was a huge coup for the Gold Anti-Trust Action Committee (GATA), which has reported since 2003 that China was surreptitiously buying large tranches of gold. Contrary to the official communication, GATA’s intelligence indicates that China’s purchases were made on the open market through intermediaries in New Zealand and Australia. Ellison Chu, director of precious metals at Standard Bank in Hong Kong, backs the GATA theory that