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Is there anything the financial elites won’t say, or pay someone else to say, to keep their games going? Collin Peterson, D, MN-07 is circulating a discussion draft of a statute to ban most credit default swaps. Here’s the operative language:
(h) LIMITATION ON ELIGIBILITY TO PURCHASE A CREDIT DEFAULT SWAP.—It shall be unlawful for any person to enter into a credit default swap unless the person would experience financial loss if an event that is the subject of the credit default swap occurs.
…
EFFECTIVE DATE.—The amendments made by this section shall be effective for credit default swaps (as defined in section 1a(34) of the Commodity Exchange Act) entered into after 90 days after the date of the enactment of this section.
This proposal flatly bans naked credit default swaps. It doesn’t really do a great job of stopping them, because the language only applies to ownership of some instrument at the moment when the CDS is purchased or sold. And it certainly only applies to CDSs purchased after the statute becomes effective. I bet no one who reads this would think anything else.
Except for financial elites and their lackeys. Bloomberg reports on this here, complete with explanations from our financial betters. Here’s a BNP Paribas analyst:
"I think you have people at the Fed and Treasury who have an understanding of the CDS market," he added. "I think they know that this is a huge segment of tradable activity at the banks and that it would cause a great deal of harm to unwind or basically terminate that market from an earnings and risk standpoint."
Unwind? Where is that in the draft bill? Nothing is going to be unwound, the existing CDSs just go on and ravage the financial system. BNP guy also explains that it was AIG that was the problem, no one else. True, except for Merrill Lynch, which recently lost Madoff size money on CDSs, requiring another $100bn from taxpayers to keep Bank of America from failing. And we don’t know what other shoes are going to be thrown at us by these angry journalists banksters. As for trading income, I think I speak for most of us when I say I would rather banks make money lending than betting on other people’s lending.
Next Bloomberg gives us a lawyer from the elite global law firm, Paul Hastings (average earnings per partner in 2007: $1.92mn)
However, "its unlikely in the current form, I think it’s undoable," … "You can’t just make credit default swaps illegal, and that’s effectively what it does."
Really? I bet Congress could make CDSs illegal, or close enough so it wouldn’t matter. In fact, isn’t that what this bill does? I thought so. Maybe he’s a lawyer from Bushland, that Camelot of the Financial Elites, where laws regulating their activities were, in fact, impossible, and rain may never fall ’til after sundown.
Last, we have the chief strategist at Credit Derivatives Research. He explains that the bill requires both sides to have a financial stake in the debt for which protection is written. That is true. That means the seller of protection somehow has to be short the bond. That’s going to raise prices for protection, and that, our financial guru tells us, will make it even harder for corporations to tap the long term bond market.
He means that if corporations are having trouble borrowing money, CDSs are the solution. Banks and investors are willing to lend money to corporations if they can get someone to write insurance for them, and CDSs are that insurance. It’s like the way you can buy a house, even if you don’t have a big down payment, as long as you have FHA insurance. He says everything is fine in the markets for single-name CDSs, like those on GM and Lehman Bros., so the “insurance” will be available.
Can you remember when borrowing wasn’t a problem for corporations, a few weeks ago, before the implosion of the financial markets? Now they can only borrow if they have insurance? For this guy who makes a living researching derivatives, CDSs are the only solution to the problem they helped cause. He reminds me of William Garvey explaining in todays NYT Op-Ed section that $50 million business jets are great. Garvey is the editor-in-chief of a glossy, Business and Commercial Aviation.
And just like Garvey, Credit Derivatives Analyst guy is dumping another fable on us. In fact, there are insurance companies that write insurance for municipal bonds. They’re shaky now, because they wrote a bunch of insurance for mortgage-backed securities, but I bet they could make a ton of money writing actual insurance for corporations, if any corporations thought they needed it. Maybe Credit Derivatives Research guy could change his company name to Corporate Debt Insurance Analysts.
I imagine Collin Peterson is hearing plenty from these guys, among many others, who got it wrong. Maybe he could hear from those of us who applaud his efforts.
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35 Comments
Masaccio, wanted to make sure that you know about the George Soros interview in today’s Financial Times (link from TPM):
http://www.ft.com/cms/s/2/9553…..fd2ac.html
Definitely related.
(FWIW, I admire Soros hugely. But then, since I first read and grasped his theory of Reflexivity, I’ve thought he made more sense than any of the academics or government economists. Too many of whom disdain him, IMHO. But then again, those were the same people who believed that ‘markets will self-correct’. Now THAT’s ‘trashy talk’.)
roTL, I love the image of the waste chemicals. We need a chelation process.
This is a direct link to Soros’ article. I read this earlier:
Several FDL writers have suggested that the crisis was precipitated by a bear raid, something that was very difficult to do under the Securities Laws before the Reagan/Bush/Clinton/Bush regime of deregulation. I was leary of tin foil hat stuff, but it sure looked like it to me. Soros would ban CDSs, so I assume he would like the Peterson plan.
The article you cite is also interesting, suggesting that the solution is for the government to sell CDSs and swamp the markets with them. I cannot imagine doing that will help, although it has the advantage of not requiring cash up front.
Weird, that Soros link worked for me. But anyway, glad you found it.
I think this whole CDO/CDS mess would be one hell of a timeline.
So far, I’ve seen timelines of the dates/amounts/companies being bailed out.
But a good timeline needs several other variables as well:
1. Date/type of legislation creating CDOs and loosening the rules
2. Senate and House committees, along with the Chairs per legislative item
3. Short selling conduct
4. Who was hedging, who was selling CDOs
5. Background noise: political news per key date (front page headlines)
6. Home foreclosure #s, per US region
7. Price of key economic indicators
8. Law enforcement resources (ie, FBI agents pulled off mortgage fraud cases to chase after ‘terra’)
Note that the rise in gas prices last spring-summer sure set up a sinister set of underlying conditions for the madness that ensued within weeks of the McCain-Palin GOP convention (but when they were still ‘ahead’ in polls of likely voters). (I guess that the easy analogy is of a distressed body that then gets whalloped by raging infection — the kind of bacteria that, like CDOs and CDSs, multiply exponentially in a short period of time and rampage.)
Don’t know what such a timeline would look like, but those are the variables that I’d map out.
Your reactions…?
Wikipedia tells us that the first CDOs were issued by… Drexel Burnham Lambert. Fascinating.
Thanks for another enlightening, superb diary on CDOs.
I’ve started to think of them as ‘financial pollutants’.
Just like ExxonValdez spilled all those millions of gallons into Prince William Sound 20 years back, each little drop of oil being eaten by a fish, which was then eaten by another fish… all those molecules of petrochemical accumulating in living tissues, one-by-one the toxins seem tiny and manageable.
But there are millions of them.
And no way of tracking them.
There’s no way to get the oil back into the holds of ships and out of the seawater and the fishes.
There are a number of ways to de-toxify the markets by eradicating CDOs and CDSs. But I think the resistance comes from people who, like oil execs, are so deeply invested in the screwy existing rules that they seem to be incapable of recognizing and acknowledging their own role in perpetuating this destruction.
Which means that grown-ups have to take charge.
A call to thank Mr. Peterson just went on my calendar for the coming week.
The time line is an interesting idea. Unfortunately, all of the markets in this stuff are secret. We don’t know who owns CDOs. We don’t know who is trading CDSs. We could get some summary information by subscribing to Markit or the Bloomberg equivalent, which publish some information about alleged trading activity in CDSs. We can glean a few details CDS portfolios of companies that are registered at the SEC. I have linked to discussions of these at Citi and Bank of America in their financial statements in some of my posts.
I doubt that we will learn anything useful in a public forum. I hope we might get the FDIC to ask before it starts buying that trash.
Wow. So Collin Peterson actually is doing something right, eh? He’s a Blue Dog, one of the eleven Blue Dogs who voted against the stimulus plan.
And Collin Peterson was a Blue Dog before there even was such a thing. Worse yet, they’ll never vote him out of office, and he’s likely to be succeeded by more of the same. I’d really like to call people like Peterson something other than Blue, because by and large, they’re not.
Maybe Purple Bobbleheads?
How about just repealing Gramm-Leach-Billey all together?
Can anyone buy a guarantee against impotence after 80?
CNN just talking about a bill Republican Martinez is shopping around on stimulus. Is this the one that raises taxes?
Where is the Democratic rapid response effort on
thisanything?We are it:(
Were much better than the Dem talking heads but we don’t get TV coverage.
If we did the world would see what a Real Liberal Media can do:)
Can we ban Credit default swaps? All of them what do you think would happen if we did?
And what happens if we don’t?
What we can do is call them what they are insurance and put them under regular insurance regulation. If we did that, you would see them disappear overnight.
(I know you know that) It’s only insurance if you have direct exposure to the loss. So the naked CDSes are not insurance. As you point out @18, what the naked CDSes are much more like is: gambling. I don’t see the point of outlawing the non-gambling CDSes so long as they’re regulated. The gambling ones should probably be outlawed, though the idea that they could instead be brought under the existing gambling regulatory regime, thereby defusing their ‘economic WMD’ potential, is a novel and interesting one.
They wouldn’t disappear, because credit default insurance is a reasonable thing to purchase. However, they would be returned to a saner basis.
My point was that if they came under insurance regulation then they would be insurance. As they are, they are a kind of pseudo-insurance whose main function does not seem to be to hedge a dubious risk but rather to give a specious justification for it. If you wanted real coverage, you would get real insurance and pay real rates for it.
Insurance regulation certainly counts as a saner basis. But I agree with the larger point that banning naked CDSs is a necessary thing. The current system is made for abuse.
I agree. As I pointed out in the text, there are companies that write insurance for municipal bonds, who would do a bang-up and profitable job insuring the debt of corporations if that would make the bankers or bond investors more willing to lend. I don’t see any value to the CDS system at all in insurance: too expensive, and too risky to the system.
We can certainly ban future CDSs, as the bill would do.
As to the existing ones, they were lawfully issued, and it isn’t clear we could just declare them unlawful now.
We could set up a system for undoing them. There are a couple of links in this diary for methods of doing that. These are clever, and I think they would work. I hope that if we go the bad bank route, and get stuck with CDSs, we will pass legislation to do one or the other.
If we don’t then their corrosive effects will continue to damage assets and companies and stockholders and markets and America.
We can ban them, but I think the criticism mentioned in the post is that there are existing CDSs and banning the purchase of them would not just ban new ones, but hurt the secondary market for them. Unlike regular insurance policies held by individuals these CDSs are traded (I suppose) just like any other asset. That’s where he says the market would be forced to ‘unwind’ in an unruly way. I’d suggest the compromise is to limit the ban to the purchase of any NEW CDS and let the existing ones play out as they were originally intended.
Also important is to make their use more transparent by putting them on a clearinghouse.
Also, to make the legislation more effective it would be best to not specifically refer to a Credit Default Swap, but to a ‘financial instrument’ which serves this or that purpose. They got around ‘insurance policy’ by simply renaming it, so regulating a type of ACTIVITY is what nails it down better.
I’m not one who thinks CDSs created this problem, but naked CDSs are certainly corrosive and lack of transparency creates tremendous uncertainty for market players.
Peterson (my Congressman) is one of the leaders of the Blue Dogs, and one of the ones who didn’t vote for Obama’s stimulus. I believe that he’s also one of the ones insisting on a return to pay-go, which is wrongheaded.
I can’t really analyze this proposal, but someone should check to see whether it isn’t just a noisy distraction. Peterson gets 73% of his money from PACs and doesn’t communicate much with his constituents. He’s safe in his seat and wins with a 65-70% margin because the Republicans have little reason to run against him.
That has got to be one of the most unintentionally funny lines I have come across. If people at the Fed and Treasury understood this market, then they could have fixed it before it got out of hand, except of course that the 2000 Commodities Futures Modernization Act deregulated derivatives markets. So people at Treasury and the Fed actually didn’t know what was going on most of the time but aside from that I am sure their understanding was impeccable.
I would note that all this guy is talking about doing is reinstating the regulations adopted by the Marine Insurance Act of 1746.
Yes, it has been known for 263 years that you have to limit insurance to those who are directly harmed by the losses.
That was what was so insidious about the CFMA I reference in my #14. It exemted derivatives drom insurance regulation, and from gambling regulation as well. Gramm knew this was nothing more than gambling and pseudo-insurance and moved to protect this scheme from both types of regulation.
So what parts, if any, in your opinion were good about Gramm-Leach-Billey?
To be honest I’m not sure what all is it. The part that was repealed and which should be restored is Glass-Steagall.
I wouldn’t jump to that so quick. We’ve gone through something and can learn from that and possibly improve on JUST returning to G-S. There has been some benefit from allowing more competition in financial services, but there have also been some major problems. Let’s sort out the good from the bad and move forward, not backward.
Clearly separating investment banking from commercial banking is to some extent absolutely necessary. But then, is it wise to separate insurance and banking, so that the number of insurance firms is shrunk? Is there some kind of regulatory fire-walling which can allow more firms to do a lot of things, but without co-mingling of intimates?
One thing I would like to see added is a mechanism for a) setting reserve requirements to limit financial contagion in the event of problems at one or a small number of firms and b) breaking up any financial institution that reaches the point that it is “too big to fail”. A financial institution that is too big to be allowed to pay for its errors through failure is a clear and present danger to the economy and must be dealt with as such.
I have never seen any reason to increase the size of financial institutions. The bigger they are, the poorer management we see, the greater risks they can take because of the greater capital they have, and the greater the risk of misuse of the information they accumulate about the financial affairs of their customers. I think PierceNichols has a good point about the size of these aggregations of capital, and the risks of contagion.
“DisgUsting” — character named McCreedy in the movie V for Vendetta
Isn’t it amazing when people like McCain, and Gramm in this instance, really say what’s on their mind and incriminate themselves.
I’m wondering about the ton of lawsuits lining up behind the foreclosure crisis. In their greedy desire for risk-free profits, they’ve succeeded in separating the loan-holder from the owner, so when they try to foreclose, many loan-holders find that they don’t have the proper paperwork. Homeowners facing foreclosure are beginning to discover that those trying to foreclose on their homes may have vulnerability.
I’m wondering if this will create a huge backfire that will scorch the greedy profit-seekers, and force reform from a different angle.
Bob in HI
It goes to show how chaotic the whole system, if you could call it that, was. It also shows why we need comprehensive solutions to create a system that actually ties all this together. Such a solution would address homeowners’ problems and not be just another gimme for the banks.