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Treasury Secretary Geithner has launched a push to install clearinghouses as the weapon against systemic collapse of the derivative markets. As with all of the financial repair missions of the Obama Administration, this happened after extensive consultation with all the people who really believe the financial system should work for the financial elites, and their lobbyists. It doesn’t bother them if taxpayers eat clearing house losses in the next disaster.
Clearinghouses are supposed to remove counterparty risk by inserting a third party between the parties to derivative transactions. Counterparty risk is the risk that one party can’t perform on its obligations under the derivative. The idea is that the clearinghouse will perform if the one party can’t. AIG is the example: it couldn’t perform on its credit default swaps, and the financial elites ran crying to Bush and Paulson to get taxpayers to perform for AIG, which worked out well for them, but not so well for the rest of us.
What could possibly go wrong? Well, for one thing, how does the clearinghouse get enough money to perform in the event of an AIG-type disaster, right now in the range of $80bn? One clearinghouse explains that the money will eventually come from the other players in the market. That won’t happen. They’ll just run back to their buddies in the Treasury to get taxpayers to do the paying.
But that isn’t all. Treasury will only force “standardized” derivatives onto exchanges. Customized derivatives will not be publicly traded; instead, general information will be reported to a depository, which will make some information public, but most will only be available to regulators, and we know how well that works. And there is a worse problem. This distinction was first made by Wendy Gramm, Phil’s wife, when she was head of the CFTC, and eventually the standardized category shrank so much it was drowned in the bathtub when President Clinton signed the law deregulating derivatives. Frank Partnoy explains the danger in the NYT:
The leading derivatives lobbying group, the International Swaps and Derivatives Association, is already looking to exploit the Treasury’s proposal to split derivatives markets in two. As part of its lobbying campaign to protect negotiated instruments, it insists that last year “the derivatives business — and in particular the credit default swaps business — functioned very effectively during extremely difficult market conditions.”
Sure, as long as you ignore AIG. Oh, and Merrill Lynch. And anyone else we don’t know about because, don’t you know, this stuff is a big secret. Let’s go to the tape. This chart shows free public information on credit default swaps:
Markit Group has developed this free "Last Quote for the most Liquid Credit Default Swaps" pricing report to address a public interest in CDS prices. This Last Quote report is based on the most recent price quote any active dealer in the CDS market provided to its institutional customers before 4:00PM Eastern.
This chart doesn’t tell us anything about how much trading there is in these things. We know nothing about that from public information. Here is the report from ICE, the US clearinghouse. From this we learn that a grand total of 11 CDSs are trading, all of them indices. None of them are single-name references, which is the kind we would find interesting. If that is the public data we will get under the Geithner plan, we didn’t make progress.
And, here is the question no one even bothers to answer: what is the cost-benefit analysis for these things? Yves Smith at Naked Capitalism asks the question in great detail here, and her commenters, many of them knowledgeable, give stock answers. Nobody explains the benefits, it’s as if they are taken for granted. No one says the risk is controlled, they merely say it is reduced.
The financial elites act like they know how to manage risk, they talk about their desire to balance their portfolios by acquiring risk at particular levels and spout gibberish about VAR and “stress testing” and other control measures. Again, we’ve seen how that works out. We also have a theoretical explanation of why their “risk management” is worthless prattle. As best I can tell, the geniuses on Wall Street have only a superficial understanding of the mathematical models on which their trading, and their risk control, are based.
The President and the Treasury don’t have to answer, they don’t bother to explain why this nuclear waste is worth the risk to taxpayers. They just do what the financial elites want them to do. And Congress will join in four-part harmony, dancing to their their Master’s tune. Lord knows both groups, Republicans and Democrats alike, have taken enough money that it would really be surprising if they didn’t do what the financial elites want them to do.
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Word.
Thanks masaccio.
great post as per usual. thanks.
have you taken a look at h.r. 977 from rep peterson and the house ag committee? i haven’t read it (just listened to some of the committee hearings on it), but was curious to know how it compares to what is now coming from the administration.
Ding ding ding.
I have a friend who knows the man who is working out the Lehman positions, being paid by taxpayers at the rate of $1 million/year because he’s the only one who can do the workout, having been in charge of those positions when Lehman existed. My friend thinks that the models are all wrong, not only because of the bias of the short periods they choose to test them, but also because there’s no macro overlay. My friend points to the same problem when we used to attend a risk meeting together to brief the big boss on the overview (me economics, my friend equity strategy). The big boss once mentioned to my friend that he didn’t know what to do with the detailed information coming from some of the other participants in the weekly meeting.
One way an exchange might fund counterparty risk is by requiring posting of collateral, based on some analysis of the relevant risk of the type of instrument being traded. The exchange participants agree on a risk pooling mechanism. In the event of a default, the defaulting party loses its collateral, and the pool is tapped to pay remaining losses. If losses exceed the pool, there’s no back up from Uncle Sam, and that’s the key.
Each event triggers a reevaluation of the risks, collateral requirements, and pool obligations. This seems to function in electricity markets, but these have not been subjected to the massive/systemic defaults seen in the financial sectors.
Is that model what the Admin has in mind?
masaccio, a helpful visual (if you ever run across it) would be anything comparing asset deflation in areas such as state governments: wages, furloughs, cuts in jobs, investment in local governments and schools; versus the absence of deflation(or less deflation) in credit default swaps.
Or, if there were a way to compare the rise in unemployment against increasing taxpayer support for credit default swaps.
I’m not asking you to build such a graph, but maybe Dean Baker, Ph.D’s non-profit, or a group like that, could develop something and put it out.
I guess in all the brouhaha (ha ha haha… apologies to Firesign Theatre) of Obamamania and his “micro-donors” the fact that he had raised over $100 million before the Iowegian Caucuses from the Banksters and their ilk is a fact lost to history.
It’s no wonder that the DLC-reincarnated is running the banks, TARP, the FED and giving away zillions. After all, they engineered the collapse under their first bought-and-paid for the unlamented Village Idiot, and now they’re getting all their money back and more with no oversight from their guy Obama. I wonder when they’ll start going back to those fancy resorts in South Carolina again, a la Bill and Hillary. Long walks on the beach at the Isle of Palms, Michele, Barry, Sascha, Malia, Bo and a horde of chosen banksters… how romantic.
It’s the game. We’re just on the sidelines watching.
This entire affairs looks, smells, acts and walks and talks like a good ole’ boys club playing an enormous game of liar’s poker. They only talk amongst themselves and sit both smug and secure in the knowledge that they have nothing of their own at risk and everything to gain, because they are playing with taxpayer money. This snowball just gets larger and larger, and more out of control, as it rolls downhill, and the little people in the valley are gonna get squashed when it finally reaches bottom. I am off the Obama fan-club wagon, and Geithner better hope he doesn’t run into me in a dark alley. It won’t be beautiful Summer’s day, if you get my drift.
There are times when collateral is not worth a hill of beans. Any time leverage exists is the most blatant example. But also, certain assets have no value when you need it. Farm land and aircraft are two favorite examples from the past. When the collateral is really needed to pay of the loan (or the loss), everyone is trying to do the same thing and the so-called collateral quickly loses the value that is needed.
Enter taxpayer …
Your friend maybe could explain what he can to congress? Or a blog if he worries about his job.
I agree, which tells me the exchange risk management works only if the collateral requirements are carefully screened and enforced, and the rule that any default cannot result in recovery beyond the pool — i.e., can’t rely on implicity taxpayer bailout, as in Fannie/Freddie.
My limited understanding here is that an exchange is simply facilitating trading of what must be uniform commodities, and it may modify risk slightly, but it really can’t get at the type of systemic risk we’re concerned about. that may/may not encourage parties to deal more in the uniform commodities, and thus help transparency/monitoring. If the govt is selling it as accomplishing something more than that, it’s misleading.
My friend is jobless and couldn’t get one during all the boom because she would point out the problems with the models during interviews. She still wants to find a Wall St. job, was her response when I suggested she go work for Treasury. But I have decided after that conversation that she wouldn’t get any farther at Treasury than Wall St. because there’s no difference between them.
How about requiring cash as collateral? Stocks as collateral as Enron found out in a down market are worthless too. In fact I keep waiting for Fox News too go under because the banks should be demanding more stock from them just like they did with Enron.
She could write diaries here about all the companies that wouldn’t hire her.
Of course markets cannot deal with systemic risk. Witness all the crashes in the stock market. That’s why I’m in favor of outright prohibition of financial instruments where there is systemic risk and they don’t do much to help the real economy. Derivatives would seem to fall into that category, as for the life of me, I don’t see any benefits from them, except for the false impression of creating financial industry economy for short periods of time.
I wrote on this earlier this week when the NYT did a lame story on “derivatives” regulation.
The main points were:
Risk is risk. It can’t diminished be diminished. It can only be passed on.
And through the miracle of naked CDSs, which Geithner supports, it can actually magnify risk.
The total worth of the exchanges that would set up these clearinghouses don’t have even a fraction of what would be needed to cover the action in them (especially in a general downturn, like the current one, where they would have to pay off many at once.)
Options and futures are derivatives. So what are we really talking about here? CDOs are derivatives too but are by their nature illiquid (odd how Paulson and Geithner have gone apeshit acting as if CDOs should be liquid, I mean their whole point is to hold them and get the cash flow from them).
Most swaps action is in fairly standardized currency and interest ones. I suppose these could be traded and they do dwarf the action in CDSs but at least so far there haven’t been any problems in them.
As for problematic derivatives like CDSs, again their whole point was that they were individualized, hence non-standard. So what is the point of clearinghouses if they can’t “clear” CDSs. OTOH if they can, what is all this talk about trading standard derivatives only?
All of this misses the point of why Geithner won’t regulate CDSs as insurance.
Finally, there are supposed to be reporting requirements on these instruments but reporting is not the same as oversight (someone actually looking at this stuff critically) and oversight isn’t the same as regulation (i.e. exerting control over the market).
In other words, this is another Obama smoke and mirrors special brought to you by his team of Geithner and Summers, guys who couldn’t organize a two car parade.
If you require 100% cash as collateral, what’s the point of doing the transaction to begin with. And anything less than 100% puts the taxpayer on the hook for systemic risk.
Not the type, take my word for it.
FDIC is hiring, perhaps your friend would be interested in working there.
http://www.nytimes.com/glogin?…..0YReRMMJeM!eMQ3CeguoQ2FXqooeMQ3CVW((mPYQ23(
The derivatives market is how big Merrill loses hundreds of millions, AIG loses 8o billion?
I assume that we the tax payers are the real third party clearing house because in a down market nobody will have the cash to bail themselves let alone anyone else out.
Never mind that unless we restrict leverage the amounts of money involved are to big even for the government to do another bailout.
And that requiring that collateral be held in cash the most liquid asset in a financial crisis (eCHAN has a very good point about aircraft as collateral having no buyers and hence no value in a crisis.)
Is a good idea but to get the profits the banks want they need a low collateral, high leverage mix which is what got them in troible in the first place.
That and they need allot of loans like that to stay big. The need to make lots of loans forces them to make bubbles tech, housing etc like junkies they don’t care about sketchy loans dirty needles they need cash injections/infusions.
Yes so lets get rid of derivatives after all if we can’t make the market safe without using tax payer money then lets kill it.
Just how would we unwind all those trades though?
Blogging doesn’t pay well, either.
It sounds as though the kind of information she has might be of great value to Nomi Prins in the writing of IT TAKES A PILLAGE, which is due out this fall.
Perhaps I am just advertising my ignorance of finance jocks, but perhaps Harry Markopolos‘ new investigative firm would be interested in her skills?
LOL.
You can say that again.
I just cannot believe we have less than 1,500 people who have donated to Marcy.
Thanks to you and to the others who had job suggestions for my friend. She’s determined to go back to Wall St., don’t ask me why, and she doesn’t take advice from others very well. She’s not a liberal, so I guess she doesn’t understand that other people might want to be helpful. *g*
(Though she is helpful to others just for the asking, I hasten to point out.)
No the game is real we don’t have enough cash for another big bailout. Nobody trusts the banks, corporations, or hedgefunds numbers right now. Anything could trigger another wave of bailouts more war in the middle east, higher or lower oil prices lots of speculating going on.
China playing games with our debt a big drop in consumer spending.
Our troubles are coming in battalions, and Geithner is the blind watchman.
I don’t know. I wrote about this earlier, here, with a description directly from the letter that CME Clearing sent to get authorization to set up its exchange. CME has the following capitalization structure:
I don’t know how well that stacks up with their trading numbers, but it’s clearly not enough to handle an AIG-sized disaster.
WRT Markopolos, I was glued to his congressional testimony. He clearly knew what he was talking about. But like many driven people, he couldn’t convince anyone else because they thought he was a nutcase.
There was that very smart Fortune reporter who figured out Enron in advance just by reading Enron’s own financial statements. No one believed her beforehand either.
Got FDR defending his SCOTUS packing idea on cspan3 right now.
Ooops. Turns out it was just a brief video clip as part of another program. When I flipped to it, I thought they would play the whole speech.
IIRC, Bethany McClean.
Just how would we unwind all those trades though?
1) Nationalize the banks
2) Nullify naked CDSs
3) Set a deadline to register CDOs and CDSs (if not registered, not enforceable in US courts. If a suit is entered in a foreign court, the company is frozen out of US markets.)
4) Write down (cramdown) value on CDOs.
5) Remove collateral calls on US government backed action
6) Amortize the risk on CDSs and link them to the cramdowned values of CDOs.
7) Prohibit issuance of any new CDSs and direct any action to regulated insurance.
8) Legislate link between underlying mortgages and CDOs.
9) Require warrants for any new issuance of mortgage backed securities.
How did I do?
Yep. I was too lazy to goggle it, but just did & you are correct.
When will Obama tell Geithner that he no longer works for the banksters and that he now works for the US taxpayers?
Actually I don’t think derivatives would work at the regular collateral of a bank loan.
And if leverage is involved does the amount of collateral required go up as the risk goes up?
I mean if I had a credit card I can borrow a percentage of my income?
With Leverage companies, hedgefunds can borrow $36 to every $1 of assets they have.
Forget credit cards think of a reverse mortgage on a home that was so generous.
What kind of collateral should a bank really have on a leveraged loan to make it as safe as a home loan for a person?
Totally frivolous, OT trivia:
When “smiling”, Secy Geithner looks as if he’s channeling Jack Nicholson.
When “smiling”, Rahm Emanuel looks as if he’s playing John Malcovich.
Eek!
Distinguish between two situations: normal vs. system risk.
(Obama getting wild cheers at ND.)
In the former case it’s easy to figure out what reasonable collateral might be, but in the latter, there’s no collateral that is sufficient. So the taxpayer’s on the hook, which means that the govt has a role to play.
Not a problem, she deserves a ton of credit. She was against Enron before it was “kewl.” I was just glad you mentioned her.
Did you read her wiki? Here’s the fun part:
And yes, she deserves all the credit she can get.
How about end the contracts now and return the money to the different parties? I’m just guessing here.
The banks without these gimmicks are never going to make the money they did before same with stocks the broad market jumps are over.
On the bright side without a huge market of risk there will be less need to play it safe with a portion of your cash T bills might take a hit.
If the government can’t finance its debt either the government cuts spending or the dollar crashes.
The GOP will say cut social security Obama if he’s smart will say cut military spending.
The less ability we have to make war the more money we save in the long run.
is there a channel or link carrying the notre dame commencement without comments?
notre dame tv? whoosiertube?
i’d kinda like to hear how the other speakers are framing their parts.
(so do you)
It was on cnn, but they’ve broken away. They said they were livestreaming so I’ll see if I can find a link.
Here’s the link.
My bold Lets just dump this because
That seems to have no upside for me as a tax payer. This government owns the banks thing has no upside if we have to do another bailout.
Anyone have odds on another bailout? Who or what gets bailout and how much?
everyone’s yakkin’ over it….
thanks, ros–
don’t have cspan 2 or 3 in the living room, and i was out on the deck potting up stuff and listening through the window…//and already have a kazillion tabs open researching a few things, so better not search…
You might try this link:
http://abclocal.go.com/kabc/livenow?id=6817364
many thanks…
thanks, adie.
and eeek-ahn, (heh, i was saving that for halloween, but i couldn’t wait that long), i wanted to see if he incorporates what everyone says into his speech.
i love speeches and true debates, when delivered by people who know what the word nuance means.
bbl.
hey massacio, antoher great post. i read and learn.
Blue Texan is upstairs!
Alan Keyes Arrested at Notre Dame During Anti-Obama Protest
Really, really well; as per usual.
It is surprising, isn’t it? We, (Smartlady and I) have always thought of this community as Firedogocean, are multiple donors, and will be regular contributors to both Firedoglake and Marcy as long as we access their sites. We were smart enough to get most of our money out of the market last May and stash it in Money Market Funds. We are proud to pay a lot of taxes, because we like driving on good roads, having smart policemen and women, good schools, civic centers with air conditioning and heating and a safe prosperous country to live and work in. Lately though, the government seems determined to cover up the misdeeds of the elite while pretending to be tough on crime. We need to know where the money went. No more unregulated secret agencies transferring taxpayer money to big (too big to fail) corporations who aren’t paying taxes and aren’t giving the taxpayers who bailed them out an even break! Smartest guys in the room my ass! A crook is a crook!
Great! When are you running for Senator?
Ok, I’m getting way over my head here, but I always thought the point of an exchange was to pool risk, and that in an emergency someone steps in from within the exchange to bail the sysstem out, olike J.P. Morgan in 1907 (of course that led to the establishment of the Fed, because it was way too risky). If that’s the reasoning behind Geithner’s plan, it doesn’t make sense to me, because the risks are independent. There’s no averaging or pooling. As I said, I’m way over my head here.
Enron..Conspiracy of fools…is a description of what happened and is being repeated daily now. The accounting rules…the investment rules…the off of the books massive porfolios that are not reported or regulated and they are downplaying the monumental equity decay that destroyed the global economy.
Fools is the appropriate word.
In March, I got notice that the Chicago Mercantile Exchange was girding up for this clearing house charade.
Don’t know more on the topic, so will just pass along what I got from bespacific.com on 3/17/09, with the headline, “SEC Approves Exemptions Allowing Chicago Mercantile Exchange to Operate as Central Counterparty for Credit Default Swaps.”
Out of curiosity, I pulled up some information on Citadel…
Citadel Investment Group – Wikipedia, the free encyclopedia
http://en.wikipedia.org/wiki/C…..ment_Group
As Dick Durbinsays: Banks “Frankly Own The Place”
http://www.huffingtonpost.com/…..93010.html
they get what they want when they support a candidate, and if they don’t, they withold further support!
imagine that. maybe ‘Progressives’ should try that someday, one of these even numbered years.
by voting Democratic, no matter how often Democrats sell you out, you are also doing exactly what the financial elites want you to do, ratifying the charade.
maybe someday ‘Progressives’ will stand for their principles, and not just gripe while Obama discredits Progressivism like Bush/Cheney did to Conservatism.
Using an existing model which has succeeded is appealing and reasonable. Any alternative might look worse. However, the part of this which has worked is not in the CDS market and the part of this which is most scary IS the CDS part. So, cross your fingers, don’t bet on it, keep watching it closely for cracks, escaping steam & such and be ready to step in with large wrenches to fix it at the first signs of problems.
That might be an amazing funny magazine article to read: “How NOT to get hired by Wall Street by knowing too much”.
A simpler but slower way is to set a date from whence there shall be no more CDSs. Then let all the existing ones proceed to be executed or fizzle until there are none left.
LOL What a hoot. Are they both goth? Do they enjoy the dark humor of that originating circumstance of their relationship? What a story to tell.
All of my aunts are old. None are new.
*snort* ;-P