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by bks » Tue Feb 24, 2009 1:02 pm
by JackRiddler » Tue Feb 24, 2009 1:06 pm
David Paul
President of the Fiscal Strategies Group
Posted February 21, 2009 | 04:54 PM (EST)
Time to Stop the Nationalization Rhetoric, and Let the System Work
This week, the Federal Deposit Insurance Corporation took over Silver Falls Bank in Silverton, Oregon. Silver Falls Bank was the 14th bank taken over by the FDIC this year. This compares with 25 banks that failed in 2008 and 3 in 2007. Bank failure is not unheard of. And up until a week or so ago, the term "nationalization" was not invoked.
Since its creation in 1933, the role of the FDIC has been to prevent runs on banks by insuring bank deposits and to oversee the orderly disposition of failed banks. For the better part of a century, it has done its job quietly and effectively. And today, we would all be well served to let the FDIC and its capable leader, Sheila Bair, do their job.
From the beginning of the current financial crisis, one of the problems has been the failure of the leading agents of the government, embodied by Hank Paulson and Ben Bernanke, to establish clear rules and follow them. Instead, we have plodded along, from crisis point to crisis point. From Bear Stearns to Fannie Mae to Merrill Lynch to Lehman Brothers to AIG to Washington Mutual, each collapse engendered a unique response by the Treasury and the Federal Reserve.
In a similar manner, the focus of the $700 billion Toxic Asset Relief Program -- the federal bailout -- to address the insolvency of the nation's largest banks has veered from the purchase of toxic assets to injections of capital to guaranteeing of assets. Now once again, toxic asset purchases are back in vogue as the strategy of choice, this time under the "good bank, bad bank rubric."
This week, the stock market broke through its technical support levels, and now appears headed toward 6,000 as its next support level. Some observers have suggested that the decline reflected the market response to looming plans for the "nationalization" of the banking system and one more step down the road to socialism, as trumpeted on the cover of Newsweek.
But market decline was not a result of the fear of nationalization, and nationalization would not mark the next milestone on the road to socialism. Quite the contrary. Investors are running away from banks -- good banks and bad banks alike -- precisely because the federal efforts to date have obscured the true financial condition of the banks. Faced with uncertainty and poor information, investors will always pull back and wait for the fog to clear.
The takeover of insolvent banks by the FDIC is the way the process is supposed to work, and the way it has always been allowed to work--up until now. For all of the debates over the "Swedish Model" -- where banks were taken over, balance sheets reconfigured, and then spun back out to private ownership -- the way they did it in Sweden is not actually all that different from the way they do it at the FDIC, when the FDIC is allowed to do its job. Insolvent banks are seized. Assets are sold off and the depositors are paid or, if possible, the balance sheet is cleaned up and the bank is sold off to a new owner.
The problem today is that a small number of our insolvent banks, notably Citi, are very big and very visible. But the problems they face are the problems that the FDIC was created to fix. This is not nationalization, it is essentially a debtor-in-possession bankruptcy process whereby the FDIC serves as the receiver.
If left to do its job, the FDIC would do what the banks resolutely refuse to do: sell their bad assets, accept the price of their business decisions, and move on. The banks refuse to do it because it would force them to face up to what the markets, and increasingly outraged taxpayers, have known for a while: They are insolvent.
For years, America has told other countries how to deal with financial crises: Cut your losses. Clean up your balance sheets. Get on with it.
This week, the stock market said the same thing.
On a side note, the Ford Motor Company -- the one that is not taking federal money -- has seen its market share rise steadily for the past four months. This is the way markets are supposed to work. Saving one company or another -- or one bank or another -- is not an inherent public good, however politically compelling. And pumping public money into one company serves to dramatically disadvantage their competitors.
One of the biggest mistakes that Hank Paulson made was demanding that banks take TARP money, even if they didn't want to -- or need to- -i n order to remove the stigma from those who did. Somehow, this was supposed to be a way of maintaining confidence in the system. But instead of protecting the bad banks, by letting them hide among the good, it has achieved the opposite. That is why investors have turned their back and are walking away.
The banking industry and the markets would be better served if the politicians and the pundits quieted their politically loaded hubris about nationalization, and if the Treasury and the Fed let the process work, as it has been designed to work. Forget about creating good banks and bad banks. Let insolvent banks take their medicine. Management, shareholders and bondholders will pay a steep price for business failure. And let the banks that are healthy take market share from those that are not.
It is time to let the process work. Punish failure. Reward success. This is not nationalization, it is the way the system is designed to work. Time to take the banks off the dole, and let Sheila Bair do her job.
February 24, 2009
One Big Bad Bank
Is Nationalization Inevitable?
By PETER MORICI
The Obama Administration is on track to nationalize the nation’s largest banks, unless it alters policy and creates a Bad Bank to absorb commercial banks’ mortgage-backed securities.
The housing market and banks are caught in a vicious cycle.
The market is glutted by builders with too many new homes, speculators unloading vacant houses, banks with repossessed properties, and homeowners seeking relief from mortgage commitments.
As housing prices fall, more homeowners with adjustable-rate-mortgages cannot refinance when their rates reset, and others, simply discouraged, default. Supply increases again, perpetuating the spiral of falling home values, mortgage defaults, and bank losses on mortgage-backed securities.
To cover losses, banks should raise new private capital by selling additional stock. But investors, seeing no end to falling home prices and bank losses, have pushed down share prices to levels making it impractical for banks to raise capital.
The TARP has aggravated the problem.
When first approved by Congress, Treasury was to buy mortgage-backed securities from the banks, but it ultimately determined it was not possible to assess their values. Instead, Treasury used TARP to inject capital into banks, purchasing warrants convertible to bank shares, and left banks to work out their problems.
As losses mounted, so did Treasury’s equity stake and involvement at Bank of America, Citigroup and several other banks. Many investors fear sweeping nationalization is inevitable, and have become even more reluctant to purchase bank stocks.
Those fears will continue until the mortgage-backed securities are removed from the banks’ balance sheets or their potential damage neutralized. However, Treasury Secretary Geithner’s proposal to create a public-private investment fund to value these assets and mitigate their consequences is vague and hauntingly reminiscent of the strategy the original TARP was forced to abandon.
As housing prices fall, the banks will have no place to go but the government for the capital to cover losses, and their ownership will pass into government hands, first Citigroup and then others.
Economists, whether employed by banks or the Treasury, cannot reasonably estimate the ultimate value of mortgage-backed securities and the losses banks will take until the number of defaults and foreclosures is known, and that is the trap that snares the market.
The number of foreclosures cannot be divined without knowing how far housing prices will fall, and the drop in housing values cannot be estimated without knowing the number of defaults and how many houses will be dumped onto the market.
A federally sponsored “bad bank,” or “aggregator bank” could purchase all of the mortgage backed securities from commercial banks at their current market-to-market values on the books of the banks. It could determine the number of defaults by performing triage on mortgages—deciding which homeowners if left alone will pay their mortgages, which if offered lower interest rates and moderate principal write downs could reasonably service new loans, and which must be left to fail.
Implementing those standards and necessary mortgage modifications across the entire market would, at once, limit the number of defaults and determine how much housing prices will ultimately fall. That is something the individual banks cannot accomplish acting independently.
The Bad Bank could be capitalized with $250 billion from the TARP, and it could raise additional capital by selling $250 billion in shares, and another $500 billion to $1 trillion by issuing bonds. The commercial banks could be paid for their securities with 25 percent in shares and the rest in cash.
By sweeping all the mortgage-backed securities off the books of the banks and limiting losses on those securities, the Bad Bank would earn money collect payments on the majority of mortgages that ultimately pay out and sell off repossessed properties at a measured pace. Like the Savings and Loan Crisis Resolution Trust, and the Depression- era Home Owners’ Loan Corporation, it would likely make a profit.
Relieved of the mortgage backed securities, the banks would not be trouble free—they still have auto loans and credit card debt to repent. However, having huge deposits and vast networks of branches, they would be worth a lot to investors again, and could raise new capital, repay their TARP contributions and write new mortgages.
The bankers could then go on their merry way, until a few decades hence, they once again determine their salaries should support the lifestyles of rock stars and create financial products to pay them.
My son plans to study finance. He can solve that crisis.
Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.
February 24, 2009
Doomed by the Myths of Free Trade
How the Economy was Lost
By PAUL CRAIG ROBERTS
The American economy has gone away. It is not coming back until free trade myths are buried six feet under.
America’s 20th century economic success was based on two things. Free trade was not one of them. America’s economic success was based on protectionism, which was ensured by the union victory in the Civil War, and on British indebtedness, which destroyed the British pound as world reserve currency. Following World War II, the US dollar took the role as reserve currency, a privilege that allows the US to pay its international bills in its own currency.
World War II and socialism together ensured that the US economy dominated the world at the mid 20th century. The economies of the rest of the world had been destroyed by war or were stifled by socialism [in terms of the priorities of the capitalist growth model. Editors.]
The ascendant position of the US economy caused the US government to be relaxed about giving away American industries, such as textiles, as bribes to other countries for cooperating with America’s cold war and foreign policies. For example, Turkey’s US textile quotas were increased in exchange for over-flight rights in the Gulf War, making lost US textile jobs an off-budget war expense.
In contrast, countries such as Japan and Germany used industrial policy to plot their comebacks. By the late 1970s, Japanese auto makers had the once dominant American auto industry on the ropes. The first economic act of the “free market” Reagan administration in 1981 was to put quotas on the import of Japanese cars in order to protect Detroit and the United Auto Workers.
Eamonn Fingleton, Pat Choate, and others have described how negligence in Washington DC aided and abetted the erosion of America’s economic position. What we didn’t give away, the United States let be taken away while preaching a “free trade” doctrine at which the rest of the world scoffed.
Fortunately, the U.S.’s adversaries at the time, the Soviet Union and China, had unworkable economic systems that posed no threat to America’s diminishing economic prowess.
This furlough from reality ended when Soviet, Chinese, and Indian socialism surrendered around 1990, to be followed shortly thereafter by the rise of the high speed Internet. Suddenly, American and other first world corporations discovered that a massive supply of foreign labor was available at practically free wages.
To get Wall Street analysts and shareholder advocacy groups off their backs, and to boost shareholder returns and management bonuses, American corporations began moving their production for American markets offshore. Products that were made in Peoria are now made in China.
As offshoring spread, American cities and states lost tax base, and families and communities lost jobs. The replacement jobs, such as selling the offshored products at Wal-Mart, brought home less pay.
“Free market economists” covered up the damage done to the US economy by preaching a New Economy based on services and innovation. But it wasn’t long before corporations discovered that the high speed Internet let them offshore a wide range of professional service jobs. In America, the hardest hit have been software engineers and information technology (IT) workers.
The American corporations quickly learned that by declaring “shortages” of skilled Americans, they could get from Congress H-1b work visas for lower paid foreigners with whom to replace their American work force. Many US corporations are known for forcing their US employees to train their foreign replacements in exchange for severance pay.
Chasing after shareholder return and “performance bonuses,” US corporations deserted their American workforce. The consequences can be seen everywhere. The loss of tax base has threatened the municipal bonds of cities and states and reduced the wealth of individuals who purchased the bonds. The lost jobs with good pay resulted in the expansion of consumer debt in order to maintain consumption. As the offshored goods and services are brought back to America to sell, the US trade deficit has exploded to unimaginable heights, calling into question the US dollar as reserve currency and America’s ability to finance its trade deficit.
As the American economy eroded away bit by bit, “free market” ideologues produced endless reassurances that America had pulled a fast one on China, sending China dirty and grimy manufacturing jobs. Free of these “old economy” jobs, Americans were lulled with promises of riches. In place of dirty fingernails, American efforts would flow into innovation and entrepreneurship. In the meantime, the “service economy” of software and communications would provide a leg up for the work force.
Education was the answer to all challenges. This appeased the academics, and they produced no studies that would contradict the propaganda and, thus, curtail the flow of federal government and corporate grants.
The “free market” economists, who provided the propaganda and disinformation to hide the act of destroying the US economy, were well paid. And as Business Week noted, “outsourcing’s inner circle has deep roots in GE (General Electric) and McKinsey,” a consulting firm. Indeed, one of McKinsey’s main apologists for offshoring of US jobs, Diana Farrell, is now a member of Obama’s White House National Economic Council.
The pressure of jobs offshoring, together with vast imports, has destroyed the economic prospects for all Americans, except the CEOs who receive “performance” bonuses for moving American jobs offshore or giving them to H-1b work visa holders. Lowly paid offshored employees, together with H-1b visas, have curtailed employment for older and more experienced American workers. Older workers traditionally receive higher pay. However, when the determining factor is minimizing labor costs for the sake of shareholder returns and management bonuses, older workers are unaffordable. Doing a good job, providing a good service, is no longer the corporation’s function. Instead, the goal is to minimize labor costs at all cost.
Thus, “free trade” has also destroyed the employment prospects of older workers. Forced out of their careers, they seek employment as shelf stockers for Wal-Mart.
I have read endless tributes to Wal-Mart from “libertarian economists,” who sing Wal-Mart’s praises for bringing low price goods, 70 per cent of which are made in China, to the American consumer. What these “economists” do not factor into their analysis is the diminution of American family incomes and government tax base from the loss of the goods producing jobs to China. Ladders of upward mobility are being dismantled by offshoring, while California issues IOUs to pay its bills. The shift of production offshore reduces US GDP. When the goods and services are brought back to America to be sold, they increase the trade deficit. As the trade deficit is financed by foreigners acquiring ownership of US assets, this means that profits, dividends, capital gains, interest, rents, and tolls leave American pockets for foreign ones.
The demise of America’s productive economy left the US economy dependent on finance, in which the US remained dominant because the dollar is the reserve currency. With the departure of factories, finance went in new directions. Mortgages, which were once held in the portfolios of the issuer, were securitized. Individual mortgage debts were combined into a “security.” The next step was to strip out the interest payments to the mortgages and sell them as derivatives, thus creating a third debt instrument based on the original mortgages.
In pursuit of ever more profits, financial institutions began betting on the success and failure of various debt instruments and by implication on firms. They bought and sold collateral debt swaps. A buyer pays a premium to a seller for a swap to guarantee an asset’s value. If an asset “insured” by a swap falls in value, the seller of the swap is supposed to make the owner of the swap whole. The purchaser of a swap is not required to own the asset in order to contract for a guarantee of its value. Therefore, as many people could purchase as many swaps as they wished on the same asset. Thus, the total value of the swaps greatly exceeds the value of the assets.*
The next step is for holders of the swaps to short the asset in order to drive down its value and collect the guarantee. As the issuers of swaps were not required to reserve against them, and as there is no limit to the number of swaps, the payouts could easily exceed the net worth of the issuer.
This was the most shameful and most mindless form of speculation. Gamblers were betting hands that they could not cover. The US regulators fled their posts. The American financial institutions abandoned all integrity. As a consequence, American financial institutions and rating agencies are trusted nowhere on earth.
The US government should never have used billions of taxpayers’ dollars to pay off swap bets as it did when it bailed out the insurance company AIG. This was a stunning waste of a vast sum of money. The federal government should declare all swap agreements to be fraudulent contracts, except for a single swap held by the owner of the asset. Simply wiping out these fraudulent contracts would remove the bulk of the vast overhang of “troubled” assets that threaten financial markets.
The billions of taxpayers’ dollars spent buying up subprime derivatives were also wasted. The government did not need to spend one dime. All government needed to do was to suspend the mark-to-market rule. This simple act would have removed the solvency threat to financial institutions by allowing them to keep the derivatives at book value until financial institutions could ascertain their true values and write them down over time.
Taxpayers, equity owners, and the credit standing of the US government are being ruined by financial shysters who are manipulating to their own advantage the government’s commitment to mark-to-market and to the “sanctity of contracts.” Multi-trillion dollar “bailouts” and bank nationalization are the result of the government’s inability to respond intelligently.
Two more simple acts would have completed the rescue without costing the taxpayers one dollar: an announcement from the Federal Reserve that it will be lender of last resort to all depository institutions including money market funds, and an announcement reinstating the uptick rule.
The uptick rule was suspended or repealed a couple of years ago in order to permit hedge funds and shyster speculators to rip-off American equity owners. The rule prevented short-selling any stock that did not move up in price during the previous day. In other words, speculators could not make money at others’ expense by ganging up on a stock and short-selling it day after day.
As a former Treasury official, I am amazed that the US government, in the midst of the worst financial crises ever, is content for short-selling to drive down the asset prices that the government is trying to support. No bailout or stimulus plan has any hope until the uptick rule is reinstated.
The bald fact is that the combination of ignorance, negligence, and ideology that permitted the crisis to happen still prevails and is blocking any remedy. Either the people in power in Washington and the financial community are total dimwits or they are manipulating an opportunity to redistribute wealth from taxpayers, equity owners and pension funds to the financial sector.
The Bush and Obama plans total 1.6 trillion dollars, every one of which will have to be borrowed, and no one knows from where. This huge sum will compromise the value of the US dollar, its role as reserve currency, the ability of the US government to service its debt, and the price level. These staggering costs are pointless and are to no avail, as not one step has been taken that would alleviate the crisis.
If we add to my simple menu of remedies a ban, punishable by instant death, for short selling any national currency, the world can be rescued from the current crisis without years of suffering, violent upheavals and, perhaps, wars.
According to its hopeful but economically ignorant proponents, globalism was supposed to balance risks across national economies and to offset downturns in one part of the world with upturns in other parts. A global portfolio was a protection against loss, claimed globalism’s purveyors. In fact, globalism has concentrated the risks, resulting in Wall Street’s greed endangering all the economies of the world. The greed of Wall Street and the negligence of the US government have wrecked the prospects of many nations. Street riots are already occurring in parts of the world. On Sunday February 22, the right-wing TV station, Fox “News,” presented a program that predicted riots and disarray in the United States by 2014.
How long will Americans permit “their” government to rip them off for the sake of the financial interests that caused the problem? Obama’s cabinet and National Economic Council are filled with representatives of the interest groups that caused the problem. The Obama administration is not a government capable of preventing a catastrophe.
If truth be known, the “banking problem” is the least of our worries. Our economy faces two much more serious problems. One is that offshoring and H-1b visas have stopped the growth of family incomes, except, of course, for the super rich. To keep the economy going, consumers have gone deeper into debt, maxing out their credit cards and refinancing their homes and spending the equity. Consumers are now so indebted that they cannot increase their spending by taking on more debt. Thus, whether or not the banks resume lending is beside the point.
The other serious problem is the status of the US dollar as reserve currency. This status has allowed the US, now a country heavily dependent on imports just like a third world or lesser-developed country, to pay its international bills in its own currency. We are able to import $800 billion annually more than we produce, because the foreign countries from whom we import are willing to accept paper for their goods and services.
If the dollar loses its reserve currency role, foreigners will not accept dollars in exchange for real things. This event would be immensely disruptive to an economy dependent on imports for its energy, its clothes, its shoes, its manufactured products, and its advanced technology products.
If incompetence in Washington, the type of incompetence that produced the current economic crisis, destroys the dollar as reserve currency, the “unipower” will overnight become a third world country, unable to pay for its imports or to sustain its standard of living.
How long can the US government protect the dollar’s value by leasing its gold to bullion dealers who sell it, thereby holding down the gold price? Given the incompetence in Washington and on Wall Street, our best hope is that the rest of the world is even less competent and even in deeper trouble. In this event, the US dollar might survive as the least valueless of the world’s fiat currencies.
*(An excellent explanation of swaps can be found here.)
Paul Craig Roberts was Assistant Secretary of the Treasury in the Reagan administration. He is coauthor of The Tyranny of Good Intentions.He can be reached at: PaulCraigRoberts@yahoo.com
Exclusive: Derivatives for Dummies by The Other Katherine Harris
Posted on February 18, 2009 by dandelionsalad
by The Other Katherine Harris
Featured Writer
Dandelion Salad
Feb. 18, 2009
Recent attempts by corporate media to explain the nature of our economic meltdown have left me ready to bite the ears off mice. They’ve been superficial, profoundly misleading and, above all, apologias for the likes of Paulson, Bernanke and Geithner. So, having spent every spare moment over the past three years studying the debacle that many saw brewing, here’s the simplest explanation I’ve come up with:
Imagine being able to insure a car that you don’t own or use. Imagine it’s the car your neighbors will let their teenage son drive, when he gets his license in a few weeks — and you know the kid is a reckless brat.
Now imagine that, by using financial derivatives called swaps, you can purchase as many insurance policies on this car as you can afford to pay premiums on.
When that car is eventually trashed and scrapped, you — and any friends you clued in on the deal - might collect millions, even billions, of dollars. By contrast, your neighbors, who bought real insurance on a real vehicle, get only its Blue Book value (and, one hopes, a chastened child).
This explains the primary problem with swaps. Anybody can bet on anything, so the nominal value of the bets far exceeds the actual worth of any property involved.
Still worse, no tangible or financial asset has to be in the picture. Wagers of any amount can be made, based only on opinions. You can bet on next Wednesday’s weather, if a counterparty wants to take the other side.
Only a fraction of swap action stems from logical situations in which, say, Party A owns a certain debt-based bond and Party B feels good enough about its prospects to accept premiums against possible default. Those are the Credit Default Swaps we hear so much about, which are a small part of the picture.
Similarly, Collateralized Debt Obligations comprise a much larger category than merely those bonds into which home mortgages have been sliced, diced, tranched and peddled to the unwary. Every type of debt is subject to the same treatment, called securitization or financialization. Commercial mortgages, student loans, home equity loans, credit card balances and auto notes spring immediately to mind, but it doesn’t stop there by any means. Among the latest wrinkles are buying up and bundling seniors’ life insurance policies and selling solar equipment with financing and service contracts attached, so that those obligations can be packaged and resold. Carbon credits, if cap-and-trade is approved in the US, instead of a sensible carbon tax, will be another new toy for the boyz.
Beyond swaps and CDOs, there are many other types of derivatives. Some serve no purpose except adding layers of expense to the delivery of commodities. Think of the possibilities as endless and you’ll be right.
This is how speculators in derivatives have created a “shadow economy” so vast it looms over the actual economy like a death-star over a bumblebee.
Much of their vast construct is not merely shadowy but wholly obscured. Among derivative securities, relatively few are traded on any exchange. So there’s no public record of the rest, which are based on private agreements. A host of swaps have arisen from so-called “dark pools of liquidity” — in which those who play may not even clearly identify themselves to one another. Yet more of these monsters from the deep arise daily. There’s still no rule against them, nor a wisp of regulation. At times the contracts are doubly hidden, recorded off the holder’s main books in so-called Structured Investment Vehicles.
All of that makes it impossible to be certain, but the Bank for International Settlements is a pretty good guesser and they last pegged the total face value of derivatives in existence at $1.4 QUADRILLION — more money than there is in all the world (at least until Ben Bernanke turned on the printing press lately). This figure may have since declined, but I wouldn’t bank on it. A lot of derivatives are long-term deals operant for many years.
Returning to our original example,you don’t even have to await the neighbor kid’s big smashup to start making money on your swaps. Say he gets a speeding ticket or has a fender-bender. Those are documented events that raise the price of coverage — for all who want it, not just the boy’s unfortunate parents. Now you can, by presenting him as a known risk, profit by selling some of your contracts to others for much more than you paid.
In this case, you wouldn’t want to sell unless you need funds badly, but imagine that your payoff depends on the failure of a company, a currency or a country. The weaker your target is perceived to be, as reflected by the cost of default insurance on its debt, the closer you move toward your ultimate goal. So you and your friends will do all you can to drive that cost up and make the world fully aware of it, including buying and selling CDS contracts openly. This makes the rising cost apparent and you can count on the rating agencies to take notice swiftly. Their downgrade will become the death-knell.
Therein lies another great problem with Credit Default Swaps. They work exactly like short-selling and rumor-mongering (which CDS owners may well be doing, too) to create self-fulfilling prophecies.
They also create the derivative world’s equivalent of margin calls, which mean trouble for luckless parties on what increasingly seem the wrong side of particular bets. Staying in the game takes cash, more and more of it.
Such circumstances also invite side-bets — on when the shaky whatsit will fall, for instance. Thus, the money monster grows bigger and bigger. Until it finally pops.
Which brings us to the enormous problem of extracting payment from those on the losing side of each bet, who of course didn’t expect to lose. Gamblers never do, until it’s far too late.
So welcome to the Casino at the End of the World. Where you’re now backing every remaining wager and paying off the winners. In bailout bucks.
Why, instead of doling out trillions of taxpayer dollars through the Fed and Treasury Department, didn’t our government simply nullify these crazy bets that never should have been made — thereby averting the present crisis? It can’t be that contracts are really all that sacrosanct. Credit card companies change terms on us all the time.
see
Exclusive: Why should I pay somebody else’s mortgage? by The Other Katherine Harris
Trouble at Treasury - Geithner gets the keys to the henhouse By Mike Whitney
The Looming Collapse of the American Empire by Chris Hedges
Finance Capitalism Hits a Wall by Prof. Michael Hudson
The Economy Sucks and or Collapse 2
by MacCruiskeen » Tue Feb 24, 2009 3:16 pm
Unbekannte Gläubiger, unsichtbare Netze
Paul Schreyer 24.02.2009
Zur Finanzierung der Finanzkrise
http://www.heise.de/tp/r4/artikel/29/29781/1.html
Barclays Bank, die Deutsche Bank, Merrill Lynch, UBS und Morgan Stanley, ... Goldman Sachs und Citigroup
The economic fallacy at work is that bank credit is a veritable factor of production, an almost Physiocratic source of fertility without which growth could not occur. The reality is that the monopoly right to create interest-bearing bank credit is a free transfer from society to a privileged elite. The moral is that when we see a “factor of production” that has no actual labor-cost of production, it is simply an institutional privilege.
by JackRiddler » Tue Feb 24, 2009 3:28 pm
by JackRiddler » Tue Feb 24, 2009 3:31 pm
by American Dream » Tue Feb 24, 2009 3:52 pm
by JackRiddler » Tue Feb 24, 2009 5:02 pm
me wrote:.
Bernanke's up before the Senate banking committee right now, presenting a plan to buy into the banks with share purchases and more massive loans, but not yet to nationalize, as I have understood. (I missed the beginning but CNBC talking heads just talked about buying shares in Citigroup at $7 a share instead of the current $2. Unbelievable. Yet another ripoff as prelude to the inevitable moment when the whole thing crashes or is taken over.)
Exclusive: Why should I pay somebody else’s mortgage? by The Other Katherine Harris
Posted on February 21, 2009 by dandelionsalad
by The Other Katherine Harris
Featured Writer
Dandelion Salad
Feb. 21, 2009
It’s a question I’ve heard frequently during the past few days - and I know that my friend who keeps asking it is far from alone in feeling greater outrage about public aid to homeowners than about the far larger sums we’re handing to financial elites who already grabbed trillions of dollars while wrecking the global economy.
Probably you’ve also appealed to friends to direct their wrath more appropriately at the banksters; their affiliated hedge-hogs and buyout vultures; and the governments which have been and continue to be their puppets. My friend theoretically grasps the wisdom of that, but still he seethes more furiously over any little break given to ordinary folks. He’s especially upset by the idea that an owner might receive $5,000 for keeping the adjusted payments current over a period of years.
That must be partly because we understand $5,000. Few can get their heads around millions and billions, let alone trillions, but we all know what $5,000 will buy. Its value to us varies with circumstances, of course. The privileged set drop that much on a handbag, while it would solve or significantly lessen many people’s urgent problems and, for many more, it would provide a welcome emergency fund or a special treat. Spent wisely, it could supply a life-changing chance for education or to launch a business.
For my friend, as for most of us, it’s not a princely sum but worth having. So it’s understandable that someone who’s always been able to pay his bills would resent its being given to somebody else, simply for paying up. This just doesn’t seem fair to him.
Neither does spending $275 billion to subsidize mortgages — which is how my friend views the program, never mind that homeowners won’t see a penny of the funds paid to incentivize lower interest rates from banks and to expand Fannie and Freddie. Nor will homeowners see any reduction in their mortgage principal. In fact, the plan does lots more for lenders and speculators in mortgage securities than for homeowners, but my friend isn’t fretting about that part of the deal (the part that galls me). What we know so far about how it will actually work is explained excellently HERE.
When my friend - who bought his house for a pittance 30 years ago and is now very comfortably retired — fumes with “where’s mine?” indignation, it isn’t becoming, but it’s certainly natural. Something in us cries out against obvious inequity. Even animals are profoundly distressed when rewarded differently from others performing the same task, as studies of dogs and monkeys have shown.
It’s a pity we have such trouble transferring our inherent sense of justice to inequities that aren’t precisely in our faces. Because they don’t move in our circles, we’ve allowed the rich and powerful to operate as if they’re a separate species not subject to normal standards — and, while they’ve been busily robbing us blind for a generation, we’ve taken their bait as they set us covetously against one another.
For instance, my friend bought their anti-union line and is a hard-core champion of free trade, so he opposes “Buy American” rules and the Employee Free Choice Act, wailing, “Pretty soon it would cost $100 to buy a shirt!” And yet he sees the decline of opportunity in America clearly enough to say, “I don’t know what I’d do, if I were young now, maybe emigrate or raise an army.” Despite being kind and generous in his personal life, he doesn’t think twice about patronizing big box stores that routinely exploit workers and states, “I vote my pocketbook,” without an ounce of shame. There are further ways in which he’s conflicted — such as:
decrying “socialized medicine” while lauding the quality of VA care (which he continues to enjoy free, courtesy of his first career);
endorsing rampant privatization of government functions, although most of his benefits in retirement derive from holding good federal jobs;
expressing scorn for liberals, while being appalled by the religious right and eager to bring back all our troops and habeas corpus;
supporting both the Sierra Club and the National Rifle Association; and
having a life-long distrust of Wall Street and a degree in economics, among other fields, but not bothering to dig beneath corporate media’s blame-the-victim accounts of the present crisis.
Of course, we’re all masses of contradictions, riddled with blind spots. And, even as we strive to discard old habits of thought, learn more and fit the pieces into a coherent picture, we’ll find it distorted at times by fits of selfishness and stubbornness that reduce us to toddlers refusing to share. This grasping, egocentric attitude has, unfortunately, been encouraged since the rise of Reagan, with the result that behavior we wouldn’t permit for long in a two-year-old we often tolerate in ourselves — at least in our civic selves.
Perhaps, by the same means that banished ethnic slurs and sexist remarks from polite discourse, we could make it just as unacceptable to speak for avarice. I’m going to give it a whirl. The next time I hear that whine about paying somebody else’s mortgage, I’ll skip the usual recital of contradictory facts and even the moral arguments - and, instead, try a horrified stare, then an earnest, “I’m sure you didn’t MEAN to sound so greedy.”
I’ll let you know how it goes.
see
Obama’s mortgage plan aims to bolster the banks + Obama’s plan + transcript
Exclusive: Derivatives for Dummies by The Other Katherine Harris
Banking on Credit Unions by Ralph Nader
The Other Katherine Harris
The Economy Sucks and or Collapse 2
by jingofever » Tue Feb 24, 2009 6:22 pm
by mulebone » Tue Feb 24, 2009 7:52 pm
Does this also validate my growing impression that this catastrophe is borne of idiots? The more I see of it, the more convinced I am that Wall Street's rise was based on the ability to believe baseless lies.
History always contains the right lessons if you know where to look. Perhaps the bankers should have spent less time inventing new ways of making paper or electronic money and more time contemplating Beanie Babies.
As far as I am concerned, staking my child’s future education fees or my pension pot on an investment in small cuddly toys with names like Weenie, Spunky, Dotty and Gigi seems like madness. However, that is exactly what many Americans did during the late 1990s. With the full benefit of hindsight, it was, indeed, madness.
The original Beanies cost .99, but the Beanie craze saw second-hand prices for rare or scarce Beanies increase to anything approaching 5,000. But it was not enough for the market to cater for rare and scarce Beanie Babies; inflated prices were obtained for all Beanie Babies, even when the market was flooded with the dumpy little things. As Beanie Babies began to change hands for ever-increasing amounts, they came to be considered an investment. In the rush to be part of this opportunity, desperate investors began to pay ever more desperate prices. Beanie Babies were bought and sold on the basis of expectation of profit rather than the value for sale to a final loving owner.
''It is impossible to comprehend the tulip mania without understanding just how different tulips were from every other flower known to horticulturists in the 17th century,'' says Dash. ''The colors they exhibited were more intense and more concentrated than those of ordinary plants.'' Despite the outlandish prices commanded by rare bulbs, ordinary tulips were sold by the pound. Around 1630, however, a new type of tulip fancier appeared, lured by tales of fat profits. These ''florists,'' or professional tulip traders, sought out flower lovers and speculators alike. But if the supply of tulip buyers grew quickly, the supply of bulbs did not. The tulip was a conspirator in the supply squeeze: It takes seven years to grow one from seed. And while bulbs can produce two or three clones, or ''offsets,'' annually, the mother bulb only lasts a few years.
Bulb prices rose steadily throughout the 1630s, as ever more speculators wedged into the market. Weavers and farmers mortgaged whatever they could to raise cash to begin trading. In 1633, a farmhouse in Hoorn changed hands for three rare bulbs. By 1636 any tulip--even bulbs recently considered garbage--could be sold off, often for hundreds of guilders. A futures market for bulbs existed, and tulip traders could be found conducting their business in hundreds of Dutch taverns. Tulip mania reached its peak during the winter of 1636-37, when some bulbs were changing hands ten times in a day. The zenith came early that winter, at an auction to benefit seven orphans whose only asset was 70 fine tulips left by their father. One, a rare Violetten Admirael van Enkhuizen bulb that was about to split in two, sold for 5,200 guilders, the all-time record. All told, the flowers brought in nearly 53,000 guilders.
Soon after, the tulip market crashed utterly, spectacularly. It began in Haarlem, at a routine bulb auction when, for the first time, the greater fool refused to show up and pay. Within days, the panic had spread across the country. Despite the efforts of traders to prop up demand, the market for tulips evaporated. Flowers that had commanded 5,000 guilders a few weeks before now fetched one-hundredth that amount.
by JackRiddler » Tue Feb 24, 2009 11:28 pm
Recipe for Disaster: The Formula That Killed Wall Street
By Felix Salmon 02.23.09
In the mid-'80s, Wall Street turned to the quants—brainy financial engineers—to invent new ways to boost profits. Their methods for minting money worked brilliantly... until one of them devastated the global economy.
Photo: Jim Krantz/Gallery Stock
In the mid-'80s, Wall Street turned to the quants—brainy financial engineers—to invent new ways to boost profits. Their methods for minting money worked brilliantly... until one of them devastated the global economy.
Photo: Jim Krantz/Gallery Stock
Road Map for Financial Recovery: Radical Transparency Now!
A year ago, it was hardly unthinkable that a math wizard like David X. Li might someday earn a Nobel Prize. After all, financial economists—even Wall Street quants—have received the Nobel in economics before, and Li's work on measuring risk has had more impact, more quickly, than previous Nobel Prize-winning contributions to the field. Today, though, as dazed bankers, politicians, regulators, and investors survey the wreckage of the biggest financial meltdown since the Great Depression, Li is probably thankful he still has a job in finance at all. Not that his achievement should be dismissed. He took a notoriously tough nut—determining correlation, or how seemingly disparate events are related—and cracked it wide open with a simple and elegant mathematical formula, one that would become ubiquitous in finance worldwide.
For five years, Li's formula, known as a Gaussian copula function, looked like an unambiguously positive breakthrough, a piece of financial technology that allowed hugely complex risks to be modeled with more ease and accuracy than ever before. With his brilliant spark of mathematical legerdemain, Li made it possible for traders to sell vast quantities of new securities, expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond investors and Wall Street banks to ratings agencies and regulators. And it became so deeply entrenched—and was making people so much money—that warnings about its limitations were largely ignored.
Then the model fell apart. Cracks started appearing early on, when financial markets began behaving in ways that users of Li's formula hadn't expected. The cracks became full-fledged canyons in 2008—when ruptures in the financial system's foundation swallowed up trillions of dollars and put the survival of the global banking system in serious peril.
David X. Li, it's safe to say, won't be getting that Nobel anytime soon. One result of the collapse has been the end of financial economics as something to be celebrated rather than feared. And Li's Gaussian copula formula will go down in history as instrumental in causing the unfathomable losses that brought the world financial system to its knees.
How could one formula pack such a devastating punch? The answer lies in the bond market, the multitrillion-dollar system that allows pension funds, insurance companies, and hedge funds to lend trillions of dollars to companies, countries, and home buyers.
A bond, of course, is just an IOU, a promise to pay back money with interest by certain dates. If a company—say, IBM—borrows money by issuing a bond, investors will look very closely over its accounts to make sure it has the wherewithal to repay them. The higher the perceived risk—and there's always some risk—the higher the interest rate the bond must carry.
Bond investors are very comfortable with the concept of probability. If there's a 1 percent chance of default but they get an extra two percentage points in interest, they're ahead of the game overall—like a casino, which is happy to lose big sums every so often in return for profits most of the time.
Bond investors also invest in pools of hundreds or even thousands of mortgages. The potential sums involved are staggering: Americans now owe more than $11 trillion on their homes. But mortgage pools are messier than most bonds. There's no guaranteed interest rate, since the amount of money homeowners collectively pay back every month is a function of how many have refinanced and how many have defaulted. There's certainly no fixed maturity date: Money shows up in irregular chunks as people pay down their mortgages at unpredictable times—for instance, when they decide to sell their house. And most problematic, there's no easy way to assign a single probability to the chance of default.
Wall Street solved many of these problems through a process called tranching, which divides a pool and allows for the creation of safe bonds with a risk-free triple-A credit rating. Investors in the first tranche, or slice, are first in line to be paid off. Those next in line might get only a double-A credit rating on their tranche of bonds but will be able to charge a higher interest rate for bearing the slightly higher chance of default. And so on.
"...correlation is charlatanism"
Photo: AP photo/Richard Drew
The reason that ratings agencies and investors felt so safe with the triple-A tranches was that they believed there was no way hundreds of homeowners would all default on their loans at the same time. One person might lose his job, another might fall ill. But those are individual calamities that don't affect the mortgage pool much as a whole: Everybody else is still making their payments on time.
But not all calamities are individual, and tranching still hadn't solved all the problems of mortgage-pool risk. Some things, like falling house prices, affect a large number of people at once. If home values in your neighborhood decline and you lose some of your equity, there's a good chance your neighbors will lose theirs as well. If, as a result, you default on your mortgage, there's a higher probability they will default, too. That's called correlation—the degree to which one variable moves in line with another—and measuring it is an important part of determining how risky mortgage bonds are.
Investors like risk, as long as they can price it. What they hate is uncertainty—not knowing how big the risk is. As a result, bond investors and mortgage lenders desperately want to be able to measure, model, and price correlation. Before quantitative models came along, the only time investors were comfortable putting their money in mortgage pools was when there was no risk whatsoever—in other words, when the bonds were guaranteed implicitly by the federal government through Fannie Mae or Freddie Mac.
Yet during the '90s, as global markets expanded, there were trillions of new dollars waiting to be put to use lending to borrowers around the world—not just mortgage seekers but also corporations and car buyers and anybody running a balance on their credit card—if only investors could put a number on the correlations between them. The problem is excruciatingly hard, especially when you're talking about thousands of moving parts. Whoever solved it would earn the eternal gratitude of Wall Street and quite possibly the attention of the Nobel committee as well.
To understand the mathematics of correlation better, consider something simple, like a kid in an elementary school: Let's call her Alice. The probability that her parents will get divorced this year is about 5 percent, the risk of her getting head lice is about 5 percent, the chance of her seeing a teacher slip on a banana peel is about 5 percent, and the likelihood of her winning the class spelling bee is about 5 percent. If investors were trading securities based on the chances of those things happening only to Alice, they would all trade at more or less the same price.
But something important happens when we start looking at two kids rather than one—not just Alice but also the girl she sits next to, Britney. If Britney's parents get divorced, what are the chances that Alice's parents will get divorced, too? Still about 5 percent: The correlation there is close to zero. But if Britney gets head lice, the chance that Alice will get head lice is much higher, about 50 percent—which means the correlation is probably up in the 0.5 range. If Britney sees a teacher slip on a banana peel, what is the chance that Alice will see it, too? Very high indeed, since they sit next to each other: It could be as much as 95 percent, which means the correlation is close to 1. And if Britney wins the class spelling bee, the chance of Alice winning it is zero, which means the correlation is negative: -1.
If investors were trading securities based on the chances of these things happening to both Alice and Britney, the prices would be all over the place, because the correlations vary so much.
But it's a very inexact science. Just measuring those initial 5 percent probabilities involves collecting lots of disparate data points and subjecting them to all manner of statistical and error analysis. Trying to assess the conditional probabilities—the chance that Alice will get head lice if Britney gets head lice—is an order of magnitude harder, since those data points are much rarer. As a result of the scarcity of historical data, the errors there are likely to be much greater.
In the world of mortgages, it's harder still. What is the chance that any given home will decline in value? You can look at the past history of housing prices to give you an idea, but surely the nation's macroeconomic situation also plays an important role. And what is the chance that if a home in one state falls in value, a similar home in another state will fall in value as well?
Here's what killed your 401(k) David X. Li's Gaussian copula function as first published in 2000. Investors exploited it as a quick—and fatally flawed—way to assess risk. A shorter version appears on this month's cover of Wired.
Probability
Specifically, this is a joint default probability—the likelihood that any two members of the pool (A and B) will both default. It's what investors are looking for, and the rest of the formula provides the answer.
Survival times
The amount of time between now and when A and B can be expected to default. Li took the idea from a concept in actuarial science that charts what happens to someone's life expectancy when their spouse dies.
Equality
A dangerously precise concept, since it leaves no room for error. Clean equations help both quants and their managers forget that the real world contains a surprising amount of uncertainty, fuzziness, and precariousness.
Copula
This couples (hence the Latinate term copula) the individual probabilities associated with A and B to come up with a single number. Errors here massively increase the risk of the whole equation blowing up.
Distribution functions
The probabilities of how long A and B are likely to survive. Since these are not certainties, they can be dangerous: Small miscalculations may leave you facing much more risk than the formula indicates.
Gamma
The all-powerful correlation parameter, which reduces correlation to a single constant—something that should be highly improbable, if not impossible. This is the magic number that made Li's copula function irresistible.
Enter Li, a star mathematician who grew up in rural China in the 1960s. He excelled in school and eventually got a master's degree in economics from Nankai University before leaving the country to get an MBA from Laval University in Quebec. That was followed by two more degrees: a master's in actuarial science and a PhD in statistics, both from Ontario's University of Waterloo. In 1997 he landed at Canadian Imperial Bank of Commerce, where his financial career began in earnest; he later moved to Barclays Capital and by 2004 was charged with rebuilding its quantitative analytics team.
Li's trajectory is typical of the quant era, which began in the mid-1980s. Academia could never compete with the enormous salaries that banks and hedge funds were offering. At the same time, legions of math and physics PhDs were required to create, price, and arbitrage Wall Street's ever more complex investment structures.
In 2000, while working at JPMorgan Chase, Li published a paper in The Journal of Fixed Income titled "On Default Correlation: A Copula Function Approach." (In statistics, a copula is used to couple the behavior of two or more variables.) Using some relatively simple math—by Wall Street standards, anyway—Li came up with an ingenious way to model default correlation without even looking at historical default data. Instead, he used market data about the prices of instruments known as credit default swaps.
If you're an investor, you have a choice these days: You can either lend directly to borrowers or sell investors credit default swaps, insurance against those same borrowers defaulting. Either way, you get a regular income stream—interest payments or insurance payments—and either way, if the borrower defaults, you lose a lot of money. The returns on both strategies are nearly identical, but because an unlimited number of credit default swaps can be sold against each borrower, the supply of swaps isn't constrained the way the supply of bonds is, so the CDS market managed to grow extremely rapidly. Though credit default swaps were relatively new when Li's paper came out, they soon became a bigger and more liquid market than the bonds on which they were based.
When the price of a credit default swap goes up, that indicates that default risk has risen. Li's breakthrough was that instead of waiting to assemble enough historical data about actual defaults, which are rare in the real world, he used historical prices from the CDS market. It's hard to build a historical model to predict Alice's or Britney's behavior, but anybody could see whether the price of credit default swaps on Britney tended to move in the same direction as that on Alice. If it did, then there was a strong correlation between Alice's and Britney's default risks, as priced by the market. Li wrote a model that used price rather than real-world default data as a shortcut (making an implicit assumption that financial markets in general, and CDS markets in particular, can price default risk correctly).
It was a brilliant simplification of an intractable problem. And Li didn't just radically dumb down the difficulty of working out correlations; he decided not to even bother trying to map and calculate all the nearly infinite relationships between the various loans that made up a pool. What happens when the number of pool members increases or when you mix negative correlations with positive ones? Never mind all that, he said. The only thing that matters is the final correlation number—one clean, simple, all-sufficient figure that sums up everything.
The effect on the securitization market was electric. Armed with Li's formula, Wall Street's quants saw a new world of possibilities. And the first thing they did was start creating a huge number of brand-new triple-A securities. Using Li's copula approach meant that ratings agencies like Moody's—or anybody wanting to model the risk of a tranche—no longer needed to puzzle over the underlying securities. All they needed was that correlation number, and out would come a rating telling them how safe or risky the tranche was.
As a result, just about anything could be bundled and turned into a triple-A bond—corporate bonds, bank loans, mortgage-backed securities, whatever you liked. The consequent pools were often known as collateralized debt obligations, or CDOs. You could tranche that pool and create a triple-A security even if none of the components were themselves triple-A. You could even take lower-rated tranches of other CDOs, put them in a pool, and tranche them—an instrument known as a CDO-squared, which at that point was so far removed from any actual underlying bond or loan or mortgage that no one really had a clue what it included. But it didn't matter. All you needed was Li's copula function.
The CDS and CDO markets grew together, feeding on each other. At the end of 2001, there was $920 billion in credit default swaps outstanding. By the end of 2007, that number had skyrocketed to more than $62 trillion. The CDO market, which stood at $275 billion in 2000, grew to $4.7 trillion by 2006.
At the heart of it all was Li's formula. When you talk to market participants, they use words like beautiful, simple, and, most commonly, tractable. It could be applied anywhere, for anything, and was quickly adopted not only by banks packaging new bonds but also by traders and hedge funds dreaming up complex trades between those bonds.
"The corporate CDO world relied almost exclusively on this copula-based correlation model," says Darrell Duffie, a Stanford University finance professor who served on Moody's Academic Advisory Research Committee. The Gaussian copula soon became such a universally accepted part of the world's financial vocabulary that brokers started quoting prices for bond tranches based on their correlations. "Correlation trading has spread through the psyche of the financial markets like a highly infectious thought virus," wrote derivatives guru Janet Tavakoli in 2006.
The damage was foreseeable and, in fact, foreseen. In 1998, before Li had even invented his copula function, Paul Wilmott wrote that "the correlations between financial quantities are notoriously unstable." Wilmott, a quantitative-finance consultant and lecturer, argued that no theory should be built on such unpredictable parameters. And he wasn't alone. During the boom years, everybody could reel off reasons why the Gaussian copula function wasn't perfect. Li's approach made no allowance for unpredictability: It assumed that correlation was a constant rather than something mercurial. Investment banks would regularly phone Stanford's Duffie and ask him to come in and talk to them about exactly what Li's copula was. Every time, he would warn them that it was not suitable for use in risk management or valuation.
David X. Li
Illustration: David A. Johnson
In hindsight, ignoring those warnings looks foolhardy. But at the time, it was easy. Banks dismissed them, partly because the managers empowered to apply the brakes didn't understand the arguments between various arms of the quant universe. Besides, they were making too much money to stop.
In finance, you can never reduce risk outright; you can only try to set up a market in which people who don't want risk sell it to those who do. But in the CDO market, people used the Gaussian copula model to convince themselves they didn't have any risk at all, when in fact they just didn't have any risk 99 percent of the time. The other 1 percent of the time they blew up. Those explosions may have been rare, but they could destroy all previous gains, and then some.
Li's copula function was used to price hundreds of billions of dollars' worth of CDOs filled with mortgages. And because the copula function used CDS prices to calculate correlation, it was forced to confine itself to looking at the period of time when those credit default swaps had been in existence: less than a decade, a period when house prices soared. Naturally, default correlations were very low in those years. But when the mortgage boom ended abruptly and home values started falling across the country, correlations soared.
Bankers securitizing mortgages knew that their models were highly sensitive to house-price appreciation. If it ever turned negative on a national scale, a lot of bonds that had been rated triple-A, or risk-free, by copula-powered computer models would blow up. But no one was willing to stop the creation of CDOs, and the big investment banks happily kept on building more, drawing their correlation data from a period when real estate only went up.
"Everyone was pinning their hopes on house prices continuing to rise," says Kai Gilkes of the credit research firm CreditSights, who spent 10 years working at ratings agencies. "When they stopped rising, pretty much everyone was caught on the wrong side, because the sensitivity to house prices was huge. And there was just no getting around it. Why didn't rating agencies build in some cushion for this sensitivity to a house-price-depreciation scenario? Because if they had, they would have never rated a single mortgage-backed CDO."
Bankers should have noted that very small changes in their underlying assumptions could result in very large changes in the correlation number. They also should have noticed that the results they were seeing were much less volatile than they should have been—which implied that the risk was being moved elsewhere. Where had the risk gone?
They didn't know, or didn't ask. One reason was that the outputs came from "black box" computer models and were hard to subject to a commonsense smell test. Another was that the quants, who should have been more aware of the copula's weaknesses, weren't the ones making the big asset-allocation decisions. Their managers, who made the actual calls, lacked the math skills to understand what the models were doing or how they worked. They could, however, understand something as simple as a single correlation number. That was the problem.
"The relationship between two assets can never be captured by a single scalar quantity," Wilmott says. For instance, consider the share prices of two sneaker manufacturers: When the market for sneakers is growing, both companies do well and the correlation between them is high. But when one company gets a lot of celebrity endorsements and starts stealing market share from the other, the stock prices diverge and the correlation between them turns negative. And when the nation morphs into a land of flip-flop-wearing couch potatoes, both companies decline and the correlation becomes positive again. It's impossible to sum up such a history in one correlation number, but CDOs were invariably sold on the premise that correlation was more of a constant than a variable.
No one knew all of this better than David X. Li: "Very few people understand the essence of the model," he told The Wall Street Journal way back in fall 2005.
"Li can't be blamed," says Gilkes of CreditSights. After all, he just invented the model. Instead, we should blame the bankers who misinterpreted it. And even then, the real danger was created not because any given trader adopted it but because every trader did. In financial markets, everybody doing the same thing is the classic recipe for a bubble and inevitable bust.
Nassim Nicholas Taleb, hedge fund manager and author of The Black Swan, is particularly harsh when it comes to the copula. "People got very excited about the Gaussian copula because of its mathematical elegance, but the thing never worked," he says. "Co-association between securities is not measurable using correlation," because past history can never prepare you for that one day when everything goes south. "Anything that relies on correlation is charlatanism."
Li has been notably absent from the current debate over the causes of the crash. In fact, he is no longer even in the US. Last year, he moved to Beijing to head up the risk-management department of China International Capital Corporation. In a recent conversation, he seemed reluctant to discuss his paper and said he couldn't talk without permission from the PR department. In response to a subsequent request, CICC's press office sent an email saying that Li was no longer doing the kind of work he did in his previous job and, therefore, would not be speaking to the media.
In the world of finance, too many quants see only the numbers before them and forget about the concrete reality the figures are supposed to represent. They think they can model just a few years' worth of data and come up with probabilities for things that may happen only once every 10,000 years. Then people invest on the basis of those probabilities, without stopping to wonder whether the numbers make any sense at all.
As Li himself said of his own model: "The most dangerous part is when people believe everything coming out of it."
— Felix Salmon (felix@felixsalmon.com) writes the Market Movers financial blog at Portfolio.com.
by freemason9 » Tue Feb 24, 2009 11:42 pm
by JackRiddler » Wed Feb 25, 2009 12:44 am
February 23, 2009
The Cooperative Model
How Credit Unions Survived the Crash
By RALPH NADER
While the reckless giant banks are shattering like an over-heated glacier day by day, the nation's credit unions are a relative island of calm largely apart from the vortex of casino capitalism.
Eighty five million Americans belong to credit unions which are not-for-profit cooperatives owned by their members who are depositors and borrowers. Your neighborhood or workplace credit union did not invest in these notorious speculative derivatives nor did they offer people 'teaser rates' to sign on for a home mortgage they could not afford.
Ninety one percent of the 8,000 credit unions are reporting greater overall growth in mortgage lending than any other kinds of consumer loans they are extending. They are federally insured by the National Credit Union Administration (NCUA) for up to $250,000 per account, such as the FDIC does for depositors in commercial banks.
They are well-capitalized because of regulation and because they do not have an incentive to go for high-risk, highly leveraged speculation to increase stock values and the value of the bosses' stock options as do the commercial banks.
Credit Unions have no shareholders nor stock nor stock options; they are responsible to their owner-members who are their customers.
There are even some special low-income credit unions -- thought not nearly enough -- to stimulate economic activities in these communities and to provide banking services in areas where poor people can't afford or are not provided services by commercial banks.
According to Mike Schenk, an economist with the Credit Union National Association, there is another reason why credit unions avoided the mortgage debacle that is consuming the big banks.
Credit Unions, Schenk says, are "portfolio lenders. That means they hold in their portfolios most of the loans they originate instead of selling them to investors, so they care about the financial performance of those loans."
Mr. Schenk allowed that with the deepening recession, credit unions are not making as much surplus and "their asset quality has deteriorated a bit. But that's the beauty of the credit union model. Credit unions can live with those conditions without suffering dire consequences," he asserted.
His use of the word 'model' is instructive. In recent decades, credit unions sometimes leaned toward commercial bank practices instead of strict cooperative principles. They developed a penchant for mergers into larger and larger credit unions. Some even toyed with converting out of the cooperative model into the shareholder model the way insurance and bank mutuals have done.
The cooperative model -- whether in finance, food, housing or any other sector of the economy -- does best when the owner-cooperators are active in the general operations and directions of their co-op. Passive owners allow managers to stray or contemplate straying from cooperative practices.
The one area that is now spelling some trouble for retail cooperatives comes from the so-called "corporate credit unions" -- a terrible nomenclature -- which were established to provide liquidity for the retail credit unions. These large wholesale credit unions are not exactly infused with the cooperative philosophy. Some of them gravitate toward the corporate banking model. They invested in those risky mortgage securities with the money from the retail credit unions. These "toxic assets" have fallen $14 billion among the 28 corporate credit unions involved.
So the National Credit Union Administration is expanding its lending programs to these corporate credit unions to a maximum capacity of $41.5 billion. NCUA also wants to have retail credit unions qualified for the TARP rescue program just to provide a level playing field with the commercial banks.
Becoming more like investment banks the wholesale credit unions wanted to attract, with ever higher riskier yields, more of the retail credit union deposits. This set the stage for the one major blemish of imprudence on the credit union subeconomy.
There are very contemporary lessons to be learned from the successes of the credit union model such as being responsive to consumer loan needs and down to earth with their portfolios. Yet in all the massive media coverage of the Wall Street barons and their lethal financial escapades, crimes and frauds, little is being written about how the regulation, philosophy and behavior of the credit unions largely escaped this catastrophe.
There is, moreover, a lesson for retail credit unions. Beware and avoid the seepage or supremacy of the corporate financial model which, in its present degraded overly complex and abstract form, has become what one prosecutor called "lying, cheating and stealing" in fancy clothing.
Ralph Nader is a consumer advocate and three-time presidential candidate.
by Hugh Manatee Wins » Wed Feb 25, 2009 1:32 am
by Nordic » Wed Feb 25, 2009 3:46 am
by Penguin » Wed Feb 25, 2009 4:52 am
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