U.s. Banking Crisis: Capitalism "gone Wild"?

[OriginalPoster]

And the brother of Jesus said, "The love of money is the root of all evil."

lehnman brothers, freddie mac, fannie mae, goldman sachs, aig insurance, etc. - no longer worthy of upper case letters. And bailed out by the world's largest debtor, who has not finished paying off the money it borrowed to save Europe from the Austro-Hungarian Empire. It is enough to make a pensioner like me afraid I might lose my COLA's before my sister ever sells her house in Florida.

It makes you think that ford and general motors are too big to fail, also.

GM is on the brink of bankruptcy...watch it...The BIG 3 are begging for $ 50 Billion help from DC...

And...too big you say ? What workers is concerned YES; not in Market Cap.....

The market Cap of GM is a mere $ 7,5 Billion (263,000 workers) and Ford (246,000 workers) has a Market Cap of $ 12 Billion.

In comparison: Garmin (8,400 workers), the GPS device manufacturer has a Market Cap of $ 7,9 Billion and Microsoft (91,000 workers) 230 Billion whilst Apple (21,000) goes for 125 Billion. and CISCO (66,000 workers) the Networking company has a Market Cap of $ 143 Billion.

A large part of America is bankrupt, completely bankrupt and the DEBT of the US rises with this rescue operation with $ 700 Billion, from $ 10,6 to 11,3 TRILLION....

that is: ten-thousand-three-hundred BILLION Dollars is debt....

Someone a cookie with his coffee ?

LaoPo

The amazing thing is: nothing of this is news, was not even news a generation ago. The same which is true for individuals should be true for governments: do only spend within your means. There was a time when 'the people' could have stood up and taken the pain, for a better future, and insisted on sound market politics.

Unluckily we are all well past this point, so the pain to come will be inflicted involuntarily, and a much bigger pain at that.

I agree except for the part about "The same which is true for individuals should be true for governments: do only spend within your means". In the US, that's not the way that people have lived for the past couple of decades. Most are in hock up top their eyeballs, living beyong your means has become an art form the in US. The US goverment might be irresposnible to run up such deficits, but ito a large degree it reflects the will of the citizenry. Why be outraged by the federal defict if you live your own life that way?

Edited September 21, 2008 by OriginalPoster

[Lopburi99]

SEPTEMBER 20, 2008

In Turmoil, Capitalism in U.S. Sets New Course

By DAVID WESSEL

This past week marks a decisive turn in the evolution of American capitalism.

Black September, the biggest financial shock since the Great Depression, is prompting a Republican Treasury secretary and Federal Reserve chairman to devise the most muscular government intervention in the economy since the Great Depression in an effort to prevent the economic devastation of the Great Depression.

Abandoning its one-rescue-at-a-time strategy of recent months, the government suddenly has shifted to a broad attack on what Treasury Secretary Henry Paulson calls "the root cause of our financial system's stresses," the rot on the balance sheets of America's financial system.

Gone is the faith, shared by the nation's leadership with varying degrees of enthusiasm, that the best road to prosperity is to unleash financial markets to allocate capital, take risks, enjoy profits, absorb losses. Erased is the hope that markets correct themselves when they overshoot.

Also scrapped is the notion that government's role is to get out of the way, limiting itself to protecting consumers and small investors, setting the rules of the game and stepping in -- only rarely -- to cushion the economy from shocks like the 1987 stock-market crash or the 1998 collapse of hedge fund Long-Term Capital Management. Both of those episodes involved government jawboning and flooding the markets with money. In contrast to today, neither time did the U.S. take significant amounts of taxpayer money or anything approaching the nationalization of a major firm.

http://mobile2.wsj.com/device/article.php?...6877559117.html

Never before in my lifetime have I had so little confidence in the U.S.'s ability to manage itself. It's not just one political party, after all Clinton and GW each bear equal responsibility for being at the helm for the past 16 years, not to mention the years and years of a largely disfunctional congress being unable to get much of anything worthwhile done in the best interests of all Americans. We relied on the government to prevent a crisis like this from ever happening! I am really fuming! Where the h_ell were the so-called "checks and balances"??

Sure hope to God somehow the $USD and other major currencies don't go deep south long term. Hopefully there are other factors (beyond my level of understanding) like the price of oil, money flowing in/out of various countries, trade agreements, geopolitical issues, or who knows what but things which can somehow maintain some semblance of stability in currency markets. It's all very scary. Those of us on pensions have cause for major concern.

The people didn't want checks and balances then and they don't want'em now. They just want their stocks to go back up. Hey, did you see the part of the Bill whereby there would be no judicial oversight? Whatever, maybe it'll give a nice bounce to the market. I don't see why you're so hard on the administartion and Congress. They started a nice war that provided a sweet "buying opportunity" for all the "stakeholders".

"Hey, did you see the part of the Bill whereby there would be no judicial oversight?"

Yes LRB, I did. What's that all about? Incredible. From the frying pan into the fire?

Your other points are also well taken.

Edited September 21, 2008 by Lopburi99

[lannarebirth]

The people didn't want checks and balances then and they don't want'em now. They just want their stocks to go back up. Hey, did you see the part of the Bill whereby there would be no judicial oversight? Whatever, maybe it'll give a nice bounce to the market. I don't see why you're so hard on the administartion and Congress. They started a nice war that provided a sweet "buying opportunity" for all the "stakeholders".

Might I be a cynic?

Coming from a German viewpoint; even if the US goes down the drain and world economy follows in a bad way, at least in old Europe the signs of the time have been seen long ago and de-coupling ourselves from the US as the only trading partner has been going on for a long time. Looking to Russia and China, totally impossible just 15-20 years ago might just keep our head out of the sling.

If things go bad they will be really bad, but not a total disaster like the US might have to go through, not even 100 years after the Great Depression.

But then I am rather an optimist, all will be well with lots of singing and dancing, nothing to worry about.

I'm not so worried about the economy. That's of lesser importance to me than how the poulace has made a Faustian bargain. Americans didn't even get knowledge out of their end of the bargain.

I hope and do not expect to see a depression in America or anywhere else. But you know one thing that was really valuable about the last one? All my life I would meet people who had lived in that era, who conducted their affairs in a manner showing humility, frugality and compassion for the downtrodden. It's sad to think thosecharcter traits have been lost, but to me anyway, an economic dowturn is a small price to pay to regain them.

[lannarebirth]

SEPTEMBER 20, 2008

In Turmoil, Capitalism in U.S. Sets New Course

By DAVID WESSEL

This past week marks a decisive turn in the evolution of American capitalism.

Black September, the biggest financial shock since the Great Depression, is prompting a Republican Treasury secretary and Federal Reserve chairman to devise the most muscular government intervention in the economy since the Great Depression in an effort to prevent the economic devastation of the Great Depression.

Abandoning its one-rescue-at-a-time strategy of recent months, the government suddenly has shifted to a broad attack on what Treasury Secretary Henry Paulson calls "the root cause of our financial system's stresses," the rot on the balance sheets of America's financial system.

Gone is the faith, shared by the nation's leadership with varying degrees of enthusiasm, that the best road to prosperity is to unleash financial markets to allocate capital, take risks, enjoy profits, absorb losses. Erased is the hope that markets correct themselves when they overshoot.

Also scrapped is the notion that government's role is to get out of the way, limiting itself to protecting consumers and small investors, setting the rules of the game and stepping in -- only rarely -- to cushion the economy from shocks like the 1987 stock-market crash or the 1998 collapse of hedge fund Long-Term Capital Management. Both of those episodes involved government jawboning and flooding the markets with money. In contrast to today, neither time did the U.S. take significant amounts of taxpayer money or anything approaching the nationalization of a major firm.

http://mobile2.wsj.com/device/article.php?...6877559117.html

Never before in my lifetime have I had so little confidence in the U.S.'s ability to manage itself. It's not just one political party, after all Clinton and GW each bear equal responsibility for being at the helm for the past 16 years, not to mention the years and years of a largely disfunctional congress being unable to get much of anything worthwhile done in the best interests of all Americans. We relied on the government to prevent a crisis like this from ever happening! I am really fuming! Where the h_ell were the "checks and balances"??

Sure hope to God somehow the $USD doesn't go deep south long term. Hopefully there are other factors (beyond my level of understanding) like the price of oil, money flowing in/out of various countries, trade agreements, geopolitical issues, or who knows what but things which can somehow maintain some semblance of stability in currency markets. It's all very scary. Those of us on pensions have cause for major concern.

The people didn't want checks and balances then and they don't want'em now. They just want their stocks to go back up. Hey, did you see the part of the Bill whereby there would be no judicial oversight? Whatever, maybe it'll give a nice bounce to the market. I don't see why you're so hard on the administartion and Congress. They started a nice war that provided a sweet "buying opportunity" for all the "stakeholders".

The provision for no judicial oversight won't stand up even if congress approves it. Google Marbury v. Madison, that decision has stood up for more than 200 years, this won't be an exception.

There was a time where I would absolutely agree with you. Seeing as how there are several provisions of the so called "Patriot Act" that would not pass judicial muster, but still are in place, it makes me wonder.

[Scott]

A good friend and an attorney told me that no one cares about the laws as long as people are making money, but as soon as people start losing money, then they start looking to the law to get the offenders. Seems this is truer than I thought at the time.

[lannarebirth]

ALMOST ARMAGEDDON

MARKETS WERE 500 TRADES FROM A MELTDOWN

By MICHAEL GRAY

September 21, 2008

The market was 500 trades away from Armageddon on Thursday, traders inside two large custodial banks tell The Post.

Had the Treasury and Fed not quickly stepped into the fray that morning with a quick $105 billion injection of liquidity, the Dow could have collapsed to the 8,300-level - a 22 percent decline! - while the clang of the opening bell was still echoing around the cavernous exchange floor.

http://www.nypost.com/seven/09212008/busin...ddon_130110.htm

[lannarebirth]

The Mother Of All Frauds

http://market-ticker.denninger.net/

[lannarebirth]

Power/Money Grab:

http://www.atlargely.com/2008/09/fascist-coup-ne.html

[philstone]

So the FED comes to the rescue They will produce mega billions of dollars in an apparant bail out However, this begs the question where does the FED get the money from? Answer: they simply print it - which in turn dilutes the value of the dollar in your pocket

I think it time for the people of Europe to send America money and food. Remember America saved them after First War and Second War. And Germany should send the most.

[lannarebirth]

Why You Should Hate the Treasury Bailout Proposal

A mere two weeks ago, the Fannie/Freddie rescue was called "the mother of all bailouts" by some commentators. If the plans of the Administration come to fruition, it will shortly be surpassed by the $700 billion mortgage rescue plan proposed by Hank Paulson late last week.

The increase of the request from the initial $500 billion and the release of the shockingly short, sweeping text of the proposed legislation has lead to reactions of consternation among the knowledgeable, but whether this translates into enough popular ire fast enough to restrain this freight train remains to be seen.

http://www.nakedcapitalism.com/2008/09/why...ry-bailout.html

[philstone]

So the FED comes to the rescue They will produce mega billions of dollars in an apparant bail out However, this begs the question where does the FED get the money from? Answer: they simply print it - which in turn dilutes the value of the dollar in your pocket

I think it time for the people of Europe to send America money and food. Remember America saved them after First War and Second War. And Germany should send the most.

[lannarebirth]

I think the question you have to ask yourself, looking back over the past decade or so is; "who have been the winners and who have been the losers?". Who benefitted and who has lost? Probably not some cave dweller.

[CaptHaddock]

That's why many of us (I + uni friends) we are very aggressive in putting into the ROTH and among other things - and managing our own funds and portfolio

Actually to be exact

6.2% = SSA + same amount of employer matching of 6.2%

1.45% = Medicare

So that whoopping almost 8% off our paycheck and plus income tax too of course

I have heard we're paying out around 40% in all the taxes combined

Income tax +Ssa+ medicare + sale tax + gas tax + property tax , ects =======OUCHHH!!!!

Teacup,

You certainly should max out your savings and take full advantage of Roth especially. However, your belief that SS will fail is not correct and comes from a disinformation campaign by the Republicans intended to destroy it. There is no government program that is as well-funded as Social Security. Using the least favorable growth estimate of the three estimates that the SS Administration prepares, the fund will make full payments until 2044 or so when the Trust Fund is exhausted and payments will depend only on contributions. Using the highest estimate of growth (2.9% annual which is below the actual post-war average growth rate of 3.4%), the Trust Fund is never exhausted.

It is important for you and your uni friends to understand why SS is so important to you and why you cannot fully replace it with your own savings and investment. SS, like other insurance vehicles, works by because the mortality rates of the population are known statistically. So SS taxes you assuming that you will live to the average life span of, let's say, 78 for a woman. They know how many recipients will be collecting at age 65, age 80, age 90, etc. So the biggest benefit they provide is the "mortality credit", which means that if you are still alive they can pay your benefit from the contributions of the many payers who have died earlier in their lives. While you plan your individual retirement you don't know how long you will live. So, you have to plan for the longest, most expensive life to avoid the horrible outcome of being both old and poor. BIG OUCH!! That savings plan will cost you a whole lot more than the 6+% you are currently paying into SS. You could buy an annuity and benefit from a similar mortality credit, but then you have to worry about the credit worthiness of the private insurance company and accept that they will skim a profit while SS does not.

What would life look like without SS? We can see by looking at the Chinese, who lack both health insurance and any SS-type retirement income plan. Chinese families save up to 48% of their income. They do this because they lack such a govt safety net and, moreover, in 50% of the cases their single child is not a son who can be expected to take care of them in their old age. If the Republicans were to succeed in destroying both employer-provided health insurance (McCain's stated policy) and SS, American families would have to start to achieve savings rates approaching the Chinese. Of course, this would wreak havoc with the consumer economy. Interestingly, the Chinese govt has announced their intention to create a social safety net specifically for the economic purpose of relieving families of the necessity of saving so much of their income so that the economy can develop domestic demand in addition to export demand. It doesn't make sense to force everyone to save for a life-span of 95 years when most will die by 75. Destroying SS and employer-provided health insurance would be a major step in reducing the American standard of living to that of the Chinese.

Insurance structures that pool risk are one of the truly great advances of modern civilization. Without them you might do fine if you happen to be lucky enough to avoid an adverse outcome such as expensive illness, forced early retirement due to health or economic considerations, or a very long and costly lifespan (which is unlucky only in the financial sense, of course.) But if you do have bad luck you are much more likely to face bankruptcy and poverty. Indeed, bankruptcy rates have been increasing dramatically in the US for two groups: families with children and senior citizens.

SS needs to be reformed to reflect the changes in American society since the 30's, e.g. women in the workplace and longer lifespans. The biggest change is that the FICA tax should be on 100% of income and not be capped at $102,000 of income as it is now allowing Warren Buffet to pay a lower percentage of his income for FICA than you do. This would make it less regressive and also ensure payments even in the case of lower than expected economic growth.

Capt Haddock

[LaoPo]

you have an alternative in your country LaoPo and that is (if it has not changed) 1% tax on your total assets in lieu of tax on your income. for some not a bad deal.

You mean the so called fortune tax. Yes, we have a sort of fortune-yield/return-tax, also called wealth tax, installed on Jan 1 -2001 (Germany banned the wealth/fortune tax already in 1997).

Someones fortune (all assets together) is measured on Jan 1 and Dec. 31; the two sums are added together, and divided by two. The taxman assumes you are able to make 'at least' a return of 4% over that sum.

This 4% is taxed with 30%, so in the end the 30% of the return of 4% is a total of 1,2% to be paid over the total fortune.

However, don't forget that BEFORE one has ''made'' a fortune...a fortune in taxes have already been paid with an enormous variation of taxes.

So; it is NOT 'in lieu' of taxes on income. Taxes on income always need to be paid although income from rentals in real estate are free of income taxes.

LaoPo

[teacup]

Teacup,

You certainly should max out your savings and take full advantage of Roth especially. However, your belief that SS will fail is not correct .......

Capt Haddock

Capt.

Our government is trying to tell us that in an off-the-wall way, if you to believe the smokes.

Well one thing for sure if it’s not there, then the 1st thing that would happen would be our entire Congress would be out of jobs. The Senators and Representatives would not let this happen. But for sure, it's in serious financial trouble.

Have you notice how the age of retirement is going up and up? Many people will die before they ever get to collect their pittance, because it is mathematically impossible that social security will be there for me when I retire, or if there - the benefits will be diluted to the point where I can only hope it will pay my cable bill!!!!!

That said, I would still plan for my own future--even with social security I’m going to want more than that. So between now and then I will just go out and buy the self-help “the financial for DUMMIES books” and just learn to manage my own money!!!……not to worry be happy!!!

Hope...... I really hope I’m quite good managing my nest eggs --got maaany decades to go

Just me

[cclub75]

Good news : the House Financial Services Committee Chairman wants to stop the wannabe financial dictator Paulson by seeking authority to oversight his plan.

Frank, a Democrat from Massachusetts, proposed that the U.S. Comptroller General ``commence ongoing oversight of the activities and performance'' of the plan, according to legislative language presented to Treasury officials today and obtained by Bloomberg News.

Let's remember the shocking section 8 of the draft of the Mother Of Bailout, cooked by Paulson and his friends (for his friends) :

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

!!

The american people must wake up and say no to this scandal.

It's astonishing. It's like the senatus consultum ultimum of the ancient Rome.

Edited September 21, 2008 by cclub75

[CaptHaddock]

Capt.

Our government is trying to tell us that in an off-the-wall way, if you to believe the smokes.

Well one thing for sure if it's not there, then the 1st thing that would happen would be our entire Congress would be out of jobs. The Senators and Representatives would not let this happen. But for sure, it's in serious financial trouble.

Have you notice how the age of retirement is going up and up? Many people will die before they ever get to collect their pittance, because it is mathematically impossible that social security will be there for me when I retire, or if there - the benefits will be diluted to the point where I can only hope it will pay my cable bill!!!!!

That said, I would still plan for my own future--even with social security I'm going to want more than that. So between now and then I will just go out and buy the self-help "the financial for DUMMIES books" and just learn to manage my own money!!!……not to worry be happy!!!

Hope...... I really hope I'm quite good managing my nest eggs --got maaany decades to go

Just me

No, it's not the "government" that is trying to tell you that SS won't be there for you--it's the Republicans. They constantly lump SS together with Medicare as crises that need to be solved, mostly by abandoning them. But SS is not in a crisis. SS will be fine. Medicare will not. Unless there is health care reform.

The age of retirement has to go up because life spans have gone up. Dramatically. During the 20th century the American lifespan went from 47 years to 79! The demographics have changed profoundly since SS became law in 1935. The New Dealers weren't in a position to forsee such change.

Yes, you should read everything you can and become competent to plan for your retirement. Few people are capable of managing it. But SS will be there for you. Particularly if you fight for it. If not, well, have you run a retirement calculator to see how much you have to save to provide for living 30 or 40 years without working?

Edited September 21, 2008 by CaptHaddock

[LaoPo]

What would life look like without SS? We can see by looking at the Chinese, who lack both health insurance and any SS-type retirement income plan. Chinese families save up to 48% of their income. They do this because they lack such a govt safety net and, moreover, in 50% of the cases their single child is not a son who can be expected to take care of them in their old age. If the Republicans were to succeed in destroying both employer-provided health insurance (McCain's stated policy) and SS, American families would have to start to achieve savings rates approaching the Chinese. Of course, this would wreak havoc with the consumer economy. Interestingly, the Chinese govt has announced their intention to create a social safety net specifically for the economic purpose of relieving families of the necessity of saving so much of their income so that the economy can develop domestic demand in addition to export demand. It doesn't make sense to force everyone to save for a life-span of 95 years when most will die by 75. Destroying SS and employer-provided health insurance would be a major step in reducing the American standard of living to that of the Chinese.

How on earth can you compare the US with China and vice versa ? It's like comparing apples with pears and you better stop doing so because it doesn't make any sense...at all.

China opened up a mere 30 years ago in 1978; what do you expect to compare the country and it's system with the US' system, created and molded over a period of centuries ?

Besides that, the present financial crisis shows that the US financial system failed and was not able to regulate itself and therefore giant huge and in fact crazy steps have to be made/taken in order to avoid chaos and a total collapse.

We'll see how far the dictatorship of "King Henry"*** Paulson will go...

*** quote from Marketwatch/The Wall Street Journal, not me.

LaoPo

[teacup]

Capt.

Yeah… and it shows I will need a couple millions to retire over here!!

So I’m going with the “declining cash requirements method” during my retirement!

=====I will be doing a great deal of traveling during the first 5 to 10 years then settling back to a more simple domestic life with possible part time work, make sure I will have extremely self-sufficient children - hehe( if we plan to have any kids, that is), and own a home in Thailand and Bali.

And all of the above could be possible if I can do the hopping to Thailand - next year or so.

Back to the banking crises:

The good news for me is that=====I just bought WM stock last week at $3.00 and planning to sell them this week or next at around $5-6.00 or so----some CHUM change for me there in the ROTH acct--yippiiiiii

Yeah……I will be HAPPPYYYY!!!!

Now....Capt HL----come and wish your little girl the best of luck here & future

[flying]

Hope...... I really hope I'm quite good managing my nest eggs --got maaany decades to go

Just me

True & good luck to you.

But please not at the expense of too much

I only say because I had a dear friend. He was always telling me.......

"Save..save..save...someday when we retire you will need it"

He was good at it but to a point where he would not have things he really wanted like a trip or even a better coffee.

If I bought a latte he would say you know......if you drank a regular coffee you could save 2 bucks

He wanted a latte

Sad thing is the poor guy died in his early 40's of cancer. He had a lot saved up too.

[Naam]

you have an alternative in your country LaoPo and that is (if it has not changed) 1% tax on your total assets in lieu of tax on your income. for some not a bad deal.

1. You mean the so called fortune tax. Yes, we have a sort of fortune-yield/return-tax, also called wealth tax, installed on Jan 1 -2001 (Germany banned the wealth/fortune tax already in 1997).

Someones fortune (all assets together) is measured on Jan 1 and Dec. 31; the two sums are added together, and divided by two. The taxman assumes you are able to make 'at least' a return of 4% over that sum.

This 4% is taxed with 30%, so in the end the 30% of the return of 4% is a total of 1,2% to be paid over the total fortune.

However, don't forget that BEFORE one has ''made'' a fortune...a fortune in taxes have already been paid with an enormous variation of taxes.

2. So; it is NOT 'in lieu' of taxes on income. Taxes on income always need to be paid although income from rentals in real estate are free of income taxes.

LaoPo

1. our fortune tax was parallel on top of the annual income tax.

2. i had no idea. now i know why you favour real estate.

[jts-khorat]

Hope...... I really hope I'm quite good managing my nest eggs --got maaany decades to go

Just me

True & good luck to you.

But please not at the expense of too much

I only say because I had a dear friend. He was always telling me.......

"Save..save..save...someday when we retire you will need it"

He was good at it but to a point where he would not have things he really wanted like a trip or even a better coffee.

If I bought a latte he would say you know......if you drank a regular coffee you could save 2 bucks

He wanted a latte

Sad thing is the poor guy died in his early 40's of cancer. He had a lot saved up too.

Your friend was very right 'statistically'; he could as well have lived until being 90, which is very little fun in an old-people home for the destitute (or so I am told).

I rather would have to drink normal coffee all my life and die with 40 than have lattes and stay 20 years in such a place -- and presumably there will be no lattes there either.

We all can die tomorrow by accident or sickness. But most of us do not.

[lannarebirth]

"The Real Reason Behind the Global Financial Crisis"

by: Money Morning posted on: September 19, 2008 | about stocks: AIG

By Shah Gilani

[Part I of a three-part series looking at how so-called “credit default swap” derivatives could ignite a worldwide capital markets meltdown]

Are you shell-shocked? Are you wondering what’s really going on in the market? The truth is probably more frightening than even your worst fears. And yet, you won’t hear about it anywhere else because “they” can’t tell you. “They” are the U.S. Federal Reserve and the U.S. Treasury Department, and they can’t tell you what’s really going on because there’s nothing they can do about it, except what they’ve been trying to do - add liquidity.

At the exchange rate Wednesday, 35 trillion British Pounds was equivalent to U.S. $62 trillion (hence, the 35 trillion pound gorilla). According to the International Swaps and Derivatives Association, $62 trillion is the notional value of credit default swaps [CDS] out there, somewhere, in the market.

This isn’t the first time Money Morning has warned readers about the dangers of credit default swaps. And it won’t be the last.

The Genesis of a Derivative Boom

In the mid-1980s, upon arriving in New York from Chicago with an extensive background in trading options and futures (the original derivatives), I was offered a job at what was then Citicorp [today’s Citigroup Inc. ©]. The offer was for an entry-level post in the bank’s brand new OTC (over-the-counter, meaning not exchange traded) swaps and derivatives group. When I asked what the economic purpose of swaps was, the answer came back: “To make money for the bank.”

I declined the position.

It used to be that regulators and legislators demanded theoretical, empirical, and quantitative measures of the efficacy of new tradable instruments being proposed by exchanges. What is their purpose? How will they benefit the capital markets and the economy? And, what safeguards will accompany their introduction?

Not any more. In the early 1990s, in order to hedge their loan risks, J. P. Morgan & Co. [now JPMorgan Chase & Co. (JPM)] bankers devised credit default swaps.

A credit default swap is, essentially, an insurance contract between a protection buyer and a protection seller covering a corporation’s, or sovereign’s (the “referenced entity”), specific bond or loan. A protection buyer pays an upfront amount and yearly premiums to the protection seller to cover any loss on the face amount of the referenced bond or loan.

Typically, the insurance is for five years.

Credit default swaps are bilateral contracts, meaning they are private contracts between two parties. CDSs are subject only to the collateral and margin agreed to by contract. They are traded over-the-counter, usually by telephone. They are subject to re-sale to another party willing to enter into another contract. Most frighteningly, credit default swaps are subject to “counterparty risk.”

If the party providing the insurance protection - once it has collected its upfront payment and premiums - doesn’t have the money to pay the insured buyer in the case of a default event affecting the referenced bond or loan (think hedge funds), or if the “insurer” goes bankrupt (Bear Stearns was almost there, and American International Group Inc. (AIG) was almost there) the buyer is not covered - period. The premium payments are gone, as is the insurance against default.

Credit default swaps are not standardized instruments. In fact, they technically aren’t true securities in the classic sense of the word in that they’re not transparent, aren’t traded on any exchange, aren’t subject to present securities laws, and aren’t regulated. They are, however, at risk - all $62 trillion (the best guess by the ISDA) of them.

Fundamentally, this kind of derivative serves a real purpose - as a hedging device. The actual holders, or creditors, of outstanding corporate or sovereign loans and bonds might seek insurance to guarantee that the debts they are owed are repaid. That’s the economic purpose of insurance.

What happened, however, is that risk speculators who wanted exposure to certain asset classes, various bonds and loans, or security pools such as residential and commercial mortgage-backed securities (yes, those same subprime mortgage-backed securities that you’ve been reading about), but didn’t actually own the underlying credits, now had a means by which to speculate on them.

If you think XYZ Corp. is in trouble, and won’t be able to pay back its bondholders, you can speculate by buying, and paying premiums for, credit default swaps on their bonds, which will pay you the full face amount of the bonds if they do actually default. If, on the other hand, you think that XYZ Corp. is doing just fine, and its bonds are as good as gold, you can offer insurance to a fellow speculator, who holds the opinion opposite yours. That means you’d essentially be speculating that the bonds would not default. You’re hoping that you’ll collect, and keep, all the premiums, and never have to pay off on the insurance. It’s pure speculation.

Credit default swaps are not unlike me being able to insure your house, not with you, but with someone else entirely not connected to your house, so that if your house is washed away in the next hurricane I get paid its value. I’m speculating on an event. I’m making a bet.

The bad news is that there are even worse bets out there. There are credit default swaps written on subprime mortgage securities. It’s bad enough that these subprime mortgage pools that banks, investment banks, insurance companies, hedge funds and others bought were over-rated and ended up falling precipitously in value as foreclosures mounted on the underlying mortgages in the pools.

What’s even worse, however, is that speculators sold and bought trillions of dollars of insurance that these pools would, or wouldn’t, default! The sellers of this insurance (AIG is one example) are getting killed as defaults continue to rise with no end in sight.

And this is only where the story begins.

The Ticking Time Bomb

What is happening in both the stock and credit markets is a direct result of what’s playing out in the CDS market. The Fed could not let Bear Stearns enter bankruptcy because - and only because - the trillions of dollars of credit default swaps on its books would be wiped out. All the banks and institutions that had insurance written by Bear would not be able to say that they were insured or hedged anymore and they would have to write-down billions and billions of dollars in losses that they’ve been carrying at higher values because they could say that they were insured for those losses.

The counterparty risk that all Bear’s trading partners were exposed to was so far and wide, and so deep, that if Bear was to enter bankruptcy it would take years to sort out the risk and losses. That was an untenable option.

The Fed had to bail out Bear Stearns.

The same thing has just happened to AIG. Make no mistake about it, there’s nothing wrong with AIG’s insurance subsidiaries - absolutely nothing. In fact, the Fed just made the best trade in its history by bailing AIG out and getting equity, warrants and charging the insurance giant seven points over the benchmark London Interbank Offered Rate [LIBOR] on that $85 billion loan!

What happened to AIG is simple: AIG got greedy. AIG, as of June 30, had written $441 billion worth of swaps on corporate bonds, and worse, mortgage-backed securities. As the value of these insured-referenced entities fell, AIG had massive write-downs and additionally had to post more collateral. And when its ratings were downgraded on Monday evening, the company had to post even more collateral, which it didn’t have.

In short, what happened in one small AIG corporate subsidiary blew apart the largest insurance company in the world.

But there’s more - a lot more. These instruments are causing many of the massive write-downs at banks, investment banks and insurance companies. Knowing what all this means for hedge funds, the credit markets and the stock market is the key to understanding where this might end and how.

The rest of the story will be illuminated in the next two installments. Next up: An examination of the AIG collapse, followed by a look at how bad things could get, and what we can do to fix the problem at hand. So stay tuned.

http://seekingalpha.com/article/96290-the-...inancial-crisis

Edited September 22, 2008 by lannarebirth

[glyph]

About 15 years ago, US thrifts suffered a similar problem, and the Resolution Trust Corp was formed to buy bad debts. A similar solution will be implemented for the banks and investments firms. All in all, it's only a big deal, if you want it to be a big deal.

"As a deer pants for water, I pant for deregulation".

Regulation works and when regulation goes on the back burner, problems arise. A couple generations ago, thrifts and banks were highly regulated, and staid institutions. To compete with the debt and equity markets, and to increase return to their shareholders, the government allowed some things to change slowly, and others to change rapidly. As an example, US governmental regulations - for banks, thrifts, and credit unions - did not allow interest to be paid on checking accounts. The financial institutions introduced NOW (negotiated order of withdrawal) accounts, essentially checking accounts that paid interest - skirting the then current regulations.

[PeaceBlondie]

Let me be less ignorant, please. My eyes have always glazed over at calls and puts, then I went blind trying to understand what a derivative was. These CDS thingamabobs - which may sink capitalism before John Obama wins the White House - sound like the biggest Ponzi scheme in history. They - the entire financial industry - refuse to explain the inexplicable because it would show themselves to be more ignorant than I am. Or is a fool somebody who knew better and made a mistake on purpose?

[highdiver]

lannarebirth..

thanks for the Article.

its amazing that while that no one is really discussing this.

According to the International Swaps and Derivatives Association, $62 trillion is the notional value of credit default swaps [CDS] out there, somewhere, in the market.

[midas]

lannarebirth..

thanks for the Article.

its amazing that while that no one is really discussing this.

According to the International Swaps and Derivatives Association, $62 trillion is the notional value of credit default swaps [CDS] out there, somewhere, in the market.

Agreed..........so 62 trillion $s somewhere out there versus the 1 trillion the Fed

is underwriting .....it sounds like a real band aid soution - so how long can we expect

the band aid to stay in place ?

[BEENTHEREDONETHAT]

lannarebirth............that is one of the most enlightening articles I have read for a long time. Thanks for that!!!!! Can't say that I really understand it but at least I have a bit of a feel for what transdpired.

It is much much worse than I had anticipated and I didn't think things were looking good before I read it. It makes you wonder how the hel_l they are going to get out of this mess, or if they even can.

[Wrong Turn]

"The Real Reason Behind the Global Financial Crisis"

by: Money Morning posted on: September 19, 2008 | about stocks: AIG

By Shah Gilani

[Part I of a three-part series looking at how so-called “credit default swap” derivatives could ignite a worldwide capital markets meltdown]

Thanks, lannarebirth, I'll read and save all 3 parts.

At the exchange rate Wednesday, 35 trillion British Pounds was equivalent to U.S. $62 trillion (hence, the 35 trillion pound gorilla). According to the International Swaps and Derivatives Association, $62 trillion is the notional value of credit default swaps [CDS] out there, somewhere, in the market.

A lot of these CDSs are obviously in the US, UK, and other parts of the world. So....this article implies that the regulators are not really sure where, but they do know how much? The $62 Trillion, figure?

A credit default swap is, essentially, an insurance contract between a protection buyer and a protection seller covering a corporation’s, or sovereign’s (the “referenced entity”), specific bond or loan. A protection buyer pays an upfront amount and yearly premiums to the protection seller to cover any loss on the face amount of the referenced bond or loan.

Typically, the insurance is for five years.

CDSs defined, in a general sense.

Credit default swaps are not standardized instruments. In fact, they technically aren’t true securities in the classic sense of the word in that they’re not transparent, aren’t traded on any exchange, aren’t subject to present securities laws, and aren’t regulated. They are, however, at risk - all $62 trillion (the best guess by the ISDA) of them.

The bad news is that there are even worse bets out there. There are credit default swaps written on subprime mortgage securities. It’s bad enough that these subprime mortgage pools that banks, investment banks, insurance companies, hedge funds and others bought were over-rated and ended up falling precipitously in value as foreclosures mounted on the underlying mortgages in the pools.

So, there could be more calamities? The potential is there, correct?

What’s even worse, however, is that speculators sold and bought trillions of dollars of insurance that these pools would, or wouldn’t, default! The sellers of this insurance (AIG is one example) are getting killed as defaults continue to rise with no end in sight.

Let's say the AIG bailout/nationalization works. There will be other defaults, correct?

And this is only where the story begins.

The Ticking Time Bomb

What is happening in both the stock and credit markets is a direct result of what’s playing out in the CDS market. The Fed could not let Bear Stearns enter bankruptcy because - and only because - the trillions of dollars of credit default swaps on its books would be wiped out. All the banks and institutions that had insurance written by Bear would not be able to say that they were insured or hedged anymore and they would have to write-down billions and billions of dollars in losses that they’ve been carrying at higher values because they could say that they were insured for those losses.

The counterparty risk that all Bear’s trading partners were exposed to was so far and wide, and so deep, that if Bear was to enter bankruptcy it would take years to sort out the risk and losses. That was an untenable option.

The Fed had to bail out Bear Stearns.

How many Defined Benefit Pensions ("pension") do you think are at risk?

How many 401Ks are at risk?

[lannarebirth]

What's interesting to me is, with all the printing of money, everywhere, that need be done, the US national deficit could double, but it could just as easily be paid off.