Nomi Prins on the Credit Derivatives Systemic Risk Bomb

Yves here. Former Goldman managing director turned journalist Nomi Prins spoke on RT about unresolved systemic risk issues, most importantly, credit derivatives, which for the most part means credit default swaps. Prins stresses the interconnectedness problem, which was earlier identified by Richard Bookstaber in his book A Demon of Our Own Design as “tight coupling.” Processes can spiral out of control when they are so tightly connected that they move through a series of steps so rapidly that they cannot be interrupted. The systemic risk version of that problem is when a failure to perform on certain contracts leads to cascading defaults at other counterparties, quickly turning into an avalanche of failures.

It’s also worth noting that the CDS market is already under scrutiny for alleged price fixing. If these charges hold up, it could be another Libor-level scandal. From Reuters (hat tip Michael Crimmins):

A Manhattan federal judge said on Thursday that investors may pursue a lawsuit accusing 12 major banks of violating antitrust law by fixing prices and restraining competition in the roughly $21 trillion market for credit default swaps.

While dismissing part of the case, U.S. District Judge Denise Cote said investors may press claims that the defendants’ Sherman Act violations caused them to pay unfair prices on CDS trades from the autumn of 2008 through the end of 2013, even as improved liquidity should have driven costs down.

This RT segment starts with a short update on Scottish secession, focusing on the issue of whether Scotland creates its own currency. England says it can’t continue to use the pound. The discussion of systemic risk and credit derivatives starts at 3:20.

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  1. proximity1

    This RT segment starts with a short update on Scottish secession, focusing on the issue of whether Scotland creates its own currency. England says it can’t continue to use the pound.”

    “England”–read, Danny Alexander, George Osborne, David Cameron and Ed Miliband say a lot of things. As they’re politicians, a lot of what they say is rank rubbish. If Scottish voters elect to sever the formal supra-nationalties with Great Britain, will then say new and different things about the possibilities of Scotland’s currency choices.

    1. larry

      And for “Scotland” read Alex Salmond, whose economic position is untenable. Like with Nixon, I wouldn’t buy a used car from him. Actually, I think Osborne believes what he says. Danny Alexander is revolting. As for Miliband, he is a wimp: he has a chance to change the character of the debate but fails to take up the challenge. And his team is nothing if not schizoid. Is it possible that he doesn’t know what he is doing?

  2. Nat Scientist

    The Scots could start fresh and leave the financial engineers on the curb, or bury them as they appear in the peat bogs.

  3. cnchal

    investors may pursue a lawsuit accusing 12 major banks of violating antitrust law by fixing prices and restraining competition

    investors may press claims that the defendants’ Sherman Act violations caused them to pay unfair prices on CDS trades

    Where are the cops? On the highway robbing motorists.

    Instead of Sherman Act violations, dig around in the garbage dump of the military and find twelve Sherman tanks and park one in front of every one of those banks, with the cannon pointed at head office.

    Then ring up the bankster and ask politely that they stop, or else.

    1. steelhead23

      cnchal, Please note, when there were armored vehicles on Wall Street, their guns were pointed at us, the Occupy protesters, Let us be clear here. Neither the U.S. military, nor its civilian arm, the militarized police, work for us. They work for the banksters under the guise of protecting “the system”. Never forget it.

    2. diptherio

      Good idea! Some cardboard Sherman tanks would make for some good street theater at the next Wall Street protest. Simultaneous commentary on anti-trust violations and police militarization!

  4. diptherio

    Bummer they had to cut her off.

    The sheer scale of the numbers is still mind-boggling to me. 5% of the US derivatives market is 11.2 Trillion! So the total US derivatives market is 224 T?!?! What’s our GDP again? 16 T….what could possibly go wrong?

  5. washunate

    I think this is why there isn’t much to add on a lot of the financial topics. There are two choices. They are the same choices we’ve had for years and years. Subsidize the banksters. Prosecute the banksters.

    Everything else is smoke and mirrors to obfuscate the essence of that choice.

  6. tagio

    I am so sick of hearing how the trillions in derivatives are going to blow up the world’s economies or bankrupt the TBTF banks. No, they won’t. The moment there is a collapse large enough to trigger widespread demands for payments on CDS, and someone in the chain defaults triggering cascading defaults (or as Zerohedge puts it, net becomes gross), ALL THE BANKS WILL DECLARE FORCE MAJEURE. The position will be that CDS are “legitimate,” and binding only in a one-off scenario, but not in a widespread liquidity crunch like a Lehman event. Everyone knows that it is impossible for the banks to pay them under those circumstances, everyone knows that no institution has reserves capable of paying them off if net becomes gross, so no one will be able to enforce them in those circumstances, impossiblity is a defense to contract performance and it will be a force majeure event. So the banks pocket the premiums, make money, and never have to pay. If you think the crackerjack attorneys who work for the TBTF banks haven’t figured out contract law 101 yet, think about it now.

    The money managers buy these things as CYA insurance so that they cannot be sued for negligence or imprudent money management by their wealthy clients who can’t be bothered to try to understand what is going on in the world. I seriously doubt many money managers believe that they are worth the paper they are printed on. The purpose of buying a CDS is to protect the professional money manager from lawsuits when their wealthy clients wake up one morning to find that 50% or more of their “wealth” has vaporized. With CDS, they can’t be blamed – it was an Act of God.

    A scam all around. Hell, you can’t even collect in a one-off scenario. The ISDA found a way to avoid payment on the bankrupt Espirto Santo CDS. These things are a complete farce.

    What will happen tho after all the derivatives are declared null and void based on force majeure, is that remaining surviving assets will become subject to higher risk premiums, because these nifty financial products won’t be around any more to eliminate the perception of risk (i.e., everyone will see that the CDS were worthless and shams). Thus, interest rates will climb, some assets will be perceived as too risky to purchase. That will cause sovereign lending rates to rise, other interest rates to rise, cause valuation adjustments, and that will tank economies. The one thing I am pretty sure of is that the banks are not going to fail, and the Fed won’t have to print several hundred trillion dollars to bail them out. The derivatives will just go poof.

    1. financial matters

      I think this is a good point but we have this playing out in smaller scales in Detroit and what happened in Cyprus and MF Global. People’s resources are slowly being sucked into the squid.

      It’s definitely a game of musical chairs and hard to know how to protect yourself. Breaking most retail money market funds away from the tri-party repo market is a good place to start. Staying away from the recent rental securities is another. Or not buying that CD that has an embedded derivative to give you a 0.5% greater yield but risk losing all the principal.

      Financial education is key so people understand more of the social aspects of the use of money rather than our current free market meme. An example would be that the government can afford to double social security to provide a more secure retirement and help with the demand side of the economy. This is a social benefit. It benefits all. As compared to privatizing social security where this money would be fed into the financial system using the free market meme (myth).

      And this is not to discredit myths. They are very important. We just need new ones.

    2. Chauncey Gardiner

      I am not an attorney, but I don’t think a force majeure argument is as cut and dried as you have presented it here. As Nomi Prins said in her interview, many of these Credit Default Swaps have been booked under UK law. Accordingly, it would seem to me that the following is likely to apply absent specific inclusive language in the CDS contracts:

      … “It is also worth noting that turbulence in or even the collapse of the economy is unlikely to constitute an event of force majeure. Several English cases have upheld this principle, including the 2006 case Thames Valley Power Limited v Total Gas & Power Limited.

      In America, commentators have suggested that Donald Trump’s claim that the global financial crisis constituted an event of force majeure would have failed, although this matter was settled before a judgement was given.”


      Whether that language is in these contracts is an open question.

    3. RBHoughton

      I think your view of the legal position cannot be right. We have plenty of precedents for the case in which a party contracts with another knowing his agreement is unenforceable. Its called fraud.

  7. Chauncey Gardiner

    Thank you for posting the interview with Nomi Prins. I am struck by how little the system has changed since 2007-2008.

  8. susan the other

    Thanks for this BoomBust. CDSs seem to be the way big finance simply extorts us into keeping the status quo. We should demand explanations of this mess and then we should demand solutions. Nullify the CDS stuff. All of it. The world will not end. Even more than Nomi Prins, I enjoyed Richard Heinberg from the Post Carbon Institute and his factual analysis of the “oil glut.” That no such glut exists. That oil reserves are as precarious as ever despite all the fracking hype and pyramiding going on here. The context being that resources wars are heating up. What was left unsaid is that no country is in as precarious a situation as we are. The EZ at least has a socially responsive coalition of governments and a good start on conservation. We’re all stuck in our cars gassing each other out on the bottle-necked “freeway.” What a good metaphor for the death of our entire system. And also something that is never said is that China is Japan all over again. But exponentially bigger and more terrifying. Maybe that’s why we pushed China and Russia together in that hasty marriage over natgas. China’s saber rattling is making us back down. And if Russia is in on it, they are being set up to be the ones to cut China off. Maybe.

  9. Oregoncharles

    “England says it can’t continue to use the pound.”
    Interesting. How would England stop them? Everyone in the world uses the dollar, and I don’t think we can prevent them.
    Of course, continuing to use the English pound would be foolish. I wonder what they’ll call their new currency, when they get around to it? The Thistle?
    It’s sort of exciting, seeing a new nation born.

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