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Old 10-24-2009, 01:22 PM   #41
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To watch Frontline's The Warning:
FRONTLINE: home | PBS

More on this story:

The Born Prophecy | ABA Journal - Law News Now

Shortly after she was named to head the Commodity Futures Trading Commission in 1996, Brooksley E. Born was invited to lunch by Federal Reserve Chairman Alan Greenspan.


The
influential Greenspan was an ardent proponent of unfettered markets. Born was a powerful Washington, D.C., lawyer with a track record for activ*ist causes. Over lunch in his private dining room at the stately headquarters of the Fed in Washington, Green*span probed their differences.

“Well, Brooksley, I guess you and I will never agree about fraud,” Born, in a recent interview, remembers Greenspan saying.

“What is there not to agree on?” Born says she replied.

Shortly after she was named to head the Commodity Futures Trading Commission in 1996, Brooksley E. Born was invited to lunch by Federal Reserve Chairman Alan Greenspan.

The influential Greenspan was an ardent proponent of unfettered markets. Born was a powerful Washington, D.C., lawyer with a track record for activ*ist causes. Over lunch in his private dining room at the stately headquarters of the Fed in Washington, Green*span probed their differences.

“Well, Brooksley, I guess you and I will never agree about fraud,” Born, in a recent interview, remembers Greenspan saying.

“What is there not to agree on?” Born says she replied.

“Well, you probably will always believe there should be laws against fraud, and I don’t think there is any need for a law against fraud,” she recalls him saying. Greenspan, Born says, believed the market would take care of itself.

The debate came to a head April 21, 1998. during a Treasury Department meeting of a presidential working group that included Born and the other top regulators, Greenspan and Rubin took turns attempting to change her mind. Rubin took the lead, she recalls.

"I was told by the secretary of the Treasury that the CFTC had no jurisdiction and, for that reason and that reason alone, we should not go forward,” Born says. “I told him ... that I had never heard anyone assert that we didn’t have statutory jurisdiction ... and I would be happy to see the legal analysis he was basing his position on.”

She says she was never supplied one. “They didn’t have one because it was not a legitimate legal position," Born says.


At congressional hearings that summer, Greenspan and others warned of dire consequences;Born and the CFTC were cast as loose cannons.

Reverting to a theme Born claims he raised at their earlier lunch, Greenspan testified there was no need for government oversight because the derivatives market involved Wall Street “professionals” who could patrol themselves.


To be totally fair to poor Alan he did refute this in the same article:

"He says Born’s characterization of the lunch conversation she recounted does not accurately describe his position on addressing fraud. “This alleged conversation is wholly at variance with my decades-long-held view,” he says, citing an excerpt from his 2007 book, The Age of Turbulence, in which he wrote that more government involvement was needed to root out fraud. Born stands by her story."
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Old 10-24-2009, 02:09 PM   #42
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Yes.

But part of the confusion is that you can have multiple insurance contracts written on the same asset. I don't need to own the asset to "insure" it. Often times I don't. So there is no limit to how many CDS contracts can be written against an individual security. And then no limit to how many contracts can be written against the unlimited number of synthetic securities that may have been created in reference to the 1st security.
but if you dont own said asset and you "insure" it arent you just "betting" on said asset? sounds alot like vegas
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Old 10-24-2009, 02:20 PM   #43
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but if you dont own said asset and you "insure" it arent you just "betting" on said asset? sounds alot like vegas
They can be for both investments and speculation. Same thing with non-derivative instruments.
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Old 10-24-2009, 08:35 PM   #44
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but if you dont own said asset and you "insure" it arent you just "betting" on said asset? sounds alot like vegas
No different than with futures, options and interest rate swaps, all of which are extremely plain-vanilla and the first two are exchange-traded (thus theoretically eliminating much of the counterparty risk). There is nothing especially exotic about CDS contracts except that they are not exchange-traded and loosely regulated (at least in the past).
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Old 10-25-2009, 09:50 AM   #45
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I watched the Frontline piece. The main characters are Born vs. Greenspan/Rubin/Summers.

Summers accused Born of threatening to destroy the economy, as the markets were booming.

They said Greenspan got personally mad, fuming, flustered, etc.

They basically went to Congress, who didn't know other than to take the word of Greenspan, Rubin and Summers. There was 90% support to go against Born.

I don't recall if they touch on the fact that shortly thereafter, they pushed through the Commodity Futures Modernization Act.

They do note that many of the CFTC's proposals from '98 are being incorporated in financial regulations reform being considered now in Congress. However, these reform bills are stalled, with accusations that Wall Street (the financial services lobby) wielding a lot of influence.
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Old 10-25-2009, 11:08 AM   #46
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I watched the Frontline piece. The main characters are Born vs. Greenspan/Rubin/Summers.
It pisses me off that Rubin and Summers are a part of the current administration. Fire them and hire Brooksley.
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Old 10-25-2009, 01:07 PM   #47
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Does the (continued) failure to accurately rate bonds argue in favor of actively managed bond funds instead of indexes? Seems it might be worth a little in annual expense ratio if there's a real human who takes an interest in actually studying the bonds objectively before adding them to the portfolio.
Not according to S&P's index performance studies . . .

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The five-year data is unequivocal for fixed income funds. Across all categories except emerging market debt, more than three-fourths of active managers have failed to beat fixed income benchmarks.
http://www2.standardandpoors.com/spf...09_Midyear.pdf

Some categories have close to 100% of active managers underperforming . . . Government Long Funds 97.6%, Investment Grade Long 92.38%, IG short 96.55%, High Yield 88.2% . . .

Probably the result of active manager yield chasing into a nasty bear market.
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Old 10-26-2009, 03:00 PM   #48
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Not really.

The index holds all bonds by market weight, just like the S&P 500. Ratings don't really matter except for the distinction between "Investment Grade" and "High Yield", which is based on ratings.

A lot of actively managed funds rely heavily on the rating agencies and will simply buy bonds that are "cheap for the rating". Many fixed income shops are very thinly staffed and don't have the resources to do detailed credit work (although there are exceptions Fidelity, Loomis, PIMCo, etc).

The sad truth is that a staggeringly large number of places have outsourced credit analysis to the rating agencies. I've seen entire pension funds managed by two guys. Why bother? I've long thought the market would be better off if the rating agencies didn't exist.
So, should an investor even by in this game? The rating agencies have proven to be incompetent and in bed with those they rate (and who pay their bills). Those ratings should be the first rough cut at assessing the riskiness of the bonds. Then, the various big buyers of bonds (mutual funds, pension funds, etc) should be doing their own research--but you say this isn't happening. And doing adequate research is probably beyond the capabilities of an individual looking to purchase $50K to $500K of bonds for his/her own portfolio.

Without a sufficient number of informed, active buyers looking for values (best return for a given level of risk) the whole premise of indexing is undermined.

So, if the game is a mess and lacking an efficient market that would at least link risk to expected return, is it more logical for individual investors to refuse to play? Maybe stick with government fixed income?
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Old 10-26-2009, 04:23 PM   #49
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So, should an investor even by in this game? The rating agencies have proven to be incompetent and in bed with those they rate (and who pay their bills). Those ratings should be the first rough cut at assessing the riskiness of the bonds. Then, the various big buyers of bonds (mutual funds, pension funds, etc) should be doing their own research--but you say this isn't happening. And doing adequate research is probably beyond the capabilities of an individual looking to purchase $50K to $500K of bonds for his/her own portfolio.

Without a sufficient number of informed, active buyers looking for values (best return for a given level of risk) the whole premise of indexing is undermined.

So, if the game is a mess and lacking an efficient market that would at least link risk to expected return, is it more logical for individual investors to refuse to play? Maybe stick with government fixed income?
Actually, I think that the credit markets are mostly efficiently priced. Despite the apparent abdication of their fiduciary duty, pension funds are not the only ones active in the markets. There are plenty of shops that are perfectly capable of doing credit work and scarfing up the inefficiently priced stuff (think PIMCO, Dodge & Cox, the people who run Wellington, many hedge funds, etc.). Aside from when the bond market is in total disarray (for a few months earlier this year), it is hard to make outsized excess returns on credit. The high % of active fixed income managers that fail to beat the indices posted by Saluki bears this out.
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Old 10-26-2009, 04:38 PM   #50
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It was the collateralized mortgage debt that was so improperly rated. Right?

Audrey
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Old 10-26-2009, 04:49 PM   #51
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It was the collateralized mortgage debt that was so improperly rated. Right?

Audrey
I don't think the "regular" corporate bonds were immune either. Should GE bonds really have been AAA in early Mar 2009?
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Old 10-26-2009, 08:30 PM   #52
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I don't think the "regular" corporate bonds were immune either. Should GE bonds really have been AAA in early Mar 2009?
The agencies' track records on corporate bonds are actually quite good. Sure we can pick out some major misses, like Enron. But over the past 100 years default studies show pretty consistently that Aaa corporate bonds default less than Aa's which default less than A's, etc. What this proves is that credit analysis works and that the rating agencies actually know how to evaluate corporate credit. That's not to say that every rating is correct. But on average they are pretty accurate.

But remember, that credit analysis is built upon years of cumulative experience regarding how much leverage specific industries have historically been able to support. When that history is robust, as is the case with most corporates, the analysis is good and so, probably, are the ratings (on average).

Where the rating agencies fall down, typically, is when they are asked to rate something new. It's pretty difficult to look at a financial product that has never existed before and grade how likely it is to default. The rating agencies have proven absolutely horrible at doing this.
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Old 10-27-2009, 09:52 AM   #53
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Couple of thoughts:

Put your faith in man or money and you will always be disappointed.

The current financial situation was/is caused by the same feeding at the trough mentality that is killing our society. Doesn’t matter if you're talking about food, finances, etc...

My $.02 worth
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Old 10-27-2009, 10:07 AM   #54
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Yes.

The "beauty" of derivatives is that they are not bound by any physical constraint. In order to create a Residential Mortgage Backed Security (RMBS) I need a pool of residential mortgages. So the size of the RMBS market is constrained by the size of the mortgage market. But once I have one RMBS security outstanding I can create as many "synthetic" RMBS securities as the market will bear, all of which use the same pool of assets as a reference point (and perversely enough, the "raw material" for the synthetic RMBS are the other side of CDS contracts from people who want to bet against the original RMBS. Neat huh?)

These synthetic transactions have the effect of magnifying the loss potential of a single default. So while in the real world, only the actual lenders lose money when a mortgage defaults, in the synthetic world all of those who own securities referencing that mortgage can lose too. So $1 lent can yield more than $1 in loses. Of course in the synthetic world someone else stands on the other side as a winner so gains and losses even out in aggregate . . . that is, of course, as long as the losing party stays solvent. Oops.

And there you have a recipe for cascading bankruptcy as defaulting "losers" wipe out the assets of the "winners".
Thanks for the entire series of responses. I'm just getting caught up today.

I'm also trying to think this through more, but right now it seems like a simple bet on whether a mortgage neither bettor owns will pay on time.

I've had a business need for interest rate swaps, but we were hedging a real risk we already had, so we were reducing our total volatility.

I have trouble seeing a hedging purpose for both sides of this mortgage default swap. Is there one? Or is one side always assuming increased total volatility?
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