mattlantz

CDS Articles

The Big Picture has a post that links to an article in the NY Times and to a couple of other posts on the Institutional Risk Analyst site.

This is the issue; how to create a credit market that works with the proper risk management.

I am especially interested in your comments on

1) the issue of what to do with CDS written against the top four money center banks, which are all under de facto public ownership as will become apparent as loss rates eat remaining private common and preferred; and

2) how to bifurcate the functionality of current CDS into a) an exchanged traded, index like product that tracks the spread/volatility of a corporate single name issuer and b) an exchange traded form of bond insurance with minimum 50% collateral vs net exposure (par less current estimated recovery rate, which will vary with spreads).

The End of Wall St

I just wanted to keep a link to this great article by Michael Lewis that appeared in the December issue of Portfolio.

That’s when Eisman finally got it. Here he’d been making these side bets with Goldman Sachs and Deutsche Bank on the fate of the BBB tranche without fully understanding why those firms were so eager to make the bets. Now he saw. There weren’t enough Americans with shitty credit taking out loans to satisfy investors’ appetite for the end product. The firms used Eisman’s bet to synthesize more of them. Here, then, was the difference between fantasy finance and fantasy football: When a fantasy player drafts Peyton Manning, he doesn’t create a second Peyton Manning to inflate the league’s stats. But when Eisman bought a credit-default swap, he enabled Deutsche Bank to create another bond identical in every respect but one to the original. The only difference was that there was no actual homebuyer or borrower. The only assets backing the bonds were the side bets Eisman and others made with firms like Goldman Sachs. Eisman, in effect, was paying to Goldman the interest on a subprime mortgage. In fact, there was no mortgage at all. "They weren’t satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn’t afford," Eisman says. "They were creating them out of whole cloth. One hundred times over! That’s why the losses are so much greater than the loans. But that’s when I realized they needed us to keep the machine running. I was like, This is allowed?"

They Can't Be Let Off the Hook

As usual, I agree with Krugman:

I’m sorry, but if we don’t have an inquest into what happened during the Bush years — and nearly everyone has taken Mr. Obama’s remarks to mean that we won’t — this means that those who hold power are indeed above the law because they don’t face any consequences if they abuse their power.

Fix the Presidency

The Atlantic has an interesting piece on Article II of the Constition.

But sometimes a president with little or no political mandate uses the office to further a surprising, obscure, or discredited political agenda. Under these circumstances, what poses as bold leadership is in fact usurpation. The most egregious case arises when a president’s policy and leadership have been repudiated by the voters, either by a defeat for reelection or by a sweeping rejection of his congressional allies in a midterm election. When that happens, presidents too often do what George Bush did in 2006—simply persist in the conduct that has alienated the country. Intoxicated by the image of the hero-president, unencumbered by any direct political check, stubborn presidents in this situation have no incentive to change course.

401(k)'s a Bust

I've always had a problem with 401(k) plans being the only option available to workers and don't feel qualified myself to manage my money for retirement (that said, I don't trust anyone else to manage it either).  And I'm in a better position than most from an education standpoint to manage my retirement account.   

The Wall Street Journal had a very good article on 401(k) plans in today's paper (sorry, pay site).  This was the most interesting part of the article:

Boston College's retirement-research center recently ran scenarios that assumed workers had contributed 6% of pay to a plan for 40 years, had invested in a target-date fund, had never touched their savings until retiring and had annuitized the assets at retirement. The chunk of preretirement income these savers could replace in retirement varied dramatically depending on when they retired. Those retiring in 1948 could replace just 19%; those retiring in 1999, 51%; and 2008 retirees, 28%.

This is the biggest issue I have with 401(k) plans; they don't provide a guaranteed stream of income.  There is too much left to chance.  That's the basic problem with the idea of an "Ownership Society", there is no pooling of risk.  The result is that there are winners and losers, and the costs are higher overall.

Depression

Why can't people understand this? (from Kevin Drum at Mother Jones)

It's sort of stunning to step back from the daily minutiae once in a while and realize just how bad this economic crisis is. As near as I can tell, the underlying shock really is as intense as the one that kicked off the Great Depression, and the only thing preventing soup lines these days is that we've learned a helluva lot since the 1930s. Retirees all continue to have purchasing power and healthcare thanks to Social Security and Medicare. The unemployed are receiving unemployment insurance. Deposit insurance is preventing bank runs. The Fed has lowered interest rates to zero and is prepared to intervene massively to prop up the money supply. Barack Obama is readying a massive federal spending stimulus package. The Treasury is pumping capital into the banking system to prevent a complete collapse of the credit markets. Aside from tinkering around the edges, most countries have agreed (so far!) not to ratchet up protectionist tariffs and trade barriers. We aren't hobbled by reliance on the gold standard.

Take that stuff away today and unemployment might already be in double digits and still heading up. Put this stuff in place in 1929 and we probably never would have had the original Depression (or World War II). So thanks, FDR! Thanks, modern mixed economy! Thanks, countercyclical policy measures! I sure hope it's enough.

Someone Else Finally Said It

I've been saying for awhile that reporting earnings quarterly causes managers to think about the short term WAY too much.  Someone else finally said it in print, NY Times Op-Ed by Michael Lewis and David Einhorn:

A lot has been said and written, for instance, about the corrupting effects on Wall Street of gigantic bonuses. What happened inside the major Wall Street firms, though, was more deeply unsettling than greedy people lusting for big checks: leaders of public corporations, especially financial corporations, are as good as required to lead for the short term.

VaR

Hilzoy at the Washington Monthly has a good post regarding VaR's role in the current financial crisis.

NYT starts to get at the problem that VaR created in the current financial crisis

Naked Capitalism points out that VaR is always wrong as it assumes the normal distribution which is not correct for asset prices.

Baseline Scenario points out that the future will not be like the past and both the parameters you use to estimate the impact of an unlikely event as well as the distribution of outcomes will change.  You can't use the past to predict the future.