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That other countries do the same.
I'm v.worried that too few people understand how these financial things work, and we MUST understand how they work in order to insist that our gummint do what needs to be done, bec. they obviously aren't going to do it on their own.
It's not as hard as it may seem. I think a lot of the people who helped create the crisis understood perfectly well that they were creating a glorified Ponzi scheme and have been deliberately obfuscating, first in order to pursue their own profits, and later to avoid being called to account for what they've wrought. Explaining it takes some words, but the concepts are simple.
The following is simplified, but I hope it'll make it easier to see the forest for the trees.
Credit Derivatives for Dummies: "Insurable Interests"
Heard a discussion of credit derivatives on PBS last night by their business "expert," Paul Solman, and was disappointed that he totally ignored what I consider to be the WORST thing about derivatives.
As Solman explained, credit derivatives are like insurance. If you hold debt of a company, e.g., the company issued bonds or other securities that you bought, and you're nervous about the company's solvency, you can buy a credit derivative to insure that if the company goes bankrupt, you'll still collect the amount of the debt.
So, first, regarding other, regular kinds of insurance, you can buy insurance for your own house or other property in case of fire, flood, etc. But you canNOT buy insurance on a house in which you have no ownership interest, because you're deemed not to have a sufficient interest in its NOT burning down. In fact, your owning insurance on a house in which you have no ownership interest gives you a positive incentive to commit arson. It's a big conflict of interest.
Owning the house, or whatever you're buying insurance for, is therefor called "having an insurable interest." You actually have a vested interest in the property, or the life, or whatever it is that's insured -- you have a vested interest in its NOT being destroyed, so you're unlikely to abuse the insurance system to, say, merely gamble speculatively on its destruction, let alone actually commit arson or whatever.
Because credit derivatives are unregulated, not only do we have no clear idea of what's out there (although the commonly agreed estimate is $62 TRILLION, which is several times the US's gross national product). But the worst part, which I've yet to hear anyone on the traditional media outlets including NPR explain, is that we have no idea whether most of the parties who bought and are still buying credit derivatives are doing so in order to protect the value of assets they actually own, or if they're just making speculative bets.
In other words, while some credit derivatives may have been bought by owners of bonds, mortgage-backed securities, or other securities to hedge the risks of owning those assets, large amounts of derivatives may well have been bought by people who were NOT purchasing insurance to protect any insurable interest, but who merely felt like betting that certain securities would crater.
In fact, they could have been purchased by people who not only felt like betting that certain securities would fail, but who had enough inside info, if not power, to know that such failure was likely to happen, or even to help cause it to happen.
SO. The BIGGEST outrage about the bailout is that the gigantic wads of taxpayer money given to Wall St. may well be being used to pay off bets made by speculators with no insurable interest -- i.e., no real need for the money -- and who may even have helped bring about the failure of the companies they bet against.
(The bonuses are of course obscene, but trivial by comparison.)
Before we give any money to derivatives issuers like AIG, we should find out what their obligations are, including which of them are to counterparties with "insurable interests" and which are to speculators. Then we'd be in a position to make informed choices about how best to allocate taxpayer money.
And there's no good reason we can't find that out. We don't even need AIG's cooperation. All the government has to do is announce to the world, if you bought a derivative from AIG and you think AIG owes or could in the future owe you money on it, tell us who you are, the amount of the payment to be made, and some other info like what if any "insurable interest" it's intended to cover. And if you don't file your claim, your claim will be wiped out.
This is what happens if you or I become insolvent. It's called bankruptcy. Another thing about regular bankruptcy is, if the total of all the claims filed against you are bigger than all you've got to pay them with, then generally, the court just divides whatever you've got left among your creditors, and the remainder of your obligations is wiped out. The creditors take cents on the dollar, and eat the remainder as a loss. And they don't get reimbursed by taxpayers. This is fair because your creditors and investors had the opportunity to investigate what kind of credit risk you were before deciding to extend any credit to you; the taxpayers didn't.
Because the banks and AIG are so big, we're told, we can't afford to make their counterparty/creditors/investors eat the loss. That may be true in some cases. In others, not so much.
You and me are sacrificing our retirements, kids' educations, etc., to make good on bets we never agreed to, placed by parties who not only stood to lose little if the catastrophes they bought insurance against weren't paid, but who may actually have had the power to CAUSE the catastrophes they were buying insurance against.
Yes, it's complicated; so is rocket science, but we don't throw up our hands and say it's too hard.
Nouriel Roubini, the NYU professor who predicted the current crisis, mentioned in a recent talk that throughout recorded history, there's been a more or less regular cycle of economic bubble-and-bust every ten years, with only one exception during which we managed to prevent such crises from arising for a solid fifty years: the fifty years while Glass-Steagall and other post-depression securities regulation remained in effect. Then we allowed Republicans and "New" Dems, financed by Free Marketeers, to dismantle it; and now we've got the biggest economic meltdown in history.
We need effective government to regulate markets and protect those of us who don't have the time or expertise to figure it all out. We've had effective regulation in the past, and we can have it again. It's not, really, a matter of brain-power; it's a matter of balls.
Here's another aspect of why the kind of speculation possible though credit derivatives is inherently problematic.
When someone gets a mortgage or an insurance policy on a property interest, say, a house they're buying, there tends to be some kind of proportionality between the amount of the mortgage debt, the insurance, and the value of the property. Typically, there's a mortgage (historically for LESS than the total appraised value of the house, but never for more), and there's an insurance policy on the house for no more than the replacement cost of the house. The mortgage and the insurance are both outstanding obligations, but they are related to one another, in that if the house is destroyed, the insurance will pay off the mortgage.
So, suppose the house was purchased for $400,000. The worst-case scenario is that the house is completely destroyed; in that case, the insurer loses $400,000, but the borrower and mortgage lender are protected from loss. If the borrower defaults on the loan, the lender can still foreclose, so then total losses are limited to $400,000 minus whatever the lender recovers through foreclosure. If the parties were deluded about the value of the house and it's now seen to be worth only $100,000, the lender's loss may be $300,000, which is very bad; but in any scenario, the total amount of losses that can be suffered by all the parties put together is pretty much limited to $400,000.
The more deluded the parties were about the true value of the house, the bigger the potential losses; but while you may be able to pretend the house is worth four times its true value, you can't fool anyone into thinking it's worth hundreds of times its true value. There's an inherent pressure that tends to limit the potential losses to something that bears some kind of proportionality to an at least vaguely plausible notion of the value of the house.
The bad mortgage loans on banks' books now are a big problem, even if there were nothing else to worry about, probably much bigger than what we faced after Pres. Reagan's deregulation of S&L's led to that other debacle back in the 1980's. In the '80's, the S&L's that made the riskiest loans were declared insolvent and were liquidated. Resolving those loans was painful, but it was easier than it will be this time around, because then, the borrower could re-negotiate the loan with her/his original lender, so many avoidable foreclosures were avoided (which tends to minimize the losses). Now, most borrowers won't easily be able to do that, because we allowed the banks that made the risky loans to "minimize" the risks by rolling them into pools of mortgage-backed securities that were sold to untold numbers of lenders. In fact, rather than minimizing the risks, securitization increased them by reducing banks' incentives to lend only to borrowers who could actually pay, effectively creating a race to the bottom. So now, we may have even more bad loans, and, unless the gummint steps in, each borrower, in order to re-negotiate her/his loan, would have to negotiate with untold numbers of lenders, which would cost everyone involved much more than the amount of the loan. So, yeah, the bad mortgage loans are a problem.
But bad mortgage loans are nowhere near the biggest factor in our current meltdown, because at least those losses can't exceed what people could persuade themselves or pretend the underlying properties were worth. The magnitude of the total of all the losses incurred by all of the borrowers, lenders, and insurers due to bad mortgage loans may be staggering, but they are not unlimited; they will bear at least some tenuous proportionality to the value of the underlying properties.
The really scary, mind-boggling factor is the credit derivatives. Because, since derivatives were sold to parties who had no "insurable interest" in the assets on which they were betting (see my similarly-titled previous post), there was NO limit to the quantities of obligations that could be incurred with respect to the same assets. It's as if, instead of there being just one insurance policy with respect to any given house, thousands of insurance policies were sold with respect to the same house, to speculators with no property or other interest in that house but who just had a hunch it might burn down. So there was no proportionality, no inherent limit to the total amount of potential losses that could be incurred with respect to any actual asset. (Not to mention the vastly increased probability that one of the many who bought such insurance might succumb to the temptation to torch the place.)
And now you and I are being bankrupted to pay off on all those "policies."
Again, I was and remain strongly in favor of fast action by the gummint to restore confidence in the stronger banks and to stimulate the economy, but I do question the "details" with respect to how the money's being applied and why we know so little about that. E.g., some parties who bought derivatives may have been pension funds trying to hedge risks with respect to an "insurable interest" they actually owned, while others may simply have been extremely wealthy speculators who owned no such interest but simply wanted to place a bet that, say, Company Z was gonna tank.
It wouldn't give me any heartburn at all if the gummint simply said, you know what, we can't afford to pay speculators big winnings we never guaranteed in the first place.
Companies like AIG were the ones who issued these derivatives. One of the things government regulators do with respect to ordinary insurance is require insurance companies to collect and maintain sufficient reserves to pay potential claims. Theoretically, if AIG had been charging enough "premiums" for all the derivatives they sold, and if they had segregated and invested enough of those premiums to cover their potential losses, they could have covered all the obligations they incurred.
But there was no government regulation. So AIG didn't collect enough premiums, and they paid too much of what they did collect to senior management and shareholders. They claim they didn't understand it. Well, I'm no rocket scientist, but I understand it, and (a) it was their job to understand it, and (b) I find it hard to believe that all the people who spent their workdays creating and being the bosses of this mess, day in and day out over several years, were utterly clueless.
The money did not just all go "poof"; some people made a lot on the bubble before it popped. They finance a lot of political campaigns.
The current chaos and continuing lack of transparency is a continuing looting opportunity. Credit derivatives are still unregulated and still continue to be sold, relating to mortgage-backed securities and lots of other things – only issuers like AIG could tell us what, but as far as I know, the gummint hasn't yet required them to tell.
Where the people lead, the leaders will follow – I have a vintage button that says that, from back when the people successfully forced an end to the Viet Nam War.
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