You may recall that I have previously pointed out that the current Wall Street crisis was not caused by 1) Barney Frank, 2) Democrats forcing Fannie and Freddie to give liars loans, 3) poor people not being able to pay their mortgages.
So what might have caused the massive meltdown of our credit markets? A little gift [click this link and see how it all began with Enron] from our old buddy Sen. Phil Gramm, the insanely hard to value, unregulated market in Credit Default Swaps. Click on the link and read a Time Magazine article from March, March!, warning that the credit swap market was going to meltdown because people were investing in CD swaps. These are somewhat like insurance policies that back up other securities such as municipal bonds, corporate bonds or debt backed securites–without having any connection with the underlying security.
"They’re betting on whether the investments will succeed or fail," said Pincus. "It’s like betting on a sports event. The game is being played and you’re not playing in the game, but people all over the country are betting on the outcome."
Matt Taibbi schools Byron York on the realities of CD swaps to debunk York’s regurgitation of RNC talking points that somehow the failure of some poor people to pay their mortgages on time could somehow swamp a market as huge as the US economy. CD swaps were bet on ALL kinds of securities not just mortgage backed securities.
The CDS market exploded over the past decade to more than $45 trillion in mid-2007, according to the International Swaps and Derivatives Association. This is roughly twice the size of the U.S. stock market (which is valued at about $22 trillion and falling) and far exceeds the $7.1 trillion mortgage market and $4.4 trillion U.S. treasuries market, notes Harvey Miller, senior partner at Weil, Gotshal & Manges. "
Got that? US Stock Market=approx. $22 trillion, Mortage market = only $7.1 trillion
Swaps market????? more than $45 trillion. Gee, which of these is more likely to have been able to swamp the entire US economy? The biggish $7 trillion wave or the HUGE $45 Trillion tsunami?
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Great post LHP! These are the kinds of clear statistics that may finally get people to realize what a Ponzi scheme this has been.
Forty five trillion, is that a lot of money?
This American Life has a really good primer on this topic.
http://www.thisamericanlife.or…..sched=1263
this is a FABULOUS post Professor Prop. –
dear Gaia ! your summation Counselor, how long, how long before that 500 pound Gorilla makes it in to the public discourse ?!?!?!
I so need to learn so much more about these “instruments” so I am looking forward to your sweet links.
DIgg please
Numbers from NPR’s Planet Money last week:
Commercial Paper market (whose freeze precipitated the panic)- $5 trillion
CDS market – $60 trillion
(which is 33% more than the $45 trillion counted here
Whatever the numbers, it was the amplifier effect of the unregulated CDS market which blew up the economy.
The argument against regulation (I remember it at the time) runs like this:
“CDSs are really large instruments traded amongst a small number of very sophisticated entities, and as such there is no public interest for regulation to protect – therefore, the Government should stay out of the way of big people who know what they are doing”
Worked out real well.
Where have you gone, Joe the Plumber, oh!
Our nation turns its lonely eyes to you
woo woo woo.
What’s that you say, Mrs. Budweiser.
Bolting Joe has left and gone away,
Hey hey hey.
What Went Wrong (An ABSOLUTE “must read”)
http://www.washingtonpost.com/…..03343.html
“Greenspan, Rubin and Levitt had reacted with alarm at Born’s persistent interest in a fast-growing corner of the financial markets known as derivatives, so called because they derive their value from something else, such as bonds or currency rates.”
Now will someone tell the Obama to dump Rubin,Summers, et al and stop being influenced by the Clintonites?
And here they are -again- locking the door (well, at least going through the motions so far) after the horses have run away.
http://washingtonindependent.c…..ves-market
Self plug
60 Minutes showed a prospectus for a single CDS – it was 263 pages long.
bits and pieces I’ve heard out there allude to a witches brew of numbers that goes in to these – Goodwill Hunting type stuff
Isn’t it scary, Mack?
Somebody used to the MSM might think that LHP was exaggerating. If anything, LHP was being conservative here.
Clinton and Greenspan had a chance to regulate these swaps back in 1998 and didn’t. The Senate voted 97-0 to avoid oversight. Yes Phil Gramm was involved, but so was everyone else. We need to blame those who deserve blame.
The size of the problem is HUGE! It is bigger than the US, Chinese, and European economies combined. When these hit the fan, they take down companies like AIG, Lehman, etc. Much of the failure can be tied to Bush, via the FHLBB, that was pushing money to IndyMac, Countrywide, WAMU, etc to make as many loans as possible so they could have a strong economy in the post 9/11 world.
Plus, don’t forget that those poor “unqualified” folks who couldn’t afford their ARMs, also paid for mortgage insurance to PMI firm, the likes of AIG—who, it’s now known, didn’t save the premiums to cover mortgage defaults, but spinned the reserves into . . . . you guessed it: CREDIT DEFAULT SWAPs!!! Ken Lay, anyone?
Is there a connection to CDS’ and the price of oil? If speculation in CDS’s was a basis for a profit that was used to push the price of oil into the stratosphere is what is now happening with oil prices, 1/2 of what they were 4 months ago but near to where it was a year ago, the result of CDS meltdown?
Punaise in my thead! Woot!
This series also has a pretty good description of how this scam works.
Part one of three:
http://www.oftwominds.com/journal08/zeus9-08.html
Who was lobbying for oversight in 1998? That person(s) needs to be identified immediately.
and ps to all: Atrios way in the hell back late last year was talking about this and how the Bond Rating Agencies were culpable, etc., all of it.
W00t backatcha!
If they can’t pay the claims they should be dissolved.
What is the point of letting them continue to sell insurance they can’t make good on?
Michael Greenberger is the person with the answers. He was at the CFTC at the time, and is now at University of Maryland. He tried to regulate them.
Yes, the Commodity Futures Modernization Act that was actually an 200 odd page ammendment that Phil Graham tacked onto another bill after his wife went to work for Enron had aprovision that excempted “energy swaps” from regulation.
When gas prices first started going crazy, there were a bunch of article saying that it was b/c of the CFMA
thank you!
and thanks everyone for the great links
14. Mark‐to‐market accounting is pro‐cyclical and can create excessive volatility. While the objective of loss recognition is an important one, application of mark‐to‐market accounting is least effective in the midst of a crisis. The recent crisis has demonstrated that asset values can become artificially depressed during a liquidity crisis.42 Prices in illiquid markets often do not reflect future earning value of assets, but instead reflect the amount of cash available to buyers in the market. Mark‐to‐market accounting, therefore, can make it harder for a financial entity to work through a crisis, because it portrays a direr picture of a financial entity at an instant in time, than may
actually be the case over a longer period of time. Mark‐to‐market accounting needs to be rethought and/or applied quite differently, at least in the financial sector. Whether or not a return to historical cost accounting is called for, the issue deserves serious study and
focus.
This diary at Kos also says a lot.
http://www.dailykos.com/storyo…..245/602838
Credit Default Swaps
Credit Default Swaps
Credit Default Swaps
Credit Default Swaps
This needs to be repeated and repeated and repeated over and over and over and over again
Mention this every time someone brings up Fannie and Freddie. Mention this every time someone mentions subprime and adjustable rate mortgages. Mention this every time someone brings up people having mortgages that they can’t afford.
Credit Default Swaps, Credit Debt Obligations, Derivatives, and Special Investment Vehicles
I’ve been talking about them for years as have most of the people on this website
Las Vegas is regulated more than Wall Street
Tell your friends, family, and neighbors
Wash
Rinse
Repeat
The swaps themselves are almost impossible to value. Insurance companies like AIG made the mistake of using traditional insurance models to calcualte risk.
In a treaditional insurance situation, if your house burns down and your insurer has to pay, that does not trigger all the other houses in the neighborhood burning down as a consequence.
But if a corp bonds in a particular sector suddenly defaults, it sets off a panic in the whole sector. Likewise several forclosures in the same neighborhood will drive down the prices of ALL houses in the neighborhood.
Regular insurance risk algorithms were applied to these swap contracts and they told investors that the resulting sum was a correct valuation of the Swap.
It was not. No one knows how to value the swaps accurately
Read the WAPO article
It is hard to say how large the swaps market is. Precisely because it is unregulated, there is no way of knowing. I have heard figures of around $600 trillion in terms of their notional value. (Notional value is not the amount at risk but the figure upon which profits and losses are based and there really are no 100% losses.) Of this, some $182.1 trillion is held by US banks which do have to report them. Interest rate and foreign currency swaps account for some 90% of these. Credit default swaps are about 8.5% of this or $15.5 trillion. Half of all these swaps $91 trillion are held by a single bank JP Morgan.
Again this doesn’t take into account all of the swaps in the world. Many are held in hedge funds or in foreign countries. Hence the much larger $600 trillion overall figure.
You can find all this, except the $600 trillion guestimate here in the most report of the OCC : http://www.occ.treas.gov/deriv/deriv.htm
“No one knows how to value the swaps accurately”; have to disagree. Talk to Bill Gross of Pimco.
I have another post–not up yet–that shows that fannie and freddie is not the problem, nor was an anti redlining law that the RNC is trying to claim forced lenders to make crappy loans. Of the top 25 retailers with crappy loans, only one was subject to the anti redlining law.
Only one and it’s near the bottom of the list
Part of the Bailout plan invovles hiring “experts” to figure out how to value these instruments.
I’ll believe when I see it.
It’s all about who is left holding the bag at the end. Some surprise winners and losers, and the game’s not over yet.
Aggregation risk. There are certain assets that are NOT collateral, like farm land, jet airliners, oil rigs from 82-86, houses in the 00s, because when one lender wants to collect on the collateral, so do all the others, the market falls apart and the assets become worthless. Securitization, which in theory spreads, and thus diminishes the risk, instead in such cases results in risk contagion. Then, derivatives, CDSs, etc., leveraged bets on the underlying nonassets, make the correction into a black hole.
I need more edumacation on this. How much of this market credit swap is mush and how much will your friend and mine Paulson stick us with?
I dunno, I just went to his home page and he seems to have bought into the meme that this is all about a housing bubble bursting.
The magnitude of this problem suggests that it is MUCH more than that.
Please see my entry “The Kashkari question” in my diary.
Gross is not the only one who knows how to evaluate tranches; CDS are structured.
Just guessing here but:
A) All of it
B) As much of it as he can con us into accepting
Phil Gramm…that *wonderful* guy who wanted to bet on people’s lives…literally.
The credit default makes sense to me. I lost my home to foreclosure two years ago, and I begged and cried and pleaded with the mortgage company to work with me. They wouldn’t. I couldn’t figure out why they would *not* want to save the house from being foreclosed upon. It didn’t make sense. Now I’m starting to get a picture that there was probably something in it for them NOT to work with me.
Egggzaktly!
As far as I can tell, nobody actually knows, though few are honest enough to admit that.
Ludwig after Levitt,Carlyle group ala Bush, ay Senate Bankimg commottee togay.
Linky?
I understand about traunches, but the underlying principle how how to evaluate risk turned out to be wrong.
Literally, they were using the wrong equation.
It is near impossible to value something when no one is buying. The definition of value has to include hypthetical willing buyers and willing sellers. No one but the government is willing to touch this crap. If the government buys the bonds at artificial valuations, then everyone will bail and a federal bankruptcy will start looking good.
Remember, bankruptcy is good when it involves corporations, because they are able to write off all the bad stuff. But it is bad when it happens to families, because those people are scumbags that never should have taken on more than they can handle and it raises the cost of borrowing to those families who did not fall behind. If that is too much, the short version is corporations good, people bad.
Don’t take a website as the only info regarding someone please. CDS were part of the subprime fiasco but they also covered many more areas. And bonds -his specialty- are the main underlying asset of most CDS.
I figure there is around $4.8 trillion in losses that have to be spread through the whole system from the housing collapse. But this does not take into account any exposure from naked credit default swaps, i.e. bets made by otherwise uninvolved parties on whether a particular transaction would succeed. Naked swaps would push this figure a lot higher but I don’t know how high because no one knows how many of them are out there. This is why naked swaps in particular I think should be nullified. Equities backed swaps, I would settle for pennies on the dollar.
They thought they were insured against the loss on the mortgage.
In the olden days –think “It’s a Wonderful Life” a bank made a mortagage loan to you. the bank kept that loan on its books and administered that loan.
If that bank was suddenly faced with a whole bunch of non performing loans, it would be in the banks own self interest to work something out with the borrower to return the loan to perfomance status, even if you won’t make quite as much profit on the loan as you originally expected.
But if you (think) you have insurance which will make you whole, you can let the mortgage forcluse. You don’t care. In fact it is in your interst not to work something out with the borrower.
linky
I said in the main post that Swaps covered MUCH more than just home loans. That,in fact, is my entire point.
Guess you missed the Fannie,Freddie,and Lehman auctions.
Yep, yep and yep
lhp, I didn’t disagree with your main point, just about valuing the CDS.
your link took me to a “Story not found” page at Market watch.
other linky?
I don’t think Gross can value the underlying mortgage backed securities. If he can’t do that, how can he value the CDS’?
ACORN is a distraction so we won’t talk about the real culprits and imprison those responsible.
Yeah, that makes sense to me. I never got to speak to a live person. Not once. I kept getting a recorded message of my *account manager*’s phone. And I’d get a robo-message saying how important my call was to them…blah, blah, blah.
Filthy bastards.
Lots of good stuff here
http://www.henryckliu.com/index.html
There is the ‘Notional amount‘ but the ‘actual’ value is a lot less.
http://en.wikipedia.org/wiki/Credit_default_swap
And about Joe the plummer, if he wants to open a biz then he’ll have to save some money first. The world has changed.
http://www.marketwatch.com/new…..aspx?guid={CEF1B650-82D0-4B19-9452-C07F02F79EE8}
It has to do with how the tranches are structured and the insurance that is applied against the various tranches.
LHP, the link works from my diary so …
The derivatives market is a giant gambling ring for betting not on horse races but on whether or not bonds will go into default. The seller of a credit-default swap bets it won’t during a particular period and the buyer bets it will. Like an insurance policy, the swap’s buyer puts up a small non-refundable amount of money for that period. But, if the bond goes into default, the seller must pay the buyer the difference between the face value (aka notional value) of the bond and its present worth. These are totally unregulated, i.e., anybody can sell swaps, whether or not they are they can make the pay off. Buyer beware.
There are 60 trillion dollars in the world, and about the same aggregate notional value in credit-default swaps. Visibly, most default-swaps cannot be paid off. IMHO, they should all be declared null, void, and unenforceable (like illegal sports bets) by the governments of the world.
That’s what I got following your link.
Why don’t you cut and paste the title, the date, and the authors. Maybe some of us can find a working link.
Maybe I’m not making myself clear. It’s not just the mortgages, Swaps insure all kinds of debt instruments including corporate bonds. Which can be a lot shakier that homeowner debt.
Am I jinxed or something? I got the “story not found” page again
How do you insure an asset, a mortgage backed security, without knowing the value of the underlying asset?
how about a link TO your diary?
No, the link doesn’t work for me either.
ubetchaiam, give us a date, the author, and the title of whatever you’re trying to link to. Maybe we can find a working link.
I did that and the ‘linker’ put in an extra space before the word ’story’ which is why you get the ’story not found’ ; again, it works fine from my diary which I did use the linker on.
There’s only $60 trillion in the whole world? How do you know that? somehow, I thought it would be more…..?
I did that up at #8 as ’self plug’ but here it is:
http://oxdown.firedoglake.com/diary/794
The other post, the one about who made the subprime loans, is up top.
There was a mix up and it should have been published before this one, so the progression is a little off.
“the buyer typically delivers the defaulted asset to the seller for a payment of the par value. This is known as “physical settlement”.”
It’s the ‘par value’.
http://en.wikipedia.org/wiki/Credit_default_swap
But for many securities, par value is a nominal value.
If you thought the security was backed by a e convertable debenture in a stock that had consistently traded above $50 a share for years, today that stock might have a market value of only pennies per share after the hit the markets have taken.
The par value of that stock might be, what?, a dollar per share? You are still wiped out
I can’t even begin to say how freaking upsetting this is to me. They took my home. A house that I paid nearly half down so I would be okay. The house I lived in for eight years and paid out thousands in improvements. Fucking bastards.
If only I could get Paulson on the phone. We only have to read wikipedia.
If Bill Gross can accurately value the Lehman CDS’ why is Lehman still in bankruptcy? What went wrong?
It was in the Wikipedia entry on credit-default swaps or on credit derivatives. But I just now looked for it and don’t find it.
No dispute there; that’s why the 15% (or $10K whichever is the Obama plan for those with retirement accounts) I see as not really doing much good for those who have already been wiped out(maybe not entirely, but to a point where it’s just not much anymore).
In case you didn’t see this (I’m trying the ‘linky’ again’).
Here’s the unadorned link:
http://www.marketwatch.com/new…..aspx?guid={8AA62917-892F-484D-B83A-6B730104302E}#comments
Yes, the human cost to this is not being addressed.
There are lawsuits pending and filed; I put an analysis of this in one of my past diaries and it pointed ‘politics’. If you want, I’ll go search my saved files and post it again.
I eventried cutting and pasting the whole thing into a browser window and still “apge not found”
Do yu want to tryto cut and past your diary into a comment window?
My empathy and sympathy; I lost my ‘retirement’ house because Wells Fargo refused to go along with a refi that would have paid them off (they had the ’second’) because of their insistence that the second (which they had written off and taken the tax credit on BTW) be paid off before agreeing to the new refi.
How about just cutting and pasting the relevant points into a comment on this thread?
If this doesn’t work, will do. (I’ll try it after the post)
Comments are like news stories on tv; they don’t give the complete picture. I’ll dig it up -later- and post it as a comment in today’s diary.
It worked, though I could not tell if you were the original poster or one of the commentors, since nothing matched up with your FDl screen name. But I read it all
I agree, I agree, I agree!
According the article below, it is going to take Lehman 200 additional professionals and some time to figure out what the contracts are worth.
http://online.wsj.com/article/…..41569.html
If I understand, eventually they will know what the contracts are worth. The folks in the outer tranches get killed? Senior level tranches? But they do not know what they are worth now which means they cannot make decisions now; not any way to run a business especially a “conservative” bank. The big banks got away from their proper role. At his point, I have the image of a low level employee ‘holding a bag of turds’ at the end of process. Meanwhile, the high ranking executives golden parachuted out – just like Enron. I hope I am wrong.
Did that somehow morph into preventing any regulation of Credit Default Swaps or was there perhaps something else going on there?
Right after 9/11 I saw a lot of indications there were some advantages to certain people if certain disastrous things happened. Some of these advantages were political, some economic.
Apparently this idea of gain through disaster, insuring and then destroying, has infested Wall Street as well as Republican ideological thinking. “Creative destruction” should be confined to the prison cell of history.
Careful with your lingo. As I understand it, there is no ‘underlying asset’ as a CDS is an unregulated contract (somewhat like an insurance policy) attached to NOTHING. It relates to an asset, but isn’t tied to it.
People with good sense might think you should properly(!) evaluate the asset to be “insured”, but what if you were talking about a pig in a poke? What if I said I want to insure something for $1M and you said sure, but it will cost you $1K/year. What difference does it make if the thing to be insured is a pocket watch, a bank or a house worth whatever the fluctuating market says it’s worth. If two people want to make a contract, then what’s logic got to do with it. Question is whether they were just playing games and everybody KNEW the ARMs were going to crash the market and that those who offered CDSs were NEVER going to pay off or they were just going to turn around and insure their CDSs with a ‘bigger fool’.
It turns into a game of musical chair with the biggest fools always banking on being ‘too big to fail’ backing by the government.
That’s where we stand. All the smaller fools are gone or suffering and the bigger fools are standing in the government bread-line.
I have a harder and harder time trying to imagine why the government should pay off any of these jokers who were just playing with imaginary dollars and photocopiers spinning out CDSs as fast as possible. We can’t let a photocopier become a new money printing press, can we?
Okay, consider that idea. What happens then?
A lot of mortgage holders will then know foreclosure doesn’t give them CDS payoffs. Will that force them to offer refinancing or will they just foreclose anyway?
Who gets hurt? Will the big holders go belly-up or will they just write it off and keep going with real money and real assets & such?
This is big math and I doubt you or I have the numbers. I doubt the big banks even let that out in the vaguest terms, so only government might be able to find out. That brings us to Paulson and how the Bush admin. views this ‘disaster’.
Do the Bushies see this as a ‘disaster’ or ‘an opportunity’?
What is a glass of lemonade worth? Maybe 50cents?
Drink a glass and then ask what the value of the next one might be?
Value is always in the gray area between buyer and seller.
What went wrong is Republican ideology. Reagan said the government is the enemy and Norquist said they should make government weak enough to drown and McCain & company said deregulate and now we have some chaos and anarchy — which means that for this era George W Bush is the perfect Republican to be in charge. Too bad for everybody else.
Casino Royale…place your bets Main Street…we got hot magic paper…grab your ankles for capital injections.
A couple of points on the mortgage market:
It appear 3/4 of ALL residential mortgages were securitized — i.e., sold off by the banks into MBS, ending up in CDOs, CDO^2,and CDO^3 et bloody cetera.
One would assume, based on foreclosure cases thrown out in five states — as I recall, Deutsche Bank in the Ohio case was first. The judge simple concluded they could show no actual holding of the 14 mortgages in question. Conclusion: many of the foreclosures that have already happened were illegal on the part of specific banks. They may have maintained a service for the securities but they themselves no long own said mortgages.
And with all the slicing’n’dicing, some of those mortgages were a reverse Frankenstein — they’re in pieces in various instruments.
Also, all this didn’t start this decade. There would have been pretty secure mortgages from the 90s and perhaps even the 80s; yet, it only takes one personal disaster, loss of job or major medical problem to come unstuck.
And a P.S.
Along the winding way, due diligence was ‘all too hard and costly’ so mortgages, whole or in pieces, as it were, simply passed on with no devaluation of asset quality — and in many cases, no proper paper trail.
Mark, my situation occurred in 1995.
Again I reference the WaPo article in #8