Guest Post: Woman Who Invented Credit Default Swaps is One of the Key Architects of Carbon Derivatives, Which Would Be at the Very CENTER of Cap and Trade

As I have previously shown, speculative derivatives (especially credit default swaps or “CDS”) are a primary cause of the economic crisis. They were largely responsible for bringing down Bear Stearns, AIG (and see this), WaMu and other mammoth corporations.

According to top experts, risky derivatives were not only largely responsible for bringing down the American (and world) economy, but they still pose a substantial systemic risk:

  • Warren Buffett called them “weapons of mass destruction” in 2003
  • Warren Buffett’s sidekick Charles T. Munger, has called the CDS prohibition the best solution, and said “it isn’t as though the economic world didn’t function quite well without it, and it isn’t as though what has happened has been so wonderfully desirable that we should logically want more of it”
  • Former Federal Reserve Chairman Alan Greenspan – after being one of their biggest cheerleaders – now says CDS are dangerous
  • Former SEC chairman Christopher Cox said “The virtually unregulated over-the-counter market in credit-default swaps has played a significant role in the credit crisis”
  • Newsweek called CDS “The Monster that Ate Wall Street”
  • President Obama said in a June 17 speech on his plans for finance industry regulatory reform that credit swaps and other derivatives “have threatened the entire financial system”
  • George Soros says the market is still unsafe, and that credit- default swaps are “toxic” and “a very dangerous derivative” because it’s easier and potentially more profitable for investors to bet against companies using them than through so-called short sales.
  • U.S. Congresswoman Maxine Waters introduced a bill in July that tried to ban credit-default swaps because she said they permitted speculation responsible for bringing the financial system to its knees.
  • Nobel prize-winning economist Myron Scholes – who developed much of the pricing structure used in CDS – said that over-the-counter CDS are so dangerous that they should be “blown up or burned”, and we should start fresh
  • A leading credit default swap expert (Satyajit Das) says that the new credit default swap regulations not only won’t help stabilize the economy, they might actually help to destabilize it.
  • Senator Cantwell says that the new derivatives legislation is weaker than current regulation

Round Two: Carbon Derivatives

Now, Bloomberg notes that the carbon trading scheme will be largely centered around derivatives:

The banks are preparing to do with carbon what they’ve done before: design and market derivatives contracts that will help client companies hedge their price risk over the long term. They’re also ready to sell carbon-related financial products to outside investors.

[Blythe] Masters says banks must be allowed to lead the way if a mandatory carbon-trading system is going to help save the planet at the lowest possible cost. And derivatives related to carbon must be part of the mix, she says. Derivatives are securities whose value is derived from the value of an underlying commodity — in this case, CO2 and other greenhouse gases…

Who is Blythe Masters?

She is the JP Morgan employee who invented credit default swaps, and is now heading JPM’s carbon trading efforts. As Bloomberg notes (this and all remaining quotes are from the above-linked Bloomberg article):

Masters, 40, oversees the New York bank’s environmental businesses as the firm’s global head of commodities…
As a young London banker in the early 1990s, Masters was part of JPMorgan’s team developing ideas for transferring risk to third parties. She went on to manage credit risk for JPMorgan’s investment bank.

Among the credit derivatives that grew from the bank’s early efforts was the credit-default swap.

Some in congress are fighting against carbon derivatives:

“People are going to be cutting up carbon futures, and we’ll be in trouble,” says Maria Cantwell, a Democratic senator from Washington state. “You can’t stay ahead of the next tool they’re going to create.”

Cantwell, 51, proposed in November that U.S. state governments be given the right to ban unregulated financial products. “The derivatives market has done so much damage to our economy and is nothing more than a very-high-stakes casino — except that casinos have to abide by regulations,” she wrote in a press release…

However, Congress may cave in to industry pressure to let carbon derivatives trade over-the-counter:

The House cap-and-trade bill bans OTC derivatives, requiring that all carbon trading be done on exchanges…The bankers say such a ban would be a mistake…The banks and companies may get their way on carbon derivatives in separate legislation now being worked out in Congress…

Financial experts are also opposed to cap and trade:

Even George Soros, the billionaire hedge fund operator, says money managers would find ways to manipulate cap-and-trade markets. “The system can be gamed,” Soros, 79, remarked at a London School of Economics seminar in July. “That’s why financial types like me like it — because there are financial opportunities”…
Hedge fund manager Michael Masters, founder of Masters Capital Management LLC, based in St. Croix, U.S. Virgin Islands [and unrelated to Blythe Masters] says speculators will end up controlling U.S. carbon prices, and their participation could trigger the same type of boom-and-bust cycles that have buffeted other commodities…

The hedge fund manager says that banks will attempt to inflate the carbon market by recruiting investors from hedge funds and pension funds.

“Wall Street is going to sell it as an investment product to people that have nothing to do with carbon,” he says. “Then suddenly investment managers are dominating the asset class, and nothing is related to actual supply and demand. We have seen this movie before.”

Indeed, as I have previously pointed out, many environmentalists are opposed to cap and trade as well. For example:

Michelle Chan, a senior policy analyst in San Francisco for Friends of the Earth, isn’t convinced.

“Should we really create a new $2 trillion market when we haven’t yet finished the job of revamping and testing new financial regulation?” she asks. Chan says that, given their recent history, the banks’ ability to turn climate change into a new commodities market should be curbed…

“What we have just been woken up to in the credit crisis — to a jarring and shocking degree — is what happens in the real world,” she says…

Friends of the Earth’s Chan is working hard to prevent the banks from adding carbon to their repertoire. She titled a March FOE report “Subprime Carbon?” In testimony on Capitol Hill, she warned, “Wall Street won’t just be brokering in plain carbon derivatives — they’ll get creative.”

How the Movie Ends

Yes, they’ll get “creative”, and we have seen this movie before …an inadequately-regulated carbon derivatives boom will destabilize the economy and lead to another crash.

I have previously pointed out that CDS sellers – like the big sellers of other financial products – know that the government will bail them out if CDS crash again. So they have strong incentives to sell them and to recreate huge levels of leverage. Indeed, the same dynamic that led to the S&L crisis also led to last year’s CDS crisis, and will lead to the next crisis as well. So – while CDS might be a particularly dangerous type of “weapon of mass destruction” (in Warren Buffet’s words), the new carbon derivatives may very well become the new form of looting on the public’s dime. If the government allows massive carbon derivatives trading with as little oversight as over the CDS market, taxpayers will end up spending many trillions bailing out the giant banks and propping up the economy when the carbon market bubble bursts.

And as I have previously pointed out: (1) the giant banks will make a killing on carbon trading, (2) while the leading scientist crusading against global warming says it won’t work, and (3) there is a very high probability of massive fraud and insider trading in the carbon trading markets.

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  1. joe blowe

    There can be no more bailouts because there is no more money. The world is bankrupt now.
    The debts cannot be paid in any time scale; perhaps hundreds of years.
    It has already happened already, and all they are trying to do is to figure out how to divide the losses, which cannot be socialized.
    The biggest problem will be the convolution of the fiat money with the real wealth of the hard working American People. There is a huge difference between funny money created through fractional banking and lent out at zero percent interest and the wealth of the people – which should remain ‘of the people’.
    Let’s not blame capitalism for we do have capitalism, but a command economy.
    Let’s not blame the crisis on the ‘excesses’ of the American People (some has happened of course). These excesses pale in comparison with the sums of money moving around in these bailouts.

  2. psychohistorian

    Thanks for the posting. Not something you are going to find anywhere close to the MSM.

    When as a society are we going to say, yet again to the financial industry, that you can’t game the system anymore. If you want to gamble, do it with your own money and let banking be boring and respectable again.

    What is it with these people that want to control everyone else’s moral and ethical behavior but their own. They have convinced the faith breathers that faith based economic philosophy of free this and that is good for humanity…or at least a few at the top. Why do we regulate what goes on in peoples bedrooms but not what effect banking practices have on the global economy?

  3. Richard Kline

    “Blythe Masters.” Never were two words more descriptive of application.

    Normally, I consider barbs at personal names rather below the belt, and I don’t know enough of Ms. Masters’ roles to have any present excess of spite for her personally. Sometimes, kismet thrusts it’s invisible hand into view, and in this name we see it all plain, to me.

    1. Uncle Billy Cunctator

      Good catch. The name always bugged me but I didn’t know why. Yves (you’re a funny person to ask, but…) do you think this is the name she was given when she was born? Do you think it’s a little inside joke?

  4. MyLessThanPrimeBeef

    Perhaps this is not directly related, but I am sure somoe comedian can steal this one for his own – it just dawned on me that carbon dating means going out with a smoker (or perhaps someone smoking hot).

    I swear I didn’t know that before.

  5. Michael Fiorillo

    Richard Kline,

    Props to you; you beat me to it.

    Like something out of Dickens, or better still, Pynchon, our Blythe Masters happily gorge on the body economic.

    God may be a real SOB, but he’s quite a satirist.

  6. Toby

    My take on her type:

    “Material Girl

    At the first making of herself
    there are no mistakes.
    She crawls from the ocean’s slick glimmer
    a soul fused with her well oiled parts,
    a whole satisfied with each taut sense.
    In her hands the simple maths of ambition,
    the impulse decisions that will pave the way.
    Without even trying
    she takes herself to the heart of the matter.
    She is a perfect fit, as blades in metal,
    blood in love, meat in flesh,
    immune to all eyes that would root her out.
    There is nowhere else she can be.

    I cannot rid my guts of her,
    cannot sort her from the strands of my DNA.
    She has slipped between the lines of my good intent,
    shone her sharp blue gaze somewhere else,
    somewhere only she lights up, there where light hurts
    and all our ugliness is upside down. She is right in there,
    as always she was, and where she looks, she sees.

    But what a world hers is.”

    The whole idea that we can only “save the world” if we have enough money to do so is insane, so insane I hardly know how to react to this sentiment any more.

    The entire perpetual-growth-dependent paradigm is terminally sick and needs to be taken out back and wacked. This obscene jockying for power and wealth at the expense, it seems, of literally everyone, is causing almost irreperable damage, all in the name of what makes financial sense, or in the name of financial “freedom,” whatever the fuck that is. Soon my only reaction will be screaming and rage, and I imagine there are many out there like me on this. How palpably sick does this system have to get before we start demanding something totally new by the billion?

  7. Dan Duncan

    This post is written as if the author disdains these derivatives.

    Let it go. Embrace the madness.

    And before you know it, our markets will be like a Haldron Collider–that actually works–as whole new exponential derivative markets will pop in to and out of existence. These will be Virtual Exponential Swap Markets….

    Pissed off about all those CDS bets against your company? Well, don’t be! Just go out and get you some CDS Squared, which will pay off BIG-TIME upon the failure of those first CDS bets.

    Notice any anomalies in the CDS Squared Market that may cause Too Big to Fail Squared? Don’t fret about it! Just get some CDS Cubed…and get paid!

    Need some extra cash—quick? Don’t go PayDay Loan…and if you’re a government, don’t go PayDay Loan Treasury-Style (“Get your 90 MINUTE T-Bills!”)…

    No, don’t do any of these foolish maneuvers. Instead, just embrace your Inner-Ponzi. Don a leather jacket, refer to yourself as “The Ponz”…and sell Custom Designed Derivative Cocktails on late night infomercials.

    “Heeyyy! For only $1,000 you can be the proud owner of CDS^6 of a GE AAA tranche that will pay you $120,000,000,000 if GE defaults on March 3, 2019 between the hours of 10:00 and 11:15 a.m. But wait! If you act in the next 15 minutes, I’ll throw in 5 additional 3 month coupons on some juicy Comcast CDS at Euler Log(6+2Pi)!”

    1. fajensen

      Pissed off about all those CDS bets against your company?
      Not Really, no. But where is My Golden Parachute? I would like to have loaded up on CDS’s too before selling all my employers IPR to China for personal gain ;-)

  8. Bob Falfa

    Can we cap-and-trade research reports from East Anglia?

    Obviously I’m a nut who has never bought the global warming hype, but if TPTB have determined to reduce carbon usage then just force it to be reduced. Lets go back to the 70’s when there was slush in the supermarket aisles during winter due to requirements on the heating/cooling. Don’t provide a way to use the same amount and claim it’s beneficial since it wasn’t used somewhere else (try to prove a negative). This way there is no pseudo-financial product to be turned into derivatives and we are left with measurable quantities not playing accounting games with leveraged pieces of paper disconnected from reality.

  9. whitemale08

    …from MBS (mortgage-backed securties) to CBSs (carbon-backed securities)…

    IT’S SICK!!!

    It’s what happens when you bail out parasites like Goldman Sucks and JP Morgan, they’re free to loot again and again.

  10. Francois T

    Anyone who has spent time studying (honestly, that is!) the climate destabilization problem know it’s real. It is a problem we’re all confronted with, whether we like it or not.

    Sucks big time, but that’s the situation we’re in.

    That said, cap and trade is definitely NOT the way to go if we want to get a handle on this problem. That’s not a matter of belief or feeling; it is what those who know, while having no important financial stake in it, are telling us.

    1) or how Wall Street and the money class could make an unbelievable killing with crap and fade without solving any problem at all.

    Prof. James Hansen: “What 350 (ppm of atmospheric CO2) does is tell you that some policies just do not make sense. In particular the cap and trade with offsets and governments continuing to increase their use of coal and to allow the beginning of the use of unconventional fossil fuels”

    3) Laurie Williams and Allan Zabel are two EPA lawyers with 40 years of combined experience. They put up a video about cap and trade titled “The Huge Mistake”:

    Pay particular attention to the segment starting at 05:20 min about the scam that carbon offsets are. This is based on European experience with refrigerant gases…priceless! No wonder politicians love it so much; there is a lot of political contributions that can be extracted from this scam.

    4) Finally, some politicians are afraid that the fees and dividends approach could be perceived as (Fade in the shower scene in Psycho…eeeeeek!) a tax. Strangely enough, polls show the contrary:

    But, as noted above, there is so much contribution money to be made with cap and trade…why deprive oneself of such a honey pot?

    So, Ms Masters and the Wall Street bitches are invited to move over into the corner and be still while the adults fix this problem.

  11. pmr9

    The problem is having to rely on cap-and-trade to generate price signals that will prevent CO2 emissions. To make coal-fired generation uncompetitive with new-build nuclear, we need a carbon price of at least $20 per tonne CO2, guaranteed over decades to allow long-term investment. This raises the retail price of electricity by only 10%. The easiest way to generate this price signal is to impose a carbon charge on fossil fuels at the point where they enter the economy, and redistribute the revenue on a per capita basis.

    Cap-and-trade ensures that the carbon price will fluctuate wildly with the level of general economic growth and the ability to scam the system with offsets. Derivatives are unlikely to offer investors in new nuclear power stations (5 years to build, 40-year lifespan) the ability to hedge against a fall in the carbon price 10 years from now – can’t even count on your counterparty being still there next year.

  12. i on the ball patriot

    This article won me over. I now believe that CDSs are OK …

    Its just a matter of democratic equality of offerings for everyone, for instance …

    We need a product to get the risk of marriages off of individual balance sheets, to separate the default risk of the partners from the marriages themselves. Therefore I propose a derivative product that would be called MISTRO, otherwise known as; Marriage Index Secured Trust Offering.

    These could be listed, sold, and traded at your local 7-11 convenience store right next to the state lottery tickets.

    Neighbors and in-laws, concerned about the strength of, and repercussions of, a failure in your marriage, could bypass barriers between different individual partner balance sheet classes, maturities, prenuptial agreements, rating categories, debt seniority levels, etc. These credit derivatives would create enormous opportunities to exploit and profit from associated discontinuities in the pricing of risk of the individual partner balance sheets.

    The MISTRO products would also be traded by communities. This would provide an opportunity for communities concerned about what failing marriages would do to their tax collection base to spread the risk of the loss of that base.

    Sooooo … it is really a matter of democratically broadening CDS products. If everyone is able to print their own counterfeit money derivative products then everything will be OK.

    We should also have a financial derivative product to spread the risk of non performing politicians. I would call them PISTROONYOUO; Politician Index Secured Trust Offering On New Yearly Oversight Upped Opportunity …

    Deception is the strongest political force on the planet.

  13. Demented Chimp

    Cap and trade doesnt work it just creates a new market for financial wizadry/fraud, enriches everyone at the top and ensures real measures get delayed and that everyone at the bottom gets screwed by climate change. The australian greens kicked it out of parliament we should do the same at copenhagan, but we wont – its the only thing on the table

    See TNI report on cap and trade and why it fails

    1. whitemale08

      …problem is that the financial oligarchs will keep a few climate-change ‘skeptics’ around to say: “I told you so”

      during the post ‘carbon bubble’, post de-population period.

      That way they can say: “Who would’ve ever known that we never did solve pollution, instead we just sacrificed

      humanity to Lord Bufffet and the other gods @Goldman Sucks and JP Morgan.


  14. bobh

    Climate change is an unfolding disaster for many species, including our own. Cap and trade is an opportunity for a few greedy humans to make money doing “financial innovation” while things fall apart. Many thoughtful humans see what is happening, but there aren’t enough thoughtful ones to do anything about it. Our president and our congresshumans do what the greedy ones tell them, and our televisions tell us there are two sides to every issue so we shouldn’t worry. I feel bad for the polar bears.

    1. alex

      “I feel bad for the polar bears.”

      The polar bears Gus and Ida live at the Central Park Zoo, and for their sort a walk downtown is no big deal. Mmmm, investment bankers, tastier than seals!

      1. bobh

        It would be morally wrong to set angry polar bears loose on 5th Avenue. Someone needs to bring the bankers uptown and throw them into the cage.

        1. alex

          That’s needlessly complicated. Polar bears are intelligent, albeit ferocious creatures. Just point them towards the corner of Wall and Broad and tell them they can eat all the investment bankers they want, but one nibble on anybody else and they get a tranquilizer dart in the butt.

          Alternative idea: keep them in the cages and let kids feed investment bankers to them, Charge a few bucks per head and use to proceeds to help pay off the bailout.

  15. Lawrence Kramer

    I wrote some covered calls today. They’re derivatives. But they have not caused the world to end. So a Cap and Trade system using derivatives must be a good idea, right?

    CDS contracts were dangerous because they could be used to work mischief: buy a CDS, then naked short the credit to death. It’s all about insurable interest. A derivative that amounts to an insurance contract with no insurable interest is bad. The CDS contracts that caused the mess were just such contracts. The problem was not that they were “derivatives,” but what kind of derivatives they were.

    Will carbon credits have that feature? Do you know or care? Or are you just trying to kill C&T by any means necessary, including arguments that make no damn sense at all?

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