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March 19, 2009

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Bill Hall

If only we had some leaders in the business community...

clarice

True. And now a free plug for Washington Sharpened Pikes..Don't storm Capitol Hill without them!

MayBee

Congress must begin taxing book royalties at confiscatory rates.
Writing a book isn't "real" work, and the wealth it generates isn't real.

It would be fair to determine an hourly wage to pay an author while he is doing the actual work of writing, and confiscate any bonus payments made years after the work is complete.

To insist on anything else is greedy.

Bill smugs

They need not worry about whether it is unconstitutional. They can simply impose a special 100% tax on any law firms that challenge the bill's constitutionality, or perhaps a 100% special income tax on any judges who find against the bill.

motionview

I demand a retro-active confiscatory tax on the AIG campaign contributions. Sure, we took the contributions, but we slipped them in on ourselves in conference. The slope from there leads to a confiscatory tax on campaign contributions on our opponents (Prop8 = hate speech), but not to worry, we don't every plan on being in that position again.

Worn out from the demagogathon,

The New Boss

bgates

I'd like to see some of the AIG money freely returned, though if those sainted figures were to get in line to do so behind the Goldman crew and the Fannie/Freddie geniuses, that would be fine.

Failing that, a tax is the fourth best option (after not imposing a tax, and not imposing a tax plus Dodd/Pelosi/Frank/Reid etc die in a fire).

matt

first they taxed the AIG employees, and I said nothing....

This kind of punitive action amazes me, and even more so, because there is not much outcry about it. Yes, Wall Street bonuses were obscene, but now I think boards of directors are sensitized enough and the pendulum is swinging back towards a more reasonable compensation structure. Legislation is not the answer.Congress is using this as cover to creep tax rates up for as many of the "rich" as they can.

The big money has already fled the States and is in Switzerland or the Caymans, probably denominated in RMB or Swiss Francs. That and metallic gold. As for hunting down some of the most egregious exponents of Wall Street and DC greed, I think perhaps a vigilante party to Gstaad or Davos next winter would balance things out.

Appalled

Congressional politicians are always for the people and against the individual (unless the individual is a campaign contributor). This is true in this AIG mess. It was true with Terry Schaivo.

Really, the solution is a government that is smaller and less enamored of its ability to effect some desired social change.

ben

Obama's teleprompter has its own blog!!!

http://baracksteleprompter.blogspot.com/

PeterUK

The Chavezification of the United States of America moves on apace.
No doubt the EU,China,Japan and perhaps India can offer those with expertise in the financial sector inducements to relocate.
Obama wil do more damage to the the financial centre of New York than Osama.

bgates

This is true in this AIG mess. It was true with Terry Schaivo.

If the government interferes with AIG's contracts, people may end up unwilling to engage in contracts.

And if the government interferes with the right of an ex-husband to pull the plug on his brain-dead ex-wife over the objections of her parents, we may __________?

PeterUK

"Obama's teleprompter has its own blog!!!"

There is a rumour that the teleprompter is leaving Obama since there are things that even a teleprompter won't do.

bgates

the solution is a government that is smaller and less enamored of its ability to effect some desired social change

I get the feeling you were the founder of "Laissez-faire Isolationists for Roosevelt" in a past life.

jimmyk

If Geithner weren't such a lamebrain he would have said at the outset something like: "We are trying to maximize the value of AIG's ongoing operations for the sake of the taxpayer. To do this we need to retain the people who have expertise and experience. They are not slaves, and if they leave, the taxpayers are worse by more than the amount we have to pay them to stay."

Instead, he jumps on the bandwagon of those shocked and angered. If he'd thought about it a moment he would have realized that was self-destructive strategy, given that he was one of the architects of the original AIG rescue plan. Instead of showing leadership and strength, he looks like the in-over-his-head doofus that he really is.

RichatUF

MayBee-

Don't forget that the work needs to clear the Cultural Czar. Wouldn't want anything with wrong ideas out there.

ben

"There is a rumour that the teleprompter is leaving Obama since there are things that even a teleprompter won't do."

Yes, and just a few weeks is probably enough for a blockbuster "tell all" book deal too.

Gabriel Sutherland
Instead, he jumps on the bandwagon of those shocked and angered.
He hedged. Shall we throw him overboard or let him continue to try to put out fires?

The AIG bailout is a Fed window for foreign banks and investment banks. Bernake has assumed control of this wayward ship without a compass. AIG was Geithner's idea. The best thing he can do is tell the truth. It's going to make the American people more angry, but it will quell in less time than if he continues to obfuscate the reality of his AIG plan.

Tell the truth. Take the punches. All the other options are worse.

matt

OT, but has anyone noticed what happens when even supporters of Obama criticize his actions? Anyone who seems to be a threat gets the 3rd degree. Buffett seems to have been the only one who did not get vilified. Santelli, Cramer, and now Coach K all are dragged into the gutter immediately if they raise a voice against Der Fuehrer's plans. Fugeddabout Rush, he's the new Satan, and and Bush came in for it when he spoke in Calgary. This is very creepy.

Charlie (Colorado)

This is very creepy.

Well, yeah, but familiar if you remember Clinton.

RichatUF

jimmyk-

Since it looks like the AIG bonus list is going to leak in the next day or so, I'm now wondering how many people have resigned from the firm this week and whether those resignations are acclerating. Looking over some of the recent conference calls and it looks like AIG has to be over-collateralized for quite a bit of this stuff (and being an adjunct of the NY Fed this doesn't seem to be an immediate problem), but I'm curious if AIG's other businesses suffer a run and employees start fleeing what the price tag of a full default on AIG obligations might be. The bond ratings agencies have a habit of springing downgrades over the weekend so this could be an interesting Monday morning story-or maybe not.

Almost looks as the Obama Administration wants AIG to fail-though I'm not so sure he'd be able to lay it at the feet of the previous administration.

ben

"He hedged. Shall we throw him overboard or let him continue to try to put out fires?"

I love easy questions....throw him overboard.

kim

matt, I can't help but think they are going to get more vicious as the power starts slipping away. Fasten your seatbelts; turbulence ahead.
==========================================

sbw

Hmmm. How to define the feeling on discovering O had named a Culture Czar...

Schadenfreud getting enjoyment from looking at itself in a mirror, getting enjoyment from looking at itself in a mirror, getting...

No wonder The Scream mouthed "O"!

Old Lurker

What's worrisome is not that the socialists will do this (this is what Marxists do, afterall), but that there are so few voices from the loyal opposition about the legality or appropriateness of trying these guys in the legislature, finding them guilty of something, then applying this penalty to them. JOMers of course have posted the Constitution's express prohibition against ex post facto bills of attainder, and also Rehnquist's explanation of how that secures the seperation of powers...but where are those rocket scientists in the House and Senate to speak out in opposition? Maybe this is OK under Scottish law or something?

PeterUK

Well,the Ides of March have passed.Hey ho,wait a little longer.Obama is making too many enemies for a man with no crew of his own.

ben

"but where are those rocket scientists in the House and Senate to speak out in opposition?"

They figure that by the time the bonus recipients sue the hell out the government and collect more millions in settlements the public will be focused on something else.

RichatUF

oops...accelerating

Nice. Obama is touring an electric car factory (golf carts?, Pelosi Widowmakers)...Progress requires government investment...

So we'll be able to get a Zombiemotors Dem Widowmaker with great terms from Zombiegroup to keep a plant in CA open?

hit and run

matt:
has anyone noticed what happens when even supporters of Obama criticize his actions? Anyone who seems to be a threat gets the 3rd degree.

http://www.barackobama.com/2007/10/02/remarks_of_senator_barack_obam_27.php>Candidate Obama, October 2, 2007:

But these last few years we've seen an unacceptable abuse of power at home. ... We get secret task forces, secret budgeting, slanted intelligence, and the shameful smearing of people who speak out against the President's policies.

Apparently when he said "unacceptable", he meant an unnacceptably small amout.

RichatUF

Gabriel-

The Federal Reserve used authority they had under the Federal Reserve Act to put together the first deal and they have been winging it ever since. The systemic risk (and the international policy {diplomacy}) that AIG poses is real.

I regards to the rest of your comment, I wonder if it has been priced in that the US Federal Reserve is propping up a bunch of European banks (maybe the Euro is, just as in defense and health care, free riding on the US dollar) and that the Euros are able to take much more modest, but more useful, stimulus measures.

DebinNC

Republicans are "wary" of AIG bonus tax. If a principled position were clear, I wish they'd take it instead of enjoying Dem disarray from the sidelines.

Extraneus

"but where are those rocket scientists in the House and Senate to speak out in opposition?"

Earlier, Rush rolled tape of a Republican congressman who was arguing on the floor of the House to vote *for* the penalization bill, as a way to discourage businesses from accepting any government money. His logic was to sacrifice these AIG "execs" for the greater good.

DebinNC

AP: 13 firms receiving bailouts owe back taxes John Lewis being the town crier indicates the "13 firms" are likely associated with Republicans.

rbj

Good lord, when tax cheat Charlie Rangel is sounding sane, the inmates have really taken over the asylum.

cincinnatus

That 90% tax can be avoided with TurboTax.

jimmyk

The systemic risk (and the international policy {diplomacy}) that AIG poses is real.

Probably so, but we don't really know what the consequences of its failure would be. I do wonder whether it was necessary to make AIG's counterparties whole. Did Goldman-Sachs really need the entire $13 Billion? Why should the taxpayers bear all of the burden? If G-S had received $12 Billion would the economy have collapsed? It's not as though they are entitled to it.

Porchlight

I get the feeling you were the founder of "Laissez-faire Isolationists for Roosevelt" in a past life.

I had that same feeling of disassociation when I read that line, too, bgates.

BTW you should be a professional writer.

Extraneus

That 90% tax can be avoided with TurboTax.

Heh. Yeah, they'll have to build in a database table listing all companies who took >$5B in bailout money. I don't believe the company you work for is even part of your 1040, is it? It's on the W-2, so I guess now it'll need to be entered in a field somewhere and checked against the database to determine your penalty. In fact, are bonuses shown as separate line items on your W-2? If not, they'll need to be separated out from now on.

This is likely to get a little complicated, since I imagine the penalties will vary by industry, probably by company within industry and possibly even division within company, so the database table may need a few more fields.

RichatUF

jimmyk-

Since I don't know what the reference entities are, I'm not sure GS would have been the only firm tripped up (did the AIG Q4 payments show up on GS's 10K?). California and Virginia both got a billion dollars too-would a sovereign default of a US state be helpful?

matt

the casualty list from the Obama administration, including his lost Cabinet picks and all of the people vilified, is starting to exceed the toll in Iraq. It certainly has exceeded the toll in Afghanistan to date.

Extraneus

Hey, maybe Obama is even planning to veto the bill on Constitutional grounds. Wouldn't that be a good one?

"I asked for all legal avenues to be considered, but this just isn't legal, and as a Constitutional scholar, I should know."

Charlie (Colorado)

I do wonder whether it was necessary to make AIG's counterparties whole.

Jimmy, are you sure that the $13B is paying off at 100 cents on the dollar?

In any case, as I've pointed out before, when we gave AIG money because they couldn't cover their liabilities, where would we expect it to go, if not to those who AIG owed the money?

Charlie (Colorado)

Hey, maybe Obama is even planning to veto the bill on Constitutional grounds. Wouldn't that be a good one?

Hey, that is a good one. Did you hear the one about Jesus and St Peter playing golf?

Swamp Rabbit

And in other news.... OsamaHusseinIslamObama launched his 2012' re-election campaign last night on the Tonight Show with Jay Leno,, film at 11.

OsamaHusseinIslamObama 2012'
(the terrorist choice)
-it's never to early to campaign-

.

Appalled

bgates & porch:

I am that 80s creation -- tending liberal on social issues and conservative (but balanced budget) on economics. I was very comfortable with the GOP in the 80s, not so comfortable since. I've never been real comfortable with Democrats of the congressional variety. They learned nothing in 1980, learned nothing in 1994,and, at the rate things are going, will learn nothing in 2010.

Meanwhile, the GOP caters too often to the social right -- and now caves too often to the economically irresponsible.

I'm not often happy with politicians. They prefer demons to solutions.

boris

the GOP caters too often to the social right

Oh GMAFB you stinky hypocrite. The folks you love to hate on account of "their" intolerance. How to be liberal on social issues I guess.

Ya I get it already, Schiavo, stem cells, and 1 man 1 woman still piss you off. Demons my foot.

ben

"conservative (but balanced budget) on economics."

Sure Appalled, that's why you support Obama: a conservative on economics. Did you vote for a Republican for Congress since you are uncomfortable with Democrats? I think you are too conflicted for the real world, seek psychiatric help quickly.

clarice

I'm not happy with listening to Appalled's preposterous carp. She prefers hackneyed stereotypes to reality.

caro
No wonder The Scream mouthed "O"!
sbw, another great bumper sticker idea. Very funny.
drjohn

Rangel certainly doesn't want the tax code working on him.

kim

Yep, Caro, I'm practicing my horrified hands against cheeks O scream. It's great psychic relief. A rallying cry.
==============================================

kim

It carries well, and attracts attention. Such fun.

A great teaparty chant.
==========================================

Dana H.

"If only we had some leaders in the business community..."

Actually, we do. Lots of them. They're the ones NOT sucking on the public teat (which is why you don't hear about them these days, because Washington doesn't give a damn about anyone who has no use for its aid).

Dotar Sojat

Atlas is shrugging.

kim

Yeah, and they are all busy trying to keep their businesses afloat. C'mon, Romney, get after it.
============================================

kim

I'm serious about this O scream. A great way to defuse inchoate populist rage is to give them something to scream about and to laugh about at the same time. Then they can focus productively on the object of ridicule.
=========================================

kim

The best screams should tap youtube charts.
==========================================

jimmyk

In any case, as I've pointed out before, when we gave AIG money because they couldn't cover their liabilities, where would we expect it to go, if not to those who AIG owed the money?

Well, yes, but I wasn't saying they should get zero. No, I don't know whether they got 100 cents on the dollar, but I've been given no reason to think otherwise, have you?

The issue is that my net worth (realistically defined) goes down to the extent taxpayer dollars are used to maintain the net worth of these institutions. Even if we grant the systemic risk argument, I would hope that they are cutting it closer than just making the counterparties whole.

JeanE

I'm reading Atlas Shrugs right now- honestly it's hard to keep straight which laws are being passed in a fictitious work written 50 years ago and which are being passed by the US Congress today. Is this what it's like to be part of the reality based community?

RichatUF

jimmyk-

It is a disentanglement problem. If AIG couldn't make their counterparties *whole* it would have been defined as a *default*. The problem with an AIG default, with the types of products they sold, is that they would have driven other firms to downgrades, partial defaults, and defaults as well. And this doesn't get into how much of AIGs other businesses would have been vacuumed for cash leaving policyholders to piss up a rope.

bad

Are there any US citizen AIG employees earning less than $250,000 per year after the bonus is added, who received a bonus?

If so, taxing this bonus at 90% means Obama will break his promise about "not one more dime of taxes if you earn less than $250,000."


Michael Murphy

I am a bit baffled at why Liddy did not tell them to shove his job up their clownish asses. I am sure that it will be easy to hire people willing to be taxed at 90%. I think we are making a mistake by not letting community organizers unwind these credit default swaps. I think they work off the books for the most part.

netmarcos

Has anyone looked up the constitution's position on "Bills of Attainder" lately?

http://www.techlawjournal.com/glossary/legal/attainder.htm

ContractLawIsDead

Congress needs to go all the way and now pass new tariffs and duties on French, German, British, Canadian, Danish, Spanish, and Swiss goods to recoup all the payments AIG made with bailout money to banks in those countries(about 36 bn).

I mean, since contract law is dead now...why not?

http://tinyurl.com/cl7py8

MayBee

I am a bit baffled at why Liddy did not tell them to shove his job up their clownish asses.

If you noticed, he arrived at the hearing after Obama had met with his economic staff.
I'm convinced they had him on the phone, begging for his forgiveness for what they were doing to him.

Neo

Next they will modify this legislation to make it apply to everybody.

WHAT DID YOU MAKE ... END IT IN

Ignatz Ratzkywatzky

Congressional politicians are always for the people and against the individual ...... It was true with Terry Schaivo

Terry schiavo was an individual. Moreover she was a defenseless one whose life was not protected by the state. As usual, the compassionate and tolerant of our society had their way by killing a defenseless and voiceless fellow citizen, all in the name of compassion and tolerance of course. And they had the decency and tolerance to tar anyone who defended her life as grandstanding, intolerant bigots, also as usual.

Good lord, when tax cheat Charlie Rangel is sounding sane, the inmates have really taken over the asylum.

Erin Burnett was actually grilling the gravel voiced tool on CNBC on this very topic this morning when that dips**t Mark Haines intervened and apologized to Charlie for her actually doing her job for once. Haines is a toad, and a foul tempered unprofessional one at that.

AST

Of the people, by the populists and for the powerful.

Cecil Turner

Has anyone looked up the constitution's position on "Bills of Attainder" lately?

Yep. (I still maintain it's ex post facto, too.) Remember when listening to enemies in wartime was "shredding the Constitution"? Farcical. And of course, Congress could've easily kept the clause forbidding bonuses, but decided not to. I guess they changed their minds (or actually bothered to read the thing . . . finally). How that's AIG's employees' fault is hard to feature.

On the actual damage to actual people front, I'd note the stalwart defense of Andrew Cuomo:

Cuomo said he won't release any employees' names until his office has answered any security concerns raised by the AIG employees.
Now that's reassuring.

bad

Are the republicans voting for that stupid 90% tax bill?

Stephen Macklin

It doesn't help when there are people like Sean Hannity claiming the title of Free Market Advocate when they clearly have no idea what the concept means.

http://nomayo.mu.nu/sean_hannity_-_free_market_killer

Cecil Turner

Are the republicans voting for that stupid 90% tax bill?

'Bout half. Same link as above:

"This political circus that's going on here today with this bill is not getting to the bottom of the questions of who knew what and when did they know it," said House Republican Leader John Boehner.

He voted "no," but 85 fellow Republicans joined 243 Democrats in voting "yes." It was opposed by six Democrats and 87 Republicans.


SteveM

I was very comfortable with the GOP in the 80s, not so comfortable since.

Because, back in the 80's, the GOP was all about supporting gay marriage and abortion. Yes, I remember. And the phrase "family values" never passed Reagans lips.

Maybe you were simply young and naive back in the 80's but the Republicans were much more conservative in all ways, including socially, than they are today.

SteveM

as I've pointed out before, when we gave AIG money because they couldn't cover their liabilities, where would we expect it to go, if not to those who AIG owed the money?


As some of us have responded before, if we're going to give money to AIG's counterparties, why don't we just give money directly to AIG's counterparties, without AIG acting as the middle man?

boris

Expect it would cost too much recreate the knowledge and expertise for dealing with the AIG database for who gets what.

bad

Thanks, Cecil.

Gmax

Didn't we get told about Obama being a brilliant lawyer? I am vague on the point but it seems like we did, ad nauseum.

So what part of the contracts class did he sleep through?

If a contract is not sacrosanct, just what is the basis of law, tyranny of the majority?

I am sure Hugo Chavez is finding this all so amusing.

Mom

Ignatz 6:26pm - "Terry schiavo was an individual. Moreover she was a defenseless one whose life was not protected by the state. As usual, the compassionate and tolerant of our society had their way by killing a defenseless and voiceless fellow citizen, all in the name of compassion and tolerance of course. And they had the decency and tolerance to tar anyone who defended her life as grandstanding, intolerant bigots, also as usual."

Never said better.

Amy

I've been shaking with rage all day at this...people just give me a funny look when I tell them this confiscatory tax should scare them. That, coupled with Frank's calling for the names of private citizens who have committed no crimes and his callous disregard for the safety of them and their families...it boggles my mind.

For the first time in my life I'm afraid of my own government.

Great post.

Allison Coates

I am so angry over this, and so angry over the lack of Republican leadership.

They didn't just tax "those bad people". Congress intentionally abrogated the contracts. They confiscated wealth because they didn't like it. and They did so RETROACTIVELY.

And for all of you who say "yeah, but those bonuses were bad": we're talking about people who worked at Morgan Stanley, US Bancorp, and PNC, BofA as directors--mid level management. That means people who didn't have ANYTHING AT ALL to do with the idea that buying insurance in the form of CDS wasn't okay because hteir AAA+ insurer might fail. That means directors in ops, in HR, in govt bonds as well as traders themselves. People who handle the money of little old ladies and orphans too. These are people who only make a couple hundred K before the bonus. Some of them make less than 250k. HALF of their income is that bonus, and what the heck are they supposed to do now?

oh, it's only 90% you say? Well, not really. Then there's the state tax in NY where they earned it, the NYC tax, and their own state tax in CT or NJ too, possibly. That's another 15% or more all told. THAT MEANS THEY ARE LOSING MONEY. And what if it counts toward the AMT???? they they are paying 31% on IT and the rest of their income, when they don't even have it!

This is wrong. This is banana republic nastiness. This is American Revolution stuff. Don't be fooled into being a populist on this.

ROA

Wouldn't taxing these retention bonuses be similar to revoking hazardous duty pay after the fact because a soldier wasn't wounded? Someone who would do that might suggest that veterans have their private healthcare insurance pay for service connected disabilities and no one could be that stupid, could they?

ROA

Wouldn't taxing these retention bonuses be similar to revoking hazardous duty pay after the fact because a soldier wasn't wounded? Someone who would do that might suggest that veterans have their private healthcare insurance pay for service connected disabilities and no one could be that stupid, could they?

PD

Maybe you were simply young and naive back in the 80's but the Republicans were much more conservative in all ways, including socially, than they are today.

But so were the Democrats.

peter jackson

Maybe it's small potatoes, but the SCHIP bill that Obama signed in February raised the tax on loose rolling tobacco from $1 per pound to over $24 dollars per pound, a 2200% increase. Whether or not the "roll your own" segment of the tobacco industry will survive remains to be seen. I guess all of the working class and retired and fixed income and even homeless folks who were trying to save money by rolling their own tobacco weren't paying their fair share.

Equality before the law my ass.

cathyf
As some of us have responded before, if we're going to give money to AIG's counterparties, why don't we just give money directly to AIG's counterparties, without AIG acting as the middle man?
I posted this over on a dead thread, so I'll repost it here:

Banks are somewhat different sorts of institutions -- all businesses deal with credit risk, but at a bank, taking credit risk in exchange for money is their core business. What this means is that creditworthiness, and explicit actions which occur in response to "credit events" are explicitly written into financial contracts, whereas in other businesses this stuff is implicit and relies on the bankruptcy code.

So company XYZ declares bankruptcy, but they still have substantial assets, and an ongoing business, and they reorganize, emerge from bankruptcy. You are company XYZ's landlord. They manage to keep paying rent to you throughout the whole process. You have no legal right to any recourse against them because they are still paying you.

Now suppose AIG were to declare bankruptcy because mark-to-market says that their assets are worthless so they are insolvent. But those MBSs keep paying off every month because only a small fraction of mortgage payers are in default, so even though the "market value" is zero, the cash keeps rolling in, and so AIG has the money to pay their obligations. Well, their landlord wouldn't have cause against them, but their counterparties would -- because the credit event of the "insolvency" has effects which AIG and the counterparties are contractually obligated to follow through on. That's true even if the insolvency is an accounting fiction and the company never runs out of money.

Think of it like this: my electric utility went bankrupt a few years back. It's a regulated utility, so my power never stopped coming down the wires, I never stopped paying bills, quite frankly, I never really noticed. Now imagine if my mortgage, and every mortgage in the state, had a clause in it that said that if the electric company went bankrupt then my mortgage was instantly called in and I had five business days to come up with my principal, paid in full. You better believe that I would care if the power company was technically insolvent!

DebinNC

Thank you, cathyf. You have a gift for teaching.

Adam Smith

Comrade - I recommend a cash position. Customers pay cash - or perhaps you can barter on craigslist. I really would not want my government to think that I made "too" much - so perhaps we should not trouble them.

Mary

It is amazing how much the price of services changes when you pay cash. We don't seem to mind paying a "fair' tax but when the total tax exceeds the take home pay it just seems easier to join the underground economy.

Does the AMT apply to these bonuses?

bgates

cathy, I appreciate that explanation, but to me it raises more questions. When you say, "the credit event of the "insolvency" has effects which AIG and the counterparties are contractually obligated to follow through on. That's true even if the insolvency is an accounting fiction" - I don't get how the family of contracts between AIG and its counterparties were supposed to work.

If one of the credit event triggers was to be AIG's bankruptcy, doesn't that mean a bunch of marks signed a contract that said in return for giving AIG a little money up front, they would be entitled to vastly more money from AIG - if AIG ever became completely unable to pay anybody anything?

JB

Anyone who works for government, does business with the government, or takes money from the government is evil.

cathyf

Well, bgates, you have to understand how some of these schemes work. Financial institution XYZ comes up with some wacky exotic structure, which they market to customers. Then the traders at XYZ go to institution ABC, which has a higher credit rating than XYZ. The scheme is that ABC actually writes the structure and sells it to the customers, and then for each transaction between the customer and ABC, there is an equal and opposite transaction between ABC and XYZ. With ABC receiving a fixed spread which is part of the extra that the customers pay for the structure because of ABC's higher credit rating.

Ok, so this is called a "credit spread", and it is all about institutions with higher credit ratings "renting out" their credit ratings to the institutions with lower credit ratings. (Perhaps "whoring out" is a more accurate term.) Everyone understands that the risk to ABC is that XYZ will default, leaving ABC holding the bag without the offsetting transaction. So then ABC goes to a third party (fourth party if you count the customers...) and gets them to write a CDS in case XYZ defaults. And XYZ maybe goes to a fourth (fifth?) party and gets a CDS in case ABC defaults. And one or more customers go to one or more other financial institution and get CDS's against ABC defaulting. (The premium on the CDS of XYZ defaulting is greater than the premium on the CDS of ABC defaulting -- that's what the credit rating means.) Oh, and different groups within the same financial institution might unknowingly write different CDS contracts on the various legs of this transactions and not realize that they have actually covered both sides of the bet.

Ok, so now you have these credit default swaps written, and they have their own contract language for what constitutes "default". The instruments which are providing the underlying cash flow to fund the exotic structures are mortgage-backed securities. Triple-A rated mortgage-backed securities. The next thing that happens is that the market realizes that the ratings on these MBSs are a crock-o-shite. So the accountants decree that the MBSs are worthless. But really, only a small fraction of the mortgages actually go into default -- a larger fraction than their ratings indicate, but nonetheless a small fraction. Which means that these "worthless" MBSs are still producing income every month.

But according to the new 2007 accounting rules, the institutions must mark the MBSs to the market value. But nobody knows what the market value should be because they know that the ratings are worthless. After enron, no accountant will sign off on any valuation above zero, no matter how obvious that the value is above zero. (All of the mortgage-payment income arriving each month has been reclassified as "magical money" which will never arrive again.)

Now without the CDS contracts, things would muddle along. The MBS cash would come in, and it would fund the exotic securities, and the different books in an institution would make or lose money, but overall the institutions would make money. But the existence of the CDS contracts screws up everything. Because once the accountants rule that an institution is insolvent (even if the insolvency is an accounting fiction) then this triggers a payoff of a CDS contract between two other financial institutions. And the financial institution which pays out the CDS runs out of money, and so then they are insolvent, which triggers payoffs of all the CDS contracts written against their default. Which sinks another financial institution. And bang-bang-bang pretty soon they are all bankrupt.

The key fact about the AIG "bailout" is that it is actually a bankruptcy of AIGFP being carried out with the absolute prohibition of any authoritative party using the word "bankruptcy." Because bankruptcy itself is a good thing in that it provides order in the liquidation and shutdown of a company (or part of a company). It protects the bystanders (creditors, competitors, employees, customers, etc.) from some of the damage of being sucked into the chaos of the liquidation or reorganization. But in the case of financial institutions which have gazillions of dollars of credit default swaps written against them, the word "bankruptcy" has catastrophic effect simply because of the contractual language.

What is going on here is that AIGFP is being liquidated in a de facto bankruptcy, with the difference between this causing a recession and the catastrophic complete destruction of the global economy being the success of the conspiracy to lie and not use the word "bankruptcy."

Which tells you just how utterly craven the politicians are being. If AIG defaults on their contracts with their employees, that could be interpreted by the arbitrators as a credit event that would start triggering the CDSs written against AIG, and the chain-reaction meltdown. The image of the suicide bomber playing with the trigger is perfectly on target -- but it's the politicians who are threatening to blow up the financial system by their inability to STFU.

Pofarmer

Oh, and different groups within the same financial institution might unknowingly write different CDS contracts on the various legs of this transactions and not realize that they have actually covered both sides of the bet.

So, are there any changes in how CDS is being used or written? That way that whole system is being used is perfectly stupid. Nobody knows what anyone else has written, or what triggers the next set of defaults.

Why can't any CDS not traded on an open exchange simply be declared void and we move on????? This is madness. Here we are, paying hundreds of billions to make sure the gamblers don't take down the ship, while they are made whole with taxpayer dollars.

cathyf
Why can't any CDS not traded on an open exchange simply be declared void and we move on?????
Ok, think about how that would work... In my example, XYZ is AIGFP, ABC is the Belgian government treasury, and the CDS was written by UBS and sold to AIGFP. So just exactly who is going to "declare" to the 3 parties that the CDS contract is void when the 3 parties are in different countries, and one of the 3 parties is a government?

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