Credit Default Swaps, Idiots in Congress, Enron and Phil Gramm

[Gardnr]

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Originally Posted by ERD50 This is the main reason I am on such a "less government" kick. All Congress bashing aside, even if every Congressperson was a certified genius, they simply cannot have expertise in all the areas that they are now involved in. Just look at the detail level of the bills in Congress. It is insane. T-Al pointed out a while back (this was a CA bill, but the idea holds), about how the bill banning incandescent bulbs had exceptions for all these specific types of bulbs, right down to the number of standoffs holding the filament, technical restrictions on the filament, bulb base size, etc, etc, etc. How many CA congress members are conversant in light bulb design? Why are they voting on these issues? Why are they taking the time to get them written into legalese and debate them? Insane. BTW, that does not mean I think they should ignore important issues, but I think any laws should address issues at a high level, not the micro-management level. In the example of the incandescent light bulb ban - if it really is in the "common good" for people to conserve electricity, raise the taxes on it, and let the free market figure out what kind of light bulbs to design, plus a million other ideas that could save electricity - more than any legislatures could come up with in a law. -ERD50

Amen. All this type of lawmaking does is to allow all kinds of different parties get their own little agendas served and result in untold numbers of unintended consequences. It's absurd and makes things endlessly complicated and almost impossible to understand; for congress and average citizens.

[ERD50]

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Originally Posted by Gardnr Amen. All this type of lawmaking does is to allow all kinds of different parties get their own little agendas served and result in untold numbers of unintended consequences. It's absurd and makes things endlessly complicated and almost impossible to understand; for congress and average citizens.

Plus, if they got out of the micro-management business, they could actually devote that time to things that *do* need their attention. There is no shortage of those.

-ERD50

[. . . Yrs to Go]

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Originally Posted by clifp I am not as optimistic as you that with Democrats firmly in control, everybody running for cover, plus Congress attempting to pass blame,that your sensible solution will come to pass.

Nope, rest assured this, or something like it, will come to pass. The Fed has given the CME until this Friday to come up with a proposal on how to implement a transition to an exchange. This is a pretty high priority for the Fed.

[. . . Yrs to Go]

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Originally Posted by ERD50 This is the main reason I am on such a "less government" kick.

But in the case of CDS it was a failure caused by a lack of government intervention. The original idea was that the government shouldn't get involved in bi-lateral contracts between sophisticated institutions (which is what Credit Default Swaps are). Sounds very reasonable and something I certainly would have supported at the time.

The problem was that these "sophisticated" institutions did a lousy job of managing their counterparty exposure to one another and allowed massive systemic risk to build in the system. Everyone assumed that market driven survival instincts would make sure everyone managed their own liabilities. Unfortunately, it didn't happen that way. Which is one of the things Allan Greenspan issued a mea culpa over.

The beauty of an exchange based system is that every contract is cleared through a single counterparty so that every short is matched off against its long. Daily collateral postings for any net liabilities keeps credit risk to a minimum.

The reason it wasn't set up this way to begin with was because financial institutions prefer the less transparent over-the-counter market. There is huge money to be made by broker dealers in markets where they have an information advantage. It was good for them while it lasted (or so they thought).

Had government mandated that these products be traded on an exchange from the very beginning, this part of the problem would have been averted.

[ERD50]

Yrs_to_go - sorry I have not replied yet to your earlier post. My reply got very wordy, and I tried to find a way to cut it down, and then got off on other things, anyway....

I agree (from what I know) that an exchange trade would bring more transparency, I think that would a good thing.

And I only have a minute now, but I think the problems with the CDS's were that there was some of that implicit govt guarantee in there, which distorted the risk. So the companies traded them with a distorted view of the risk. That's what I'm getting from this.

True that companies will *ask* for special treatment that is advantageous to them. It is the govt responsibility to say NO when that is best. Just like kids ask for candy before dinner.

-ERD50

[FIRE'd@51]

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Originally Posted by . . . Yrs to Go Had government mandated that these products be traded on an exchange from the very beginning, this part of the problem would have been averted.

Won't there still be an over-the-counter market for these products even if they have an exchange? There's a futures market for currencies, but its volume is dwarfed by over-the-counter transactions.

I agree that the idea of a central exchange with contract matching and variation margin is a good thing (in the case of CDS it also will provide transparent prices), but so long as there continues to be a large over-the-counter market running in parallel, it seems to me that much of the potential for systemic risk will remain.

[. . . Yrs to Go]

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Originally Posted by ERD50 And I only have a minute now, but I think the problems with the CDS's were that there was some of that implicit govt guarantee in there, which distorted the risk.

I never heard this before. CDS really has nothing directly to do with the whole housing mess (Fannie, Freddie, and all). And to my knowledge the government was never involved in the Credit Default Swap market (at least before the credit crisis). CDS is just another way to trade credit risk. It's very similar to buying or selling a bond on margin. It doesn't really serve any purpose the government would be interested in.

[. . . Yrs to Go]

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Originally Posted by FIRE'd@51 Won't there still be an over-the-counter market for these products even if they have an exchange?

I'm not sure precisely how they're going to go about it. I'm not even sure the Fed knows at this point (they are still asking for proposals). But there was talk of requiring broker dealers to use a centralized counterparty and clearing organization. I don't know to what extent they'd still have the ability to do over the counter trades along side the exchange.

[samclem]

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Originally Posted by . . . Yrs to Go . . . CDS really has nothing directly to do with the whole housing mess (Fannie, Freddie, and all).

I'm not sure why you say this. The CDSs were key to keeping the whole game, at least on the private side, in operation. The CDS's facilitated the bundling of very risky mortgages into more marketable securities by allowing the risk of default to be sold (often to buyers who knew little about what they were getting)
The link to the GSEs is not direct, but it is present. While the private side was bundling and selling this junk (for high profit--as long as home prices kept going up), Fannie and Freddie were also engaged in the subprime business (encouraging and buying loans that had no busines being written). This was a conscious decison pushed by (mostly liberal) legislators. Maybe they did it for the "social good." Or maybe they did it for other reasons (the top recipients of GSE campaign contributions werre Chris Dodd, John Kerry, Barrack Obama, and Hilary Clinton). (link to source)
There was a "race to the bottom", with the private lenders in competiton with the GSEs for clients--regardless of abilty to actually repay the loans.
The difference: At least on paper, the private players (banks, mortgage lenders, brokers for the resulting securities, those who bought the contracts) were gambling with their own money, and there's no real argument against people doing dumb things with their own money (unless they later go to the taxpayer and ask for a bailout. Who knew they'd have the gaul to ask? Who knew our government would be foolish enough to actually do it?).
On the other hand, the GSEs were gambling with at least an implicit backing of our tax dollars. That's a horse of a different color. Moreover, the involvement of US-government-linked entities in the subprime mortgage business provided a veneer of respectabilty to the enterprise that it had lacked before. Private subprime lenders had always been there in the past, but the business was vaguelly disreputable, ranking only one notch above payday lenders and pawn shops. Once the government-linked entities started writing loans to the same clients, it became much easier to sell the private products backed by the same "quality" loans.

Just my take. I didn't sleep in a Holiday Inn Express last night.

[Independent]

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Originally Posted by audreyh1 It seems to me that it was really the excessive leverage that made all of this so risky. Yes, the other stuff was a mess too. But if there hadn't been such extreme leverage, perhaps the rest of the mess would have been survivable without causing a collapse of the financial system?

I'll agree with this. Yes, people who bought houses with 0% down had "too much leverage". They lost and their lenders lost. But that wouldn't have threatened the "collapse of the financial system" if financial institutions had carried enough capital to weather the storm.

Of course the problem is in defining "enough". I think that our normal practice of regulating commercial banks and insurance companies errs on the safe side. That seems reasonable, given the magnitude of the disaster that we're told can occur if we err on the other side.

[chinaco]

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Originally Posted by ERD50 This is the main reason I am on such a "less government" kick. All Congress bashing aside, even if every Congressperson was a certified genius, they simply cannot have expertise in all the areas that they are now involved in. Just look at the detail level of the bills in Congress. It is insane. T-Al pointed out a while back (this was a CA bill, but the idea holds), about how the bill banning incandescent bulbs had exceptions for all these specific types of bulbs, right down to the number of standoffs holding the filament, technical restrictions on the filament, bulb base size, etc, etc, etc. How many CA congress members are conversant in light bulb design? Why are they voting on these issues? Why are they taking the time to get them written into legalese and debate them? Insane. BTW, that does not mean I think they should ignore important issues, but I think any laws should address issues at a high level, not the micro-management level. In the example of the incandescent light bulb ban - if it really is in the "common good" for people to conserve electricity, raise the taxes on it, and let the free market figure out what kind of light bulbs to design, plus a million other ideas that could save electricity - more than any legislatures could come up with in a law. -ERD50

Well... apparently things have to be ruined every 75 to 100 years to remind our politician that people and their behaviors do not change. If you let people have the opportunity to take huge risks... they will (at everyone elses expense).

Most of the legislators took it on faith because certain (experts) said it was the way to go.

But there are a couple of key villains in this story. Phill Gramm is one of them. He was lobbied... then he pushed and shoved some of this cr@p in the bill. After that he and his wife took jobs in the very industries that benefited. I am sure there are a couple of other congressmen and senators that sold us out.

I do not want to over simplify or generalize... but it seems to me that we continue to get scr3wed and ripped off in the securities markets by the financial institutions (hedge funds, etc.) that manipulate the market. Then once our money is essentially gone because they ruined the thing... they turn to congress and the administrtation for a bailout and we have a huge tax bill....

This is why strict regulation is needed. Otherwise we will continue to be screwed by the hucksters. People can scream about big government all they want... and it is certainly imperfect. But who else will protect us from the these situations? Some people get on their high horse and pontificate about free markets and "let the market handle it"... but the fact is that the securites markets, credit markets, the economy and our savings are all interlinked. And there are a bunch of clever people that take advantage of us. The field is not level! We are getting scr3wed.

[ERD50]

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Originally Posted by chinaco This is why strict regulation is needed. Otherwise we will continue to be screwed by the hucksters. People can scream about big government all they want... and it is certainly imperfect. But who else will protect us from the these situations? Some people get on their high horse and pontificate about free markets and "let the market handle it"... but the fact is that the securites markets, credit markets, the economy and our savings are all interlinked. And there are a bunch of clever people that take advantage of us. The field is not level! We are getting scr3wed.

Chinaco, this is a total straw-man argument.

First, just because I believe that govt is too involved, and involved in the wrong ways, does not mean that I am in favor of a "wild west" scenario. There *are* degrees to this thing, and if *that* is your argument against a more free market, it is flawed and weak, weak, weak.

I'm tired of having the the "if you believe in less govt, you must believe in NO govt" words put in my mouth.

And, we were screwed by the people that made the regulations.

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Well... apparently things have to be ruined every 75 to 100 years to remind our politician that people and their behaviors do not change. If you let people have the opportunity to take huge risks... they will (at everyone elses expense).

Exactly, and it was the govt that helped people take big risks. So how do we rely on them to "protect us" - see samclem's post above for the background.

Maybe later, if I have time, I may start a thread along the lines of "How should the govt regulate markets?" That would be in a positive, what should we do, constructive, maybe educational mode, rather than this mode of blaming a favorite target of whoever is posting.

-ERD50

[chinaco]

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Originally Posted by ERD50 Chinaco, this is a total straw-man argument. First, just because I believe that govt is too involved, and involved in the wrong ways, does not mean that I am in favor of a "wild west" scenario. There *are* degrees to this thing, and if *that* is your argument against a more free market, it is flawed and weak, weak, weak. I'm tired of having the the "if you believe in less govt, you must believe in NO govt" words put in my mouth. And, we were screwed by the people that made the regulations. Exactly, and it was the govt that helped people take big risks. So how do we rely on them to "protect us" - see samclem's post above for the background. Maybe later, if I have time, I may start a thread along the lines of "How should the govt regulate markets?" That would be in a positive, what should we do, constructive, maybe educational mode, rather than this mode of blaming a favorite target of whoever is posting. -ERD50

Sorry ERD?? I had no way of knowing you were a Phil Gramm booster.

Lighten up! I was not criticizing you... just your buddy Phil.

[youbet]

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Originally Posted by chinaco This is why strict regulation is needed.

So, based on your post above and what you've said in other threads, you're a fan of extreme levels of gov't regulation. What do you have in mind? Still want to be able to chose where you live? Whether to breed or not? What to plan for dinner? Whether a child must be aborted or not?

If you're just talking finances, would you like to see a much simpler tax code that is fiercely enforced? Or a complicated tax code that is hardly enforced? If you want strict regulations on banking and financial institutions, what do you have in mind beyond what we currently have? What social adgendas should all these regulations support? Who should benefit? Who should suffer?

Etc etc

It's easy to scream for "strict regulation." It's a little more challenging to call out what you have in mind.

[ERD50]

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Originally Posted by chinaco Sorry ERD?? I had no way of knowing you were a Phil Gramm booster. Lighten up! I was not criticizing you... just your buddy Phil.

Not a Phil Gramm booster, but I *will* take your advice to lighten up.

I guess I've gotten worked up responding to what seems like a rash of these posts that seem to be calling for "regulation", and I'm just getting very tired of the idea that I can't be allowed to decide for myself what is best for myself, and that I need to pay the govt to figure it out for others, too.

I saw youbet's post after I logged in - that would be a good start - describe how this would work - and no cherry picking - if I can't figure out what mortgage is best for me, how can I figure out which car, or which TV, which investment, etc, etc, etc. So give me a big picture plan. I have some ideas, but I'll sit back for a while, relax, and listen.

Thanks, ERD50

[chinaco]

Oh... I see. Now you expect me to provide substance... that's a little unfair!


I want a level playing field for the average person. I would like regs that keep the iresponsible fat cats and institutions from manipulating things politically, in the markets, and in businesses... to the degree that it harm us. What ever it takes.

Are you thinking that everything is OK. Let them keep doing what they have been doing?

Heck they darn near ruined all of us (40% losses... and it may not be over). They wrecked the market and economy. Then they come begging for almost a trillion USD to bail out the offenders (which we will pay in taxes). We of course are compelled to comply or risk of losing everything.

PG is the symbol of a bought and paid for legislator that sold out America and took the rewards for doing so.

Yes stricter regulation is needed. How much and in what areas is to be determined. They are sorting it out right now.

[ERD50]

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Originally Posted by chinaco Oh... I see. Now you expect me to provide substance... that's a little unfair! I want a level playing field for the average person. I would like regs that keep the iresponsible fat cats and institutions from manipulating things politically, in the markets, and in businesses... to the degree that it harm us. What ever it takes.

Thanks for taking up the challenge, that's a fine wish list of results, but not a plan to get there.

What I'm asking is - HOW do you regulate the "irresponsible fat cats and institutions" w/o also hurting the good guys? And also w/o taking choices away from responsible people.

lightly yours, -ERD50

[. . . Yrs to Go]

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Originally Posted by samclem I'm not sure why you say this. The CDSs were key to keeping the whole game, at least on the private side, in operation. The CDS's facilitated the bundling of very risky mortgages into more marketable securities by allowing the risk of default to be sold (often to buyers who knew little about what they were getting)

This is simply not true. It was through the subordination of equity tranches that allowed large chucks of sub-prime mortgages to gain high ratings and, thus, marketability to the masses. CDS had nothing to do with it.

The CDS portfolios that have been problems (at AIG, Lehman, Bear, etc) were all written against corporate bond issues . . . and mostly investment grade issues at that. The government had nothing to do with any of this.

Free and completely unregulated markets screwed this one up all on their own (and then needed worldwide government intervention to save the free markets from their own excesses) - it does happen, you know?

[chinaco]

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Originally Posted by ERD50 Thanks for taking up the challenge, that's a fine wish list of results, but not a plan to get there. What I'm asking is - HOW do you regulate the "irresponsible fat cats and institutions" w/o also hurting the good guys? And also w/o taking choices away from responsible people. lightly yours, -ERD50

Hey... we probably have some common ground. There are some @$$h0les that have caused us harm... wreckless behavior that negatively affects us over and over again. Let's figure out a way to snuff them out... naturally no one is interested in constraining responsible people.

But even responsible people make mistakes. A certain level of regulation is needed just to paint the stripes on the road, so to speak. "Stay withing the lines." A good example (and I think it is universally agreed upon now)... those CDS derivatives that have been oversold with inadequate reserves and used as speculative side bets (by people who do not own the securities)... have caused many of us great harm.

Do you think there is some regulation needed there? You can see where a certain number of those corporations have harmed us. Or is that going to unreasonably constrain the good guys?

[ERD50]

Thanks chinaco, but I'm still looking for the "big picture".

Even if you come up with a good set of "white lines" for CDS derivatives, that leaves an infinite number of possibilities for other scams. I've said it before, the scammers can react faster than the law. Make a law and find a way to enforce it, the scammers move on to greener pastures.

I'll throw out one idea along those lines though, and this is barely thought out, just running it up the flag pole, before finishing my first cup of coffee, so take it FWIW -

Maybe we need some regulation such that ANY use of margin or leverage includes some standardized disclosure of the risk. With examples that anyone could understand. And yes, this would include home mortgages. I find it simply amazing that a pretty large % of the population could probably point to the use of 10:1 margin in the stock market in the 1920's as one of the causes of the Great Depression (or at least understand it when explained to them), but most of those people wouldn't think of their 10% down home mortgage as being in a similar class.

We didn't learn from the GD, we just moved the problem from high leverage stock investments (which hurt people when the bubble burst) to high leverage house investments (which hurt people when the bubble burst).

-ERD50