Category Archives: Derivatives

Satyajit Das: Will a Central Counter Party Tame Derivatives Market Risks?

By Satyajit Das, derivatives expert and the author of Extreme Money: The Masters of the Universe and the Cult of Risk Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives – Revised Edition (2006 and 2010)

This four part paper deals with a key element of derivative market reform – the CCP (Central Counter Party). The first part looks at the idea behind central clearing of OTC Derivatives.

The key element of derivative market reform is a central clearinghouse, the central counter party (“CCP”). Under the proposal, standardised derivative transactions must be cleared through the CCP that will guarantee performance.

The CCP is designed to reduce and help manage credit risk in derivative transactions – the risk that each participant takes on the other side to perform their obligations (known as “counterparty risk”). The CCP also simplifies and reduces the complex chains of risk that link market participants in derivative markets.

Satyajit Das: Euro-Zone’s Leveraged Solution to Leverage

Yves here. This is as concise, accessible, and not surprisingly, not at all encouraging assessment of the latest Eurorescue ~~ruse~~ mechanism.

By Satyajit Das, the author of Extreme Money: The Masters of the Universe and the Cult of Risk

If as Albert Einstein observed insanity is “doing the same thing over and over again and expecting different results”, then the latest proposal for resolving the Euro-zone debt crisis requires psychiatric rather than financial assessment.

Philip Pilkington: The History of Greed – An Interview with Jeff Madrick

Jeff Madrick is a journalist, economic policy consultant and analyst. He is also the editor of Challenge magazine, which seeks to give alternative views on economics issues, as well as a visiting professor of humanities at The Cooper Union, director of policy research at the Schwartz Center for Economic Policy Analysis, The New School, a senior fellow at the Roosevelt Institute and the author of numerous books. His latest book, The Age of Greed, is available from Amazon.

Interview conducted by Philip Pilkington, a journalist and writer based in Dublin, Ireland.

Philip Pilkington: Your book The Age of Greed is a detailed historical survey of some of the key figures that facilitated — broadly speaking — the transition away from the progressive, government-regulated economy of the post-war years and toward the finance-driven, deregulated economy in which we now live. In this interview I don’t want to focus on all the figures that crop up in the book as that is done so there in great detail. Instead I want to explore the broad sweep of this history focusing both on some of the more recognisable of these figures and on the actual cultural, political and economic shift that took place over this period.

Satyajit Das: The Financial Compass

By Satyajit Das, the author of Extreme Money: The Masters of the Universe and the Cult of Risk

Roddy Boyd (2011) Fatal Risk: A Cautionary Tale of AIG’s Corporate Suicide; John Wiley & Sons Inc, New Jersey

Justin Cartwright (2010) Other People’s Money; Bloomsbury, London

Nicholas Dunbar (2011) The Devil’s Derivatives: The Untold Story of the Slick Traders and Hapless Regulators Who Almost Blew Up Wall Street…And Are Ready To Do It Again; Harvard Business Press, Boston, Massachusetts

Barry Eichengreen (2011) Exorbitant Privilege: The Rise and Fall of the Dollar; Oxford University Press, Oxford

Diana B. Henriques (2011) The Wizard of Lies: Bernie Madoff and the Death of Trust; Times Books/ Henry Holt & Company & Scribe Publications, Melbourne

Graeme Maxton (2011) The End of Progress: How Modern Economics Has Failed Us; John Wiley, Singapore

In his novel, Justin Cartwright writes that: “There are beginning and there are ends, and there are also many ways of telling the same story.” The problem is that the great 2007 financial crisis shows no signs of ending. Far from ending, the crisis has shown a virus’ capacity to reconstitute itself. Given the literary difficulty of an uncertain end, publishers and editors have improvised in telling the story – a multiple points of the compass approach to “credit lit”.

Matt Stoller: Authorized Losses – The Lehman Lesson UBS’s Rogue Trader Missed

By Matt Stoller, the former Senior Policy Advisor to Rep. Alan Grayson and a fellow at the Roosevelt Institute. You can reach him at stoller (at) gmail.com or follow him on Twitter at @matthewstoller

I read this headline in Bloomberg: UBS Has $2B Loss; Man Arrested in London. Apparently, a rogue trader lost $2 billion, and is now sitting in jail because the trade was unauthorized by senior management. Since it’s the 3rd anniversary of the Lehman Brothers bankruptcy, I figure it’s a good time to be nostalgic about who is authorized to lose what.

Why is Bank of America’s Stock Cratering Yet Again? It’s the Extend and Pretend Endgame

Yesterday, the S&P 500 ended flat, yet Bank of America continued its truly impressive implosion, with its stock tanking 7.89%. It is now trading at a market cap of $65 billion, versus a book value of common equity of roughly $215 billion.

Market commentators were having so much fun discussing the meltdown that FT Alphaville even dedicated a post to the “The Bank of America Explanation Game.” This was its tally, and the post includes an explanation for each:

Michael Hudson: The State and Local Budget Crisis

By Michael Hudson, a research professor of Economics at University of Missouri, Kansas City and a research associate at the Levy Economics Institute of Bard College

The cost of the 2011 cutbacks in federal spending will fall most directly on consumers and retirees by scaling back Social Security, Medicare, Medicaid and social spending programs. The population also will suffer indirectly, by lower federal revenue sharing with U.S. states and cities. The following chart from the National Income and Product Accounts (NIPA, Table 3.3) shows how federal financial aid has helped cities shift the tax burden off real estate, although the main shift has been off property taxes onto income – and onto consumption (sales) taxes.

James Galbraith on How Fraud and Bad Economic Thinking Got Us in This Mess

Yves here. Our resident mortgage maven Tom Adams pointed me to a speech by James Galbraith via selise at FireDogLake, which discusses, among other things, how certain key lines of thinking are effectively absent from economics, as well as a lengthy discussion of the failure to consider the role of fraud. Galbraith is not exaggerating. The landmark 1994 paper on looting, or bankruptcy for profit, by George Akerlof and Paul Romer, was completely ignored from a policy standpoint even though it explained why the US had a savings and loan crisis.

Similarly, Galbraith refers to an incident at the most recent Institute for New Economic Thinking conference, in which he stood up and said, more or less, that he couldn’t believe he has just heard a panel discussion on the financial crisis and no one mentioned fraud. The stunning part was how utterly unreceptive the panel and the audience were to his observation. You’d think he’d had the bad taste to say the host had syphilis.

I strongly urge you to read the entire piece; non-economists may want to skim the first third and focus on the crisis material and what follows. This is the key paragraph:

This is the diagnosis of an irreversible disease. The corruption and collapse of the rule of law, in the financial sphere, is basically irreparable. It’s not just that restoring trust takes a long time. It’s that under the new technological order in this field, it can not be done. The technologies are designed to sow and foster distrust and that is the consequence of using them. The recent experience proves this, it seems to me. And therefore there can be no return to the way things were before. In other words, we are at the end of the illusion of a market place in the financial sphere.

Satyajit Das: Still Stressed After All These Tests!

By Satyajit Das, the author of Extreme Money: The Masters of the Universe and the Cult of Risk (forthcoming August 2011) and Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives – Revised Edition (2006 and 2010)

For the second time in two years, the European Banking Authority (“EBA”) completed tests on European banks to demonstrate their “solvency” under conditions of “stress”.

The results have been over shadowed by other momentous events – the announcement by the European Union (“EU”) of a range of measures to deal with the European debt crisis. The tests remain highly relevant as the EU measures are unlikely to “resolve” the debt problems and European banks remain heavily exposed to losses. The risk of a European banking crisis remains.

“Time to Take Stock”

Yves here. I had come across the speech mentioned in this post, “The Race to Zero” by Andrew Haldane of the Bank of England and decided not to write it up because I had come across it a bit late. This post will probably persuade readers that that was a bad call.

By Sell on News, a macro equities analyst. Cross posted from MacroBusiness

Exactly how did we get into this mess with the capital markets? A situation where the global stock of derivatives is over $US600 trillion, which is about twice the capital stock of the world. A situation where high frequency trading is over two thirds of the transactions on the NYSE and about the same in the stock markets of the UK and Europe. Likewise they are over half the action in foreign exchange markets and they are rapidly becoming dominant in the futures market. Andrew Haldane from the Bank of England is arguing against allowing high frequency trading — algorithms chasing algorithms chasing algorithms — from being allowed to proliferate pointing at volatility as the problem:

Third Way Document Proves Democratic Party Supports Institutionalized Looting by Banks

It is one thing to suspect that something is rotten in Denmark, quite another to have proof. Ever since Obama appointed his Rubinite economics team, it was blindingly obvious that he was aligning himself with Wall Street. The strength of the connection became even more evident in March 2009, when Team Obama embarked on its “stress test” charade and bank stock cheerleading. Rather than bring vested banking interests to heel, the administration instead chose to reconstitute, as much as possible, the very same industry whose reckless pursuit of profit had thrown the world economy off the cliff.

But now we see evidence in a new paper by the think tank Third Way of an even deeper commitment to pro-financier policies. The Democratic party has made clear that it supports institutionalized looting by banks, via the innocuous-seemeing device of rejecting the idea of writedowns on bonds they hold.

Canary in the Treasury Coal Mine: Chicago Merc Increases Collateral Haircuts for Treasuries and Foreign Sovereign Debt

We had thought the authorities and the banks (no doubt with winks and nods from the Fed) would work to make sure that haircuts on collateral were maintained while the Washington game of debt ceiling chicken played itself out.

Either the Merc (more formally, the Chicago Mercantile Exchange) wasn’t on the distribution list or it decided not to play ball. <

Alexander Gloy: Greece – Two Bail-outs and a Funeral

Yves here. Quite a few readers in comments expressed confusion over the announcement of the latest Greek bailout, and some of the details were admittedly a bit murky. This piece will hopefully help clear matters up.

By Alexander Gloy of Lighthouse Investment Management

Here we go again. Another bail-out. [Sigh.]

I’ll try to make this as entertaining and easily readable as possible – but first the details of the bail-out agreed on July 21st:

Soliciting Nominations for the FEMA Awards for Exceptional Financial Crisis Management

We are in the process of seeking recommendations for our inaugural FEMA Awards for Exceptional Financial Crisis Management. We must thank our reader Swedish Lex for providing the inspiration for establishing these prizes.

We are looking for nominees in each category. We have provided some illustrative candidates for specific prizes. Readers are also encouraged to suggest additional categories if they feel we have overlooked noteworthy types of crisis behavior that are worthy of recognition.

Our initial categories: