The primary problem is that you have extremely unsophisticated individuals making decisions in regard to derivatives in a fiduciary position. The IB’s are after one thing and one thing only, the damn revenue, they could give a flying $##@#$$ about the underlying pensioners, employees, etc   http://www.bloomberg.com/apps/news?pid=20601109&sid=a0uqSyVKVINY&refer=home 

John Succo, who runs a $1.5 billion hedge and contributes investment commentary to Minmyanville, mada a similar point recently:  ”The Federal Reserve creates credit through its open market operations like REPOS and coupon passes. If the Fed wants to inject liquidity (credit) into the system, they simply call up large broker dealers and buy some of their bonds with credit they create out of thin air (this expands their balance sheet). The dealer then passes this credit on to “the market” by making loans to mortgage companies or margin accounts or whatever. Because each layer of lender is only required to keep marginal capital on hand, a $1 billion REPO done by the Fed eventually creates as much as $100 billion in new credit to the consumer.  [snipping an interesting debunking of the notion that the China has excess savings]  This situation is very unstable in the long run. The Federal Reserves’ balance sheet this year alone has expanded by $30 billion in this way and created $3.5 trillion of new credit in the U.S. Public debt around the world is growing exponentially and total debt in the U.S. now stands at nearly 3.6 times GDP (1929 was 2.8 times).”  Full article: http://www.minyanville.com/gazette/bios.htm?bio=16

Yet the Fed sat idly by and watched mortgage debt expanded a further 20% in two years, with resulting unprecedented Current Account Deficits, leveraged speculation, and global liquidity excess inspiriting speculative Bubbles in asset, securities and commodities markets across the globe.”   ”IDLE?” THIS CONCEPT IS NOT ONLY RIDICULOUS–IT DOES A DISSERVICE TO READERS. WHAT ARE THE POWER RELATIONSHIPS WHICH RECEIVED ADVANTAGES FROM THE POLICY, AND WHICH POWER RELATIONSHIPS WERE DISADVANTAGED BY IT?  ”MORAL HAZARD” IS ANOTHER IDIOTIC TERM. IT MASKS AN IDEOLOGICAL AGENDA, AND TELLS US PRECISELY ZERO ABOUT THE FACTS INVOLVED IN ANY SUCH “MORAL HAZARD.”   TAKE, FOR EXAMPLE, SUBPRIME MORTGAGES. WHAT ABOUT THIS STATEMENT ABOUT THEM:  IT WAS THE POLICY OF THE FEDERAL GOVERNMENT TO MOVE SUBPRIME BORROWERS INTO OWNERSHIP AND HOUSING, BUT NOT THAT THEY REMAIN OWNERS OR IN THE HOUSING.   TRUE OR FALSE? TO ANSWER IT, YOU HAVE TO ACTUALLY LEARN THE FACTS WHICH WENT INTO THE INCREASE IN SUBPRIME MORTGAGES. YOU ACTUALLY HAVE TO INVESTIGATE–AND THINK. CALLING IT “IDLE” OR A “MORAL HAZARD” HAS ONE GOAL: TO IMPEDE THE FACTUAL INQUIRY. WHY DO THE WRITERS USING SUCH TERMS, WANT TO IMPEDE THE FACTUAL INQUIRY? THIS IS YET ANOTHER FACTUAL INQUIRY. AND SO IT GOES, UNTIL WE ACTUALLY HAVE REASONS FOR SAYING THE POLICY WAS INTENTIONAL (AND WHAT THE INTENTION, IN FACT, WAS), IDLE OR A MORAL HAZARD (WHATEVER THE LATTER TWO MEAN).    

this is brad setser. the following comment was recently posted on a blog post keyed off another Tett column that I wrote over the holdiays. I figure that it is more likely to generate an answer here, so I am pasting it in.   ”I have a very basic question about the mechanics of CPDO, I hope someone of you would be definately able to answer this. How the leverage(that is to be utilized)or conversly the target portfolio size is actually calculated for a ‘typical’ CPDO. I understand that the levarage is a function of the difference between the NAV and the present value of the payments (coupon, principal, admin expenses), and that leverage will be decreased with increase in NAV and vice versa; but i dont really get how exactly the target portfolio size or leverage is calculated. Say if NAV is $100, PV of payments is $200 at the start and the CPDO starts with a leverage of 15x then if the after say 6 months the NAV increases to $120 then how much will be the leverage at that time (i know it involves a lot of assumptions but i just want to know the mechanics of leverage calculation)    thanks “  

How is it that the Fed can recognize and act on a need for added liquidity to drop $’s from helicopters but feigns blindness and impotence when the opposite situation arises?  Nothing but lyin, cheatin thievin whores.

  Mortgage Implode-O-Meter. List of subprime lenders going under. Scroll down to “List of the Now Defunct Lenders”. The guy started this list in December 2006 and has recorded 13 imploded lenders to date.

Gillian’s article makes very clear that there are two kinds of investors: Those who don’t know that there’s a crash coming, and those that do know, but are still earning commissions by convincing the first kind to keep buying into the bubble.  This is out and out fraud. Ms. Gett doesn’t seem to realize this, but what her article shows is that hedge fund managers in particular are committing fraud. They are making promises of / hinting at big returns when they know that those promises / hints won’t be met.  Managers and advisors have a fiduciary duty to their clients to give them the best professional advice available. Any advisor or manager who makes money by purposely giving incorrect advice is committing criminal fraud.  These advisors and managers think that they’re safe, because all their clients have signed multi-page small print contracts that say that the client is responsible for all losses. But those contracts won’t protect the managers and advisors from charges of criminal fraud.  Furthermore, no contract in the world will protect these managers and advisors from angry investors when they find out that the advisors protected themselves financially but didn’t protect their clients.  Do you remember what happened in 2001 after the Nasdaq crash and the Enron scandal? People wanted to put CEOs in jail — ALL CEOs, even perfectly honest ones. People were going crazy. Well, it’s going to happen again.  The Enron scandal is one historical example, but a better example might be the bankruptcy of the French Monarchy in 1789 that led to the French Revolution. In the Reign of Terror that followed, any person who was an aristocrat, a relative of an aristocrat, a friend of an aristocrat, a servant of an aristocrat, or even had a resemblance to an aristocrat, would be tried and quickly convicted and sentenced to the guillotine.  So I have some advice for the economics experts, journalists, professors, investors, central bankers, pundits and politicians that have been telling us that everything OK and getting better: You’d better have your underground bunker picked out, because people are going to be coming after you, and the guillotine is going to seem mild compared to the punishment that they’re going to want to inflict on you.  John J. Xenakis Generational Dynamics  

So.. How long ’till mainstream American media wakes up? Right after the implosion? Like they did after the 29 crash? Some of us, labeled “permabears” have been follwing this for quite some time. But few have been listening. Here is a “rollup” from my Econ Dreams – Nightmares blog under category: Risk/Derivatives

Moral Hazard: John Ryskamp  Is everything that ain’t correct, and that is just about everything with ‘economics’ which includes the ‘theory’, the ‘practise’, the “experts”, the system(s) (global), and the credentialized economists.  In “science” if the theory cannot predict, then it is worthless; such is the state economic theory (theories) and all this, is then “Moral Hazard”.  I hope that this explains the triviality and uselessness of the pursuit of what must be categorized as ‘analytical paralysis’ (en global economics) in which both macro and micro economics face today; that is, “moral hazard”. 

The Fed reserve system was put in place to combat excessive boom-bust cycles that arose from excessive credit creation and monetary expansion. The idea that the Fed should sit “idly by” or participate in the current speculative credit expansion appears to be a complete abrogation of this responsibility.   Within limits, expansion of the money supply following the NASDAQ crash, 9/11, the Iraq fiasco, slow job growth, and Katrina is reasonable. Hundreds of millions of Americans rely on a strong economy for our way of life.  The lunacy of the Fed is more in the degree, timing, and method of expansion than in the principle itself. When the song of the market masters begins to lull me to sleep, I remind myself that the gov’t's 2 – 2.5 % official inflation simply doesn’t jive with 100 % housing and commodity inflation, credit expansion, dollar deflation, the fiscal expansion, and trade imbalances.   Perhaps, the Fed’s currency rate position and attempt at controlled inflation will limit the carnage of violent bubble collapse. I hope so, because that is what is left. So far, so good. Where the hell were they 2 years ago.

John J. Xenakis says, “…Professor John Sterman, director of the MIT System Dynamics Group, as saying: ‘Thoughtful leaders increasingly recognize that we are not only failing to solve the persistent problems we face, but are in fact causing them. System dynamics is designed to help avoid such policy resistance and identify high-leverage policies for sustained improvement.’”  This is consitent with what the Post Keynesian writers have been saying for some time, although I’m not sure JX is aware of their work. I do like the inter-generational twist that JX throws in at his site. It reminds me of William Strauss and Neil Howe’s book, The Fourth Turning  For more on Post Keynesian financial economics, see my recent post responding to Mark Thoma and Brad DeLong and their replay of Krugman’s “The Hangover Theory,” In it I show how Hyman Minsky provides the answer. I also embedd four related hyperlinks, two of which point to Steve Keen’s “complexity theory” mathematical rendion of Minsky’s work. Eric Tymoigne has done much with that too over at the Levy Institute.  I also posted up a short overview of Minsky’s work, in A Minsky-like Restatement of Keynes Market Irrationality Warning.  All this to try to get folks to wake up to some newer, non-conventional economics thinking..

gmd:  On a related note, isn’t the fact that the FED is hiding M3 tied in with all of this excess credit? Is our true inflation rate, related to the size M3, 7 percent?, 8 percent? I would appreciate your thoughts, and anyone elses concerning M3.   I don’t think you’ll get a comment from “credentialed” economists on M3. The Fed discontinued it, therefore it doesn’t exist (and if you believe that, I’ve got a bridge to sell you).  However, The Economist once noted that broad money supply growth seems to always end up in inflation, long-term. Here’s a chart.

The whole purpose of the article is to point out how misguided the Fed is on policy. In this respect, it does represent a “moral hazard” as it erodes the meaning of thrift, hard work, and real economic productivity.   THOSE TERMS–THRIFT, HARD WORK, RECAL ECONOMIC PRODUCTIVITY–ARE MORE IDEOLOGY, AND WHAT IS MORE, I DON’T THINK THEY REFLECT WHAT WENT ON WHEN THE FEDERAL GOVERNMENT DECIDED TO SANCTION SUBPRIME MORTGAGES. WHAT IN FACT WENT ON IN FORMULATING THAT DECISION? AGAIN, WHAT WE NEED IS FACTUAL ANALYSIS. TOO MUCH ECONOMIC ANALYSIS VEERS OFF TOO RAPIDLY INTO THE NORMATIVE–PROBABLY BECAUSE PEOPLE JUST DON’T WANT TO INVESTIGATE FACTS. WHICH IS UNFORTUNATE. BUT DOES ANYONE REALLY THINK A DECISION WAS MADE TO DISCOURAGE ‘HARD WORK’? THAT’S NOT ANALYSIS–THAT’S A FRUSTRATION WITH ANALYSIS. AND IT IS FRUSTRATING, BUT TOSSING OUT LOADED TERMS IS ANOTHER WAY OF TRYING TO FRUSTRATE FACTUAL INQUIRY.  

Do we have any statistics on the percentage of the sub-prime loans? Thanks.  The indicators seem to point to a housing improvement, I’m just not convinced yet.

Core Principles: Laws of Causality – Moral Hazard  Common belief has it that for every ’cause’ there is an equal and opposite ‘effect’.  Wrong! Moral Hazard (at the core elements of understanding and perception).  Every cause – acting upon phenomenon of similar nature – creates a slight (mileage varies) resistence, and this resistence alters in response, the primary cause which again acts upon the resisting effect, to create the final manifesting ‘effect’. This is true for all things and takes the linearity fully out of all equations.  Get around this, and you begin to reduce ‘moral hazard’.  There is only one type of analysis to undertake meaningfully and that is “heretical” analysis, that is to say, question everything and accept nothing – no assumptions a priori. We must always strive for core principles in all matters.  Economics has become more of a consensual and fashionable statement for the Ayn Rand affairs of mere men, much like morality. Intellect has no need of fashion statements er morality and economics will never pursue the fashions of men’s impositions and wet dreams, whilst the underlying principles are ignored (not understood).  Stability leads to instability… H. Minski (and the Laws of Thermodynamics)  

JR and others,  Some of these posts (myself included) are getting off-topic and a little silly. Let’s just deal with the factual realities out there. That will keep the argument grounded so that we don’t slip into the realm of politics or philosophy.   To that end…  There’s another great Gillian Tett article that deals with credit derivatives. The most meaningful point is the one Doug Noland argues each week. It is the point I’m constantly repeating to NR about the Ponzi: The Fed needs to raise rates to at least 6% but maybe to 7% to slow things down.   The “moral hazard” of the Fed is failing to do their job in order to keep a bunch of politicians and Wall Street con-artists happy.   Here is the factual point laid out by Gillian Tett:   ”So does this leave central bankers less powerful than before? Independent Strategy, a research group, points out that the derivatives and structured finance sectors have recently grown so fast that they have come to dwarf traditional measures of liquidity – such as a narrow definition of money (cash and bank reserves) or a broader measure (including bank deposits and loans).  Consequently, these monetary yardsticks no longer provide meaningful guides to liquidity, it claims – while the role that central banks play in money creation is also falling, making it harder for them to shape the credit cycle. That, Independent Strategy concludes, explains one of the great mysteries of the past two years: why the cost of borrowing in the capital markets has remained low even though central banks have been raising rates.  ”Rising policy interest rates have had no effect on slowing the expansion of liquidity . . . because increases in short-term rates did not cascade into the pricing of the bigger . . . tranches of the liquidity pyramid,” the group says in a research report. “Now new-fangled financial instruments create liquidity independent of central bank control.”  Such arguments – unsurprisingly – find no great favour among central bankers themselves. Instead, most believe that rate rises can still affect the more esoteric parts of the system, since the different parts of the financial world are ultimately interconnected.”  For the full article:   http://www.ft.com/cms/s/a5daab98-a43c-11db-bec4-0000779e2340.html    

Keynes wrote in The Economic Consequences of the Peace  Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become ‘profiteers,’ who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.  Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.  The Fed is unwittingly supporting Lenin and Chavez more every day…

” Your species insists on destroying itself, you pollute your own environment while depleting it’s natural resources. Your kind also refuses to learn from history, take your economic practices for example.”   The Chief Machine speaking to Morpheous in THE MATRIX  p.s. bubble still in metamorph-stage noting how CNBC pumps hedgies on a daily basis, only station where I mute the programming (except bond report) and enjoy the commercials……

One of the interesting and, again, highly disturbing features of credit derivatives is that their trading processes tend to be primitive. Deals seem to be recorded with pen and paper – and one imagines on cramped and overwritten shirt-cuffs – while hedge funds and banks scramble to improve their credit-derivatives trading systems by spending hundreds of millions of dollars in aggregate on suitable information technology. As reported by the London Financial Times on 16 August 2006, “Credit derivatives are tools that let investors place bets on whether bonds or loans will default. The industry is estimated to have $17,000bn of total outstanding contracts…and the sector has doubled in size every year since 2002. This growth has taken institutions by surprise and forced them to handle deals with small levels of support staff. A recent survey from the International Swaps and Derivatives Association showed that one in five credit derivatives trades by large dealers in 2005 contained mistakes and many suffered settlement delays.” All of this sharpens the picture of a financial industry in the dollar size of its deals as big as or bigger than anything in financial history, being conducted by unmonitored institutions and dealers, with staffs that are largely inexperienced and, as the Financial Times puts it, with “sloppy back-office procedures [that] could cause serious damage.” The financial magnitudes they handle are indeed so great that they could, it seems, precipitate a global crash of unprecedented proportions; yet they are being run with some of their procedures apparently comparable with those of a church-fête bingo game – Extract from “America’s Suicidal Statecraft” by Dr James Cumes  

Anonymous:  ”This is a serious question: have you ever been treated for clinical depression or bipolar disorder? Your absolute fascination with the negative appears symptomatic of some sort of mental illness.” Written by Anonymous on 2007-01-22 02:20:57  Functioning sentient humans (homo sapien sapien) have the unique capacity of “negation” and this capacity is expressed in scientific maxims whereby any theory must a priori allow for and indeed encapsulated the negative.  I call this “heretical research” and the integrity of our scientific pursuits and indeed the advance of civilization, depends critically on being able to question (Theory)from a negative position. To do otherwise is insane, childish and highly dangerous; er suicidal.  The Professor’s approach imo is professional correct although I consider his constraint and limitations of his analysis to “consensual” statistics (lagging) to be a ubiquitous and major problem area of his whole profession; economics. However, this of course, is his chosen approach which must be respected, but the quality of his work has been to date of the highest integrity while we all must realize that he is not the final word on economics and the fact that there is NO “silver bullet” solution, in any dynamic and non-linear phenomenal event.  OTOH maniacal egophrenia is a serious mental illness that affects those of the financial industries (and elsewhere)in their pursuit of more valueless fiat, than they need. I do not see Prof Roubini suffering from this insanity but I certainly do see it in others (on this Blog and elswhere).  peter  

This business of too much credit gets to the heart of the matter: The reason that there is too much credit is that there is too little liquidity. The world is facing a massive liquidity crisis, and up to now the answer has been more credit. Why else do you think that the Fed is turning a blind eye to traditional measures of money supply, and the massive increase in home equity ATM money? It is simply that households cannot be maintained with current supplies of money. More has to be manufactured to keep the wheels turning.  This is the economy of the wolf. There will be nothing left when we have start over again.  Snarl 

“Rising policy interest rates have had no effect on slowing the expansion of liquidity . . . because increases in short-term rates did not cascade into the pricing of the bigger . . . tranches of the liquidity pyramid,” the group says in a research report. “Now new-fangled financial instruments create liquidity independent of central bank control.”    Such arguments – unsurprisingly – find no great favour among central bankers themselves. Instead, most believe that rate rises can still affect the more esoteric parts of the system, since the different parts of the financial world are ultimately interconnected.”     THIS SOUNDS LIKE FAUX LIQUIDITY. WHERE IS IT GOING?

There is a fair amount of faux liquidity running down my pants leg right now…only I don’t think it’s very “faux”.  Dampman

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