Posted on 06/27/2009 9:49:44 AM PDT by FromLori
In the world of derivatives, profits for the dealers come from complexity and secrecy.
As a new regulatory system for derivatives is shaped on Capitol Hill, the banks will try to preserve as much of both as they can. To the extent they succeed, it will be the customers, and the financial system, that are at risk.
Already the banks seem to be winning one important battle, that of explaining why derivatives exist.
In Congressional testimony this week, Mary Schapiro, the chairman of the Securities and Exchange Commission, and Gary Gensler, the chairman of the Commodity Futures Trading Commission, laid out the case for extensive regulation. But they also had kind words for the products. Derivatives, Ms. Schapiro said, “allow parties to hedge and manage risk, which itself can promote capital formation.”
For some derivatives, that is true. But the generalization is not always accurate, and there needs to be consideration as to whether some derivatives deserve to exist at all.
“Simply put,” said Richard Bookstaber, one of the pioneers of financial engineering on Wall Street, “derivatives are the weapon of choice for gaming the system."
Mr. Bookstaber wrote one of the best books about the causes of the financial crisis, “A Demon of Our Own Design,” and did so before the crisis erupted. This month, his testimony to a Senate subcommittee provided a stark lesson in the uses to which derivatives have been put.
“Derivatives,” he testified, “provide a means for obtaining a leveraged position without explicit financing or capital outlay and for taking risk off-balance sheet, where it is not as readily observed and monitored.” They let institutions dodge taxes and accounting rules
(Excerpt) Read more at nytimes.com ...
Watch the money changing hands on this CRAP AND TRADE nightmare.
Derivatives are not innately evil. However, there has to be some limit on the amount of credit exposure that a bank assumes from a counter-party, and a limit on the amount of counter-party liability that a bank or insurance company can assume.
It was not necessarily bad that the banks and insurance companies entered into these agreements, but the unbelieveable notional amounts of liability and exposure that were generated. When the piper had to be paid, AIG and others could not come up with anywhere near enough cash to meet their obligation under these contracts - so us taxpayers did.
Ah, yes, but issuing ‘insurance’ without capital to back it up is fraud, is it not? I remember last fall when an ‘insurer’ offered the players only their ‘premiums’ back because they could not pay off.
What’s the play on the ‘new’ carbon deriviatives market?
This just ain't nuclear physics, people.
BTW, just FYI, writing a CDS is exactly equivalent to writing a naked put option, just on a different group of securities. The CBOE and option traders generally have known how to deal with the proper margining of naked puts for 33 years.
Cap and Trade is the replacement for Subprime and securitized mortgages, 50 to 1 leverage the banks used the last 10 years, etc. Without a housing bubble, the only way the bankers can continue to make money at our expense is cap and trade. Why? BECAUSE THEY WILL BE RUNNING THE MARKET FOR CARBON OFFSETS!!! The UBS’s, Goldman Sachs, etc of the world will game the system the same way they made liar loans, 110% mortgages, etc.
snipped from:
http://www.freerepublic.com/focus/bloggers/2280038/posts?page=9#7
GS and other crooks will no doubt be all over this market, because the supply 'figures' can be gamed so easily. Solution: individual punters should stay the hell away from any c.c. mkt.
Institutional traders should (and they will, sooner or later) insist on hard-dollar documentation of the alleged offset(s), with an equally hard-dollar penalty to be assessed and enforced in the case of deliberate shenanigans. Bet your life there'll be a few such cases in the near future if Crap & Tax goes into effect.
The derivatives should be traded on the open market in some standardized format. Trading them in secret only insures that their true value remains unkown. Markets need to evaluate these instruments and that is exactly what the banks don’t want to happen.
There is no reason whatever that even the most exotic instruments should not be exchange-traded. Granted, the open interest in a lot of them would be very small (as open interest is in a LOT of derivative-based mkts right this minute)...but that's just an indicator (a good one, too) that 1) the instruments in question serve no or little general economic purpose, and 2) the only reason that i.b.s and hedge funds sell a shjtload of these instruments is just that -- they SELL them -- with promises of sugar plums to unsophisticated counterparties.
Rather like an extended warranty on a brand-new car, come to think of it...
Under Federal reguation, I don’t think an obligation as a counter party to a derivative contract would be interpreted as “insurance”, though effectively that is what it is. That may have been one of the things that attracted AIG to get in the business. I am vaguely familiar with that body of regulation, but not competent enough to say that definitively.
I am clueless as to how cap & trade derivatives would work. I haven’t read up on it and have not put any thought into it.
You are correct about a deal cop or a risk manager. Those guys make decisions based on measurement of risk. The mortgage market instigated a cascade of risk that was felt throughout the credit markets and banking. Underlying all of this, IMHO, was that far more risk was buried in the mortgages and mortgage backed securities than anybody realized.
I went to a bank regulator conference a little over a year ago and I was surprised to hear an FDIC capital markets expert talk a high level of sub-prime/ Alt A mortgages backing AAA rated securites. I don’t think that very many investor types buying those securities really knew that, hence they were hoodwinked into thinking the AAA rated securities were almost riskless. The bond-debt rating companies like Moody’s and Fitch were certainly fooled and ended up with a whole lot of egg on their faces. Who knows whether they were a party to the fraud or were just fooled themselves.
I know just enough about this subjectto be dangerous, but I have pretty much viewed the securitization process done by the investment bankers with regard to the subprime/ Alt-A mortgage paper to be out and out fraud . . . a fraud that was encouraged by the likes of Barney Frank and Chris Dodd.
He did this by creating, at ACORN's behest, a 'scorecard' system within which, if a bank did not have a sufficiently high ''shjtbum lending'' score, ACORN could complain to the Comptroller of the Currency and prevent said bank from opening new branches, offering new loan products, even adjusting rates on savings accounts and CDs, and a whole lot of other things.
Most banks just acquiesced and started lending bigtime to said shjtbums. Then, not being total idiots, they bundled up the mortgages and sold them to all comers, pretty much as quickly as they could. THEN, the i.b.s got into the game and levered this crap up to the guts.
Couldn't have happened w/o Cuomo, m'FRiend.
You are probably right. I saw quite a few bank merger applications delayed by these shakedown groups over the years. Sometimes it was infuriating.
Regards
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