And speaking of Henry Blodget and Clusterstock, he brings us this report:
Credit default swaps are “instruments of destruction” that should be outlawed, billionaire investor George Soros said on Friday.
Soros said the asymmetry of risk and reward embedded in CDS exerted so much downward pressure on the bonds underlying the contracts that companies and financial institutions could be brought to their knees.
“Some derivatives ought not to be allowed to be traded at all. I have in mind credit default swaps. The more I’ve heard about them, the more I’ve realised they’re truly toxic,” he told a banking conference.
I’m still waiting for my check and 72 virgins, George.
At any rate, I’m inclined to think Soros is right, although I’m sure there are a bunch of you who could explain how they truly could be useful tools. And while I am at it, I should probably note that while I take potshots at Clusterstock a lot, I really do like their website. I kind of have the same sort of love-hate relationship with it that I have with the TNR. Sometimes I think their stuff is really good, sometimes I think it is just horrid. Jonathon Chait is the classic example at TNR- when he is good, he is superb. When I think he is bad, I just think he is atrocious.
Maybe that is what makes them compelling websites and authors to read. I think one of my biggest flaws as a blogger and flaws with this website is that we spend an inordinate amount of time pointing out when I think the media does shoddy work. I’ve had caustic things to say about a lot of journalists, but then I rarely spend equal time highlighting their good work. I trashed Jake Tapper mercilessly for what I think was some hackworthy stuff, but if you watch his blurbs on the ABC Nightly News, which I have been doing, they are actually very good a lot of the time. In short, we’re heavy on the criticism, short on the praise, and then kvetch about a lack of balance in the media. In other words, we’re hypocrites.
The nature of the blogging beast.
burnspbesq
I respectfully disagree with Mr. Soros.
I think you can clean up CDS abuses with two simple rule. First, you can’t own a CDS unless you also own debt securities of the company whose credit events trigger a payout. Second, you can’t write a CDS unless you have capital set aside that would be considered sufficient capital and surplus if you were an insurance company and the CDS was considered an insurance policy (or you immediately cede the risk to a third party who satisfied the capital requirements).
The legitimate use of CDSs is as a form of insurance, so let’s regulate them as though they were insurance. This seems like a no-brainer to me.
DougJ
I don’t bloggers are heavy on the criticism, but they are light on the praise. But I think part of the reason is that it just seems gratuitous and obsequious to say “this great Times article” instead of just “from the Times”. In fact, I think that’s the main reason.
geg6
I admit that I am very ignorant in these discussions of the instruments of the financial markets. I can only use my common sense and the small knowledge that my job provides me in assessing the financial health and ability of my students and their families, a micro view of effect rather than a macro view, which is required to discuss things like CDSs. But if they were a large factor in what has happened over the past few years to create our current economic disaster, if they can have the effects on real people that I am currently witnessing every day, and if Soros, a person whose judgment I generally trust, says he thinks they are more bad than good, I gotta say I agree. Perhaps there’s a way to make them work properly that I haven’t heard or understood, but I have to believe Soros knows all the arguments and still has come to this conclusion.
burnspbesq
Oh. My. Goodness.
The strange alien life force that occasionally takes over David Brooks’ body and causes him to think rationally has returned.
http://www.nytimes.com/2009/06/12/opinion/12brooks.html?_r=1
Someone much smarter, and also more cynical, than me once said that the United States would have a VAT as soon as Democrats figured out how much money it could raise and Republicans figured out how regressive it is. I guess this is one small step toward that goal.
lutton
here’s an interesting story on CDS where a ‘little’ firm (can you really be little when you’re dealing with $130 Million in CDS) pulled a fast one on some of the Wall Street Titans:
http://www.econbrowser.com/archives/2009/06/how_to_lose_on.html
a fun read if you have a minute or two…
burnspbesq
@lutton:
Gotta love it when the guys who get rich by gaming the system, get gamed.
That is extremely funny. Thanks for making my morning!
The Grand Panjandrum
@burnspbesq: I’ll second that approach.
This are insurance policies not so cleverly disguised as hedging instruments. We would never allow an insurance company to be as under capitalized as AIG is with the CDS’s.
And as far as praising the establishment media, i.e. the Villagers? Fuggedaboutit. They have enough ego to withstand any criticism coming from the blogosphere. If anything they should be treated like the proverbial red-headed step child and beat down regularly. The reationale? Just, because. When they give up doing reach arounds for DC insiders to gain access I’ll consider changing my mind, but until then they get the smack down at every opportunity provided. It should be enough they don’t get their testicles crushed in a vice when they do a good job. That should be the reward. They don’t fuck up, we don’t fuck them up.
Comrade Stuck
Whatever this is all about, a simple common sense rule should apply imo. You can’t gamble with other peoples money without their express permission. The best form of risk management, seems to me.
Punchy
Yeah, and I’m still waiting for my 72 virgin Cheqs
JGabriel
John Cole @ Top:
burnspbesq:
That was quick. Ok, I’m gonna disagree with Burnspbesq even though I know jackshit about financial markets, because that’s never stopped me before.
The problem, I think, is the treating of the CDSs like insurance. To be honest, I’m not even sure banks should be permitted to insure their home loans at all. It encourages banks to treat loans like a win/win situation and neglect due diligence, because they still collect on the loan even if the borrower defaults – which is partly how we got into this mess.
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Comrade Stuck
You are on a waiting list. Virgins in America don’t exactly grow on trees.
Though checks do if you are a bank.
blogenfreude
Nassim Nicholas Taleb wants them banned because we don’t understand them, our ability to predict the future in this regard is nearly non-existent because we rely on the past for our prediction. I agree.
Face
Ficksed
JGabriel
David Brooks (approvingly quoted by burnspbesq):
Given the state of economy, wouldn’t that be a really bad idea? I mean, we want to encourage consumer spending right now, don’t we?
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JL
@Comrade Stuck: I don’t know, I live in the south and we have born again virgins. Do they count?
@burnspbesq:
What seems like a no-brainer to you won’t happen unless Obama really is a god like Rush says.
The Grand Panjandrum
@lutton: Oh man! That was great. This sort of thing happens all the time in equity option markets, but I can’t remember it happening in this market. Sweet. They got schooled by a small firm in Austin, Texas. These big players have been coddeled by the Fed for so long they’ve forgotten how to think on their feet. I guess the big dogs were expecting these guys to get up off the porch, eh?
burnspbesq
@JGabriel:
If your concern is that banks don’t have to care about credit quality if they can shift the risk of loss, and therefore underwriting standards have gone to hell (a concern that I share, FWIW), not allowing them to insure against default risk only gets you part of the way to where you want to be. You would also have to shut down the secondary market, of which securitization is only one part, and basically tell the banks that if they originate it, they have to hold it to maturity. Which would suck a lot of liquidity out of the system and make it more difficult for moderate-income people to get a home loan. You may consider that a good outcome, or you may not.
JL
@JGabriel: Yeah, that would be a really bad idea now. Several friends are supply siders and I asked a question. I’m not an economist and I don’t even pretend to be. I simply wanted to know at what time in history did supply side help the middle class?
I always wanted to address that question to Bush.
JGabriel
Smaller financial company screws over the big ones by doing the obvious ( via Econobrowser (via lutton)):
I think that further validates everyone’s suspicions that the CEO’s of those companies are way overpaid and should be tossed out on their asses.
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burnspbesq
@JGabriel:
There are perfectly respectable arguments that putting in a VAT now would be a bad idea. But at some point we have to put our fiscal house in order, and we can’t raise enough revenue to pay for all the things we claim we want, and pay down the deficit, if income taxes are our only source of revenue.
The Irish model (low corporate income tax for competitiveness’ sake and a VAT to make up the revenue) works extremely well under all but terribly abnormal economic conditions.
JGabriel
burnspbesq:
Sure we can; let’s start by raising marginal tax rates on income over $10 million/year to 75%.
burnspbesq:
Oh. You mean we can’t do it while our reigning taxation philosophy is comfort the comfortable and screw the middle class. I’m actually ok with us changing that philosophy, though I understand it carries political risks.
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Irrelevant,YetPoignant
The complaints over a lack of balance is, I believe, a separate issue from failing to point out when our favorite journalistic foils actually do their job well and accomplish decent reportage. They’re supposed to do their job decently well: it’s only remarkable (i.e., worth remarking on) when they fail to do so. Twenty inoffensive NYT articles reporting on Sri Lanka (or whatever) is outweighed by one Miller piece that distorts or contradicts reality from this perspective – you are not cheerleaders (“Hooray! The Indonesian desk of the WaPo filed their reports today, and the dispatches contain helpful information that edifies the situation for us!”) but, rather, necessary critics (“Hey, now! The local reporting on the judicial reforms in the district court got several facts wrong; here is the correct information at this link. Shame, shame on these journalists!”).
The watchword here is “keep ’em honest,” not “fire them all and replace them with bloggers!” The blogosphere serves us best, I believe, a corrective on journalistic media, not as a replacement.
[‘Tho I do think you’ve been a l’il too harsh on Tapper. His recent interview with Boumediene, for example, was both highly professional and very admirable, so he may deserve a little breathing room for a the next month or so. Then hound him! Hound him with all your might!]
burnspbesq
@JGabriel:
I get the visceral attractiveness of that, but it doesn’t raise very much revenue. That slice of the income distribution is really thin; my guess is that it’s no more than a couple of thousand athletes, entertainers, CEOs (not all CEOs are paid exorbitantly), and hedge fund guys.
So you could raise a few billion by doing that. “Is it worth the political shit-storm?” is the question.
PeakVT
Given the state of economy, wouldn’t that be a really bad idea? I mean, we want to encourage consumer spending right now, don’t we?
Sorta. We don’t want consumption to fall off a cliff. But over the medium term (3-10 years) consumption needs to fall by about 7% of GDP, or $1T a year. A picture to help explain why is here.
Shygetz
Errr, isn’t Ireland in dire financial straits, considerably worse than most of the Western world?
While this may be a stretch of an analogy, I grew up in a state that had no income tax, only a consumption tax. Every year the state budget was a struggle, as consumer confidence seemed to be much more volatile than income. My original home state STILL doesn’t have an income tax, even after multiple career politicians threw themselves on their swords and positively begged their constituents to allow an income tax. How’s good ole’ Tennessee doing now? You be the judge.
Tying a larger chunk of our revenue to a consumption tax is, IMO, a very bad idea.
JGabriel
burnspbesq:
It was an example – we can also raise marginal rates to 40% at 500k/yr and 50% at 1m/yr. I suspect that would probably be worth a lot more than a few billion a year, though I could be wrong.
And yes, I think it would be worth the political shitstorm. On the other hand, it’s understandable, if disappointing, that a lot of politicians would not.
ETA: By the way, I’m not entirely against a VAT, though I’d like to see it on the lower end, maybe in the 5% range, and only if it’s combined with some sort of transactional tax in the stock and financial markets.
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Laura Clawson
I think I disagree with the notion of balance or fairness here. You seem to imply that the thing to do would be praise Tapper’s “actually very good” stuff to balance out criticism of his hackworthy moments. I’d argue it’s about criticizing the bad stuff and praising the good stuff, whoever it comes from. Do Tapper’s good pieces rise to the level of “wow, this is really groundbreaking and important”? If so, they should be written about. But not to balance out what you write about him specifically.
I would though say we as bloggers should highlight good stuff in the traditional media and call it out a little more specifically. Agreed with DougJ about the obsequiousness of saying “this is really great from the NYT” all the time, but sometimes it’s merited. And I think that happens sometimes, or at least the importance of a piece is recognized. Most recent one I remember getting really widespread credit is the Atul Gawande article on health care in McAllen, TX. For instance.
There are other things we can do, though — like if we’re prone to naming the reporter of a bad piece, we should name the reporters of good pieces to give them credit. That is, criticism shouldn’t be directed at Jake Tapper and praise at ABC.
Hmmm…I’ll stop before I start to ramble too much.
Captain Goto
Disagree.
I’m not sayin’ that we should raise the top marginal rates to the 80-90% levels where they were under Eisenhower (tho’ I love the idea of scaring the rich fucks by hinting at it). But IMHO, there’s a shitload of progressiveness that the Reaganauts gouged out of the tax code, that could be put back in without doing any real harm to “competitiveness.”
I’m not even sure that it would have to go that high, but I’d gleefully take that top rate back up to 40% in a heartbeat before I instituted something as big a pain in the ass (and I suspect very regressive, tho’ I’m not sure) as a VAT.
Shygetz
@burnspbesq: A few billion? Only if we continued to privilege capital gains income over labor gains income. That should be the first reform–treat capital gains and labor gains both as the same income, and tax them at the same marginal rates. Do that, and suddenly you’re not talking about a few billions from a high end marginal tax bracket…
Captain Goto
Of course, JGabriel and others beat me to it.
anonevent
I had a very similar debate about Democrats over at GOS one time. We tend to criticize much easier than praise. The Dems do nine things right and one thing wrong, and we hammer them for messing up. No wonder they get scared of doing anything. They are pack animals, not cats. A cat will hiss and scratch if you threaten it, a dog will cower.
tc125231
You know, there’s not a lot of praise being earned out there. Several of the more praiseworthy ones –say Krugman, who you may or may not like, but who nailed the course of this mess far ahead of anyone else, and who continues to produce analytic –vs. anecdotal –insights into the state of the economy only get trashed by the media –even more so than Nassim Nicholas Taleb.
Peter Drucker wrote that one thing that was never in short supply was mediocrity. That is certainly the case now in both our corporate, media, and political elites. WE are in a serious mess here –and Obama, whose solutions are B or B- at best –looks like the brightest man who ever lived. The media can’t seem to write a coherent analysis of why.
That’s because THEY (and the ever sub-mediocre GOP) are the ones making Obama look like Solomon.
gwangung
I have two points about commenting about media and their competence….
A) Doing their job and doing their job WELL are not the same things. THe latter should garner much more praise than the former, and rightly so.
B) Like any animal, media should be criticized when they do poorly and praised when they do OK, so that they have a clear idea of what they should be doing. It’s operant conditioning, which works very well on humans.
KevinNYC
I was also going to mention Nassim Nicholas Taleb. Read him if you want to understand the dangers of credit default swaps and current risk management.
He argues that risk management as practiced on Wall Street is a great danger. If it’s very good, it accounts for maybe 99% of possibilities, but that 1% of what it doesn’t cover, can wipe out all the years of profits that were accrued. In fact, by treating once every few occurrences as if they were once a century occurences, it fools traders into assuming far too much risk.
iluvsummr
@lutton: Banks “scamming” other banks. I love it. I’m sure the bondholders are happy even if those who bet against the bonds aren’t. I agree with burnspbesq’s first post on criteria that should be imposed for owning or writing a CDS.
burnspbesq
@Captain Goto:
If I had prefaced that statement with “Given the current political state of play …” would you still disagree?
Any movement to raise income tax rates or to make the rate structure more progressive has to overcome 40 years of wingnut propagandizing and framing. Don’t underestimate the difficulty of that, is all I’m saying.
burnspbesq
@Shygetz:
Errr, isn’t Ireland in dire financial straits, considerably worse than most of the Western world?
Yes it is, but not (or at least not primarily) because of tax policy.
The real estate bubble in Ireland was so insane that in 2007 and early 2008, Dubliners with money to spend were bargain-hunting … in New York.
jcricket
There’s no single tax system that’s perfect: property, income, sales, VAT, capital gains, corporate taxes – they all have ups and downs. Some are more regressive than others (but not always). We need them all.
The reality is that almost everyone’s going to have to pay more taxes in the future. Especially the rich and large corporations, who have been shifting the tax burden onto the rest of us for 30+ years (or rather, shifting the burden onto the future). We have trillions of dollars of services & infrastructure that the American public will not stand to be without, so the only logical conclusion is to fund them properly.
The key will be making sure the revenue from additional taxes, along with decreased military spending (we could cut it in 1/3 and still outspend our nearest rivals by 2x), go to programs and services being used by the vast majority of us (social security, medicare/medicaid/schip/public insurance plan, infrastructure, fixing schools, etc).
Obama knows this, but he’s being smart – you can’t unwind 30 years of telling people that cutting taxes leads to a magical nirvana of increased government revenue. You start by getting the ultra-rich and evil corporations to pay their fair share. Then you leverage that success, along with the increased availability/efficiency in government services, to get people on-board with other tax increases.
les
@burnspbesq:
[obligatory space to keep the f’in software from disappearing everything if I blockquote after a ref back]
I’m not sure; you make a good point, but an alternative effect of eliminating [some or all] of CDS type insurance might be to make the secondary markets choosier, and make the secondaries help enforce good underwriting by originators. Could be a good thing.
I’ve been lawyering real estate development/financing for 25 years; I think I know what’s up, and am at least reasonably bright. The only time I ran into a CDS, the lender insisted on it; after endless spreadsheets, power points, conferences, etc. it never made any business sense whatsoever. After innumerable blinding headaches, the borrower got a tiny interest rate reduction coupled with significantly higher transaction costs, probably a wash at best; upper level market types and brokers raked a pile of fees; and no clear benefit accrued to anyone else, as it was never clear that the “balanced risks and cash flows” were in fact balanced or lowered anyone’s risk. What the transaction absolutely did not do was put more $$ into any actual economic activity–and isn’t that what the financial sector is supposedly about?
Disclaimers: I’m not an economist, an MBA, a PhD mathematician nor a Master of the Universe, so I may well not know of which I speak.
JL
@burnspbesq: What about a flat tax with a 75000 deduction. That would increase spending and increase saving. Of course the flat tax would be in the 20% plus range and you make it more progressive by raising the rate over 500,000. Of course this would have to be on all income. The repubs would have a fit because they know what we have no is not progressive.
Roq
I’m not sure they need to be outlawed outright, but they need to be traded openly and regulated heavily.
It’s sad, but… I think a lot of people have come to believe they’re not so bad after all because they never went off. But the truth is, they sort of did; we experienced/are experiencing the financial version of the Cold War. If you want to know why both the Bush and Obama administration treated the banks so gently, you need look no further than CDSs. The *threat* of them going off brought our entire national Treasury to its knees – financial mutually assured destruction.
CDSs are the real reason these banks are “too big to fail.” Essentially, they’ve consolidated the top 80% of our banks. If one goes, it starts a cascade of disaster. This is why the banks got such different treatment from the car companies. Failure was not an option. I’ve really come to believe that the admin looked at the situation and decided that a Japan-like “lost decade” was the best possible outcome. So that’s what we’re gonna get.
burnspbesq
@JL:
Sounds like you may have been reading one of my favorite recent books on tax policy issues, “100 Million Unnecessary Returns” by Michael Graetz.
I could roll with something like that.
Obligatory fanboy disclaimer: graetz was my tax prof in law school, and I ended up going into tax.
Martin
I agree with this. That would make 95% of CDSs illegal and the remaining ones would function as effective hedges.
random asshole
The asymmetry of risk and reward is a prevalent theme in many derivative products. However, the ones that are publicly traded on exchanges (with clearinghouses, margin requirements, and other associated regulation) like equity options have never had problems like those we’re seeing with CDSs.
Quite frankly, if these things were publicly traded with margin requirements similar to what we see on commodities exchanges, we never would have had these problems as it would have been financially impossible to write CDSs with notional value totaling the world GDP. Risk-reward asymmetry is NOT the issue; the issue is dealing with counter-party risk, a risk exchanges themselves assume by virtue of being exchanges. The real insanity here was that since there was no central authority, entities had to hedge against the risk in their hedges, something that never happens with options or futures.
JL
@burnspbesq: No but I will. I just bookmarked it.
Don
Normally I would avoid opining on economic issues when I come to the table unencumbered by knowledge or facts. However I realized a few months ago that I’d spent far more time reading on credit default swaps and collateralized debt obligations than most people. Perhaps all of you have been watching the marketplace.org whiteboard videos as well, in which case I apologize.
The biggest two issues I see with CDSes is that (a) it’s an entirely speculative and unbalanced bet and (2) there’s no transparency as to the totality of the market.
The speculation strikes me as the most insane. We not only regulate insurance companies to make sure that they have enough money to pay out, we also say that you can’t just take out insurance on properties you don’t own an interest in or on people who you don’t have a relationship with. It’s not legal for me to take out a life insurance policy on John Cole, why is it okay for me to buy a CDS betting on whether or not his business will pay their loans? Plain and simple, buying CDSes is gambling.
The opaque market might be a bigger contributor to this insanity, though. CDSes have largely fallen off the media radar of late, but when we were hearing more about them it would occasionally be mentioned that we believed the total number outstanding was an order of magnitude larger than the total world GDP.
In pondering it more, however, I don’t know that those markets would have been too put off by writing the 38th bet against Corporation X failing to pay their bills. Clearly there was an insane greed going on with these things that overcame normal reason. Maybe the people involved would have kept pulling the lever regardless of how over-saturated the CDS market was….
hrtrader
a poetic justice story:
http://www.calculatedriskblog.com/2009/06/hamilton-on-cds-trade-fool-and-his.html
The trade involved credit-default swaps and securities backed by subprime mortgages. The original securities … were backed by $335 million of subprime mortgages mostly on homes in California made at the housing bubble’s peak in 2005 …
Following a wave of refinancing and defaults, only $29 million of the loans were left outstanding by March 2009, half of which were delinquent or in default…
Believing the securities would become worthless, traders at J.P. Morgan bought credit-default swaps over the past year from Amherst … Other banks including RBS Securities … and BofA also bought swaps on the securities from different trading partners.
The banks … paid as much as 80 to 90 cents for every dollar of insurance, the going rate last fall according to dealer quotes, expecting to receive a dollar back when the securities became worthless …
At one point, at least $130 million of bets had been made on the performance of around $27 million in securities …
In late April, traders at some banks were shocked to find out from monthly remittance reports that the bonds they had bet against had been paid off in full. Normally an investor can’t pay off loans like that but if the amount of outstanding loans falls to less than 10% of the original pool, the servicer … can buy them and make bondholders whole.
That’s what happened in this case. In April, a servicer called Aurora Loan Services at the behest of Amherst purchased the remaining loans and paid off the bonds.
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another few links:
we should be talking more about Rep Alan Grayson. Here he grills Citigroup CEO Vikram Pandit. Check out the other videos on YouTube. We need more representatives like Grayson.
http://www.youtube.com/watch?v=A-DOwLnQ4nk
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and this one is just entertaining, waiting to learn more:
http://www.asianews.it/index.php?l=en&art=15456&size=A
my blog
http://www.groovinator.blogspot.com