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June 05, 2008

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Rick Ballard

So, are the Lehman counterparties, the ones exiting, that is, privy to information which has not been provided to the "trading public" as a whole due to inadequate regulation?

I wonder if JPM's tummy has settled down sufficiently to be able to gobble up Lehman as they did Bear Stearns?

DES

The CFTC investigation was started over food prices. They added to the oil because no one wants to pay for their drug.

DES

The CFTC investigation was started over food prices. They added to the oil because no one wants to pay for their drug.

DES

The posting ruins the web and you can't use the back button.

Anyway, the point of the investigation of the oil is the lobby tried to tie food prices into oil prices, so they investigate food and oil commodity exchanges saying the prices should go down. All the prices go up when they investigate and always have; so watch oil and food go higher. The key to oil is not transport of the food, but the refining. Oil from food. So, more refineries, but we can't because of national security and the producers can't because of national security. So, food becomes a national security issue like the climate and we start a new intelligence agency after they give Congress a favorable report like the Geo spacial intelligence agency. We could call it the Food Security Intelligence Agency after the bills override. We can hire all those lobbyists that ran up the price.

The and Arnold is in trouble cause he didn't stop Colorado from having to pay full price for the Damn work and they had to use matching funds. California doesn't care about food, just their houses.

Charlie (Colorado)

Is there a memo circulating to push this Gramm-McCain attack line?

Nah, y'think?

Clarice

I take it this is this election's Halliburton...
Throw in some mumbo jumbo and names of big corporations, accuse the Rep candidate or people close to him of something really bad with a big corporation and rest assured the muddled press and voters will fall for it like a ton of twits.

boris

rest assured the muddled press and voters will fall for it like a ton of twits

Against muddle twittery even the gods JMH would struggle in vain

vnjagvet

Tom:

Thanks for understanding this and explaining it.

Clarice:

If this is the latest Halliburton, good luck to the Corn's of this world getting it across to JQ Sixpack, et al. Personally, I don't think it is a bit complicated to take hold as a general election issue. It happened under Clinton's watch. Where's the hook into McCain?

glasater

TM--Thank you for doing yeoman's work in writing this post. The talking heads at CNBC could use you as a guest host:-)

I await Cathf's comment/s and her "take" on this subject.

bgates

vnjagvet -
64 TRILLION DOLLARS mumble mumble RISING TIDE OF FORECLOSURES mutter mutter MCCAIN, MEMBER OF 'KEATING FIVE' mumble mumble KEN LAY mutter mutter REPUBLICAN mumble mumble....
Who says the hook has to make sense?

vnjagvet

Yeah you're right, bgates. [slaps head exiting stage left]

cathyf

A couple of additions/clarifications:

1) The whole reassignment thing can happen all at once when the swap is originated. Example: Suppose the parties are Customer, AABank and AAABank. A salescritter from AABank goes out and sells some derivative to Customer. But the derivative is structured as a transaction between Customer and AAABank, with an identical position between AAABank and AABank. Customer pays more for the derivative because of the triple-A credit rating as opposed to the double-A credit rating. AABank and AAABank split the difference between the double-A and triple-A price according to whatever they hammer out. Typically, the two banks will have an extensive series of motley and assorted positions between them, so a key question will be whether the new position adds to the credit risk that they have with each other, or it reduces the exposure that they have to each other (which is the job of the portfolio risk managers to figure out.)

2) As can be seen in the previous example, an institution's credit rating converts into cash on the barrelhead. The assertion that they are "unregulated" because some particular bunch of bureaucrats from some particular agency of some particular government doesn't have oversight is downright silly. The key regulators of the global financial system are the credit rating agencies. (And the reason that we have a mortgage market debacle is precisely because the rating companies fell down on the job on a massive scale.)

3) It's not just that foreign banks are involved in these transactions, but even foreign governments. (Sovereign risk is better than triple-A for most 1st world countries.) Any congresscritter who thinks that we can send the American CFTC to audit the books of a European government's treasury needs a whack upside the head with a clue-by-4.

4) (this is picyune...) Phil Gramm says: "When I heard the number as we first started discussing this issue, I was convinced that an error had been made and that someone had mistakenly said trillions instead of billions; I was wrong." I think he was probably right the first time, in that people exaggerate the value of the derivatives market by conflating valuation with notional amounts. Take a typical fixed-for-floating interest-rate swap. Typically, they are put on such that they are worth zero at the beginning. Suppose the floating rate is 2% at the beginning. Then at the first 6-mo coupon it has slipped to 1.875%, so party A pays party B 0.125% of notional. That's 625 million. Then the next coupon comes and the rates are back at 2%, and so the coupon is zero. And then the next coupon, and the interest rate goes to 2.0625%, and now party B is paying party A 325 million. All of a sudden we've gone from a trillion to a couple hundred million.

The whole point of swaps is that they have offsetting sides made up of things which are close, but not exact, substitutes for each other. Because they are such close substitutes, the value of the position has to be orders of magnitude smaller than the value of the underlying notional amount.

glasater

Cathyf--I knew you would come through:-)

Don

Corns makes a huge deal of the Commodity Modernization Act while he conveniently downplays the repeal of Glass-Steagall. Corn quotes Greenberger, who pretends as if his version of the CMA actually had a chance at passing. Then Corn implies that Gramm gamed the system to have a toothless CMA passed into law. That's bull***t. There's no way that Greenberger's version of the CMA was EVER going to allow the CFTC authorization to regulate OTC derivatives. Corn and Greenberger ignore the fact that the SEC, President Clinton, Greenspan, and Rubin were ALL against it. They were afraid that if the US regulated OTC derivatives, the US would lose all of that business to London, which has happened to large degree anyway.

What Corn downplays is the repeal of Glass-Steagall, signed into law by President Clinton in 1999. The law that repealed Glass-Steagall allowed companies with insured bank deposits to merge with investment banks/brokers, which allowed financial supermarkets like Citigroup and others with FDIC-insured deposits to become huge players in the deregulated OTC derivatives market.

What's really interesting is how Corn downplays this, even when the act that repealed Glass-Steagall is called the Gramm-Leach-Bliley Act. The act has Gramm's name on it for crying out loud. Why isn't Corn going nuts over this legislation??

trilobite

cathyf, IANAE, and no doubt you understand more about credit swaps than I do. But how exactly do you figure that private industry, credit rating agencies, are "regulators"? They can't give orders, nobody oversees them, they don't issue guidelines (just ratings) - this seems unlike regulation as I know it. And why is it "downright silly" to say that when Congress orders the agency that normally regulates securities not to regulate these securities, they are "unregulated"? Sounds more like the ordinary meaning of English words to me. Not regulated by the appropriate agency = unregulated. You don't explain or even hint at why this is wrong, much less "downright silly."

And what's with the mockery of "some particular bunch of bureaucrats from some particular agency of some particular government"? Is there some other bunch of bureaucrats that would be better? Is regulation best acccomplished by having ALL the bureaucrats of ALL the agencies of ALL the governments weigh in? That seems, um, downright silly. Perhaps I am missing something.

Or perhaps you just despise regulation and are trying to pretend that it has no place in the market?

Tom, your post is somewhat reassuring, but I still don't see why it was necessary to take what look to a layman like some kind of securities and exempt them from securities regulation. I'm sure it made trades easier, but only by removing the usual methods of oversight and verification of assets.

Your reasoning seems to boil down to, nobody would ever be that stupid, and if they were it would show up somewhere else eventually, so we might as well not take precautions. The same reasoning would, of course, support abandoning any particular safety feature in any field. Yet it turns out people often are that stupid, and eventually is often too late. Why is it especially helpful to have no direct regulation in this particular market?

Rick Ballard

Trilobite,

Credit rating agencies perform the most ruthless form of regulation in existence when they are functioning properly. They have also functioned at least as well (please read "much better") than the regulators who bend to the whisper of a pol.

If you don't believe that credit raters exaction of a pound of flesh for misconduct is ruthless, then you haven't paid attention as value of a company which misteps is decimated overnight.

cathyf
Congress orders the agency that normally regulates securities not to regulate these securities
That's the "downright silly" part... If you have Deutsche Bank marketting a EUR-JPY FX swap to a Japanese company, with the Lichtenstein treasury acting as the counterparty to both sides for a fixed cut of the profit, then "Congress" (as in the US Congress) and "the agency that normally regulates securities" would have no place there. You know, since Germany, Japan and even Lichtenstein are sovereign nations and don't take kindly to us ugly Americans sticking our noses in their business.
cathyf

Rick, it's not just the "decimation" function, which is the blunt instrument form of behavior modification, and closer to what regulators do. With regulators, the institutions's practices are graded on a pass/fail system -- either they are fine, or the institution has to stop them. With the rating agencies there are lots of gradations of scale. Being a double-A rated institution is fine and honorable, but you make a little less money on every trade than if you are triple-A rated.

Credit ratings are a far more delicate instrument than any regulatory regime. (Well, than any financial regulatory scheme. County health department inspections with their numeric scores are pretty detailed, too.)

trilobite

cathyf, thanks for the response. I do understand that a lower credit rating can put a big hurtin' on a company, and that a CRA can modulate the level of pain. OTOH, regulators can go after very specific misconduct, prescribe remedies, force transparency, and anticipate trouble from failure to follow the rules. That last has its downside, but it is liable to catch problems before a credit agency would notice it, especially if the CRA has no filings to review. There's also the problem that the credit agency has no oversight. You say S&P failed - okay, what is the consequence to S&P? Probably none, especially since there's not really much competition in that field.

There may be a good argument for why CRAs are so good at this that regulation is unnecessary, but I haven't heard it here so far. What you seem to be saying is, CRAs screwed up, they won't suffer for it, but they're still better than regulation because they are so good at what they do. Huh?

As for your Deutsche Bank/Japan/Lichtenstein question, surely you are not saying that all credit swaps are among foreign entities. May we not at least regulate our own entities?

Forbes

ZZZZZZZZZZzzzzzzzzzzzzubbubhuhgulp...Gee Tom, this is almost as interesting as one of your old Plame Name Blame Game Flame-outs! But I'll try to stay awake during class, promise.

Actually, a quite good description of the CDS market machinations. And a nice assist by Cathyf.

And yeah, pretty late in the day ('08) to talk about happenings when Larry Summers was Treasury Secretary. Those are my favorite Republican conspiracies.

Has David Corn ever been right about any of these bombshells he launches?

cathyf
surely you are not saying that all credit swaps are among foreign entities.
Well the OTCs are all more or less exotic, and they are inherently more risky than exchange-traded instruments. Whenever an exchange-traded instrument is good enough, that's what the customers will choose -- precisely because every exchange-traded instrument is a trade with the exchange, which has the highest credit rating you can get. So whenever a regulated and unregulated instrument are the same or almost the same, the customer will always choose the regulated one -- part of its value is precisely the regulation.

So, yes, in fact the OTCs are almost exclusively instruments which are not practical to regulate. And the most common reason for the impracticality is that the parties are global companies and global groups in global investment banks and the positions are complex mixtures of multiple interest rates, fx rates, stock indices, etc. which have pieces in multiple currencies.

sophy

We all love game, if you want to play it, please Buy metin2 gold and join us.

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