Opacity
First there was an opaque financial system. Many billions of side bets were bet in a global casino. These were derivatives, and derivatives of derivatives. Trillions of dollars were bet to secure banks from the consequences of buying and selling risky mortgage bundles. They amounted, in theory, to insurance without any rational basis on which to appraise the dangers. There were specialists, "the best and the brightest," many of them trained as physicists, who designed systems of "instruments" that their employers loved to swap because they understood that they could use them to raise the leverage on borrowed money. The specialists did the work their employers asked them to do. Everyone agreed to believe that they knew what they were doing. Ratings agencies believed it and promoted the illusion. For their technical prowess they and their colleagues had been schooled in universities that taught the ultimate in technological knowledge. They were the contemporary versions of angelologists, computing how many credit-default swaps could be balanced on the head of a chip. it worked as long as it worked.
Now it is generally accepted that the opaque financial system these people devised was crazy. It was built on a shared, crackpot delusion that worked as long as it worked--that is, as long as it dished out gratuities (thanks for nothing) to the makers of the markets in funny money. Now, in a fashion hardly anyone understands, banks are being shoveled full of more money in a fashion almost as opaque as the first round.
Now the people who inherit the collapsed house of financial paper, headed by Barack Obama, had nothing to do with building up the collective delusions that brought us to this pass. But their ability to make the financial system sane rests on the confidence that people repose in their judgment. That's Obama's problem now. People don't trust bankers now, and have no reason to. Obama should tell them, clearly, in his homespun way, what's worth trusting and what's not.
Harold Meyerson in today's WP:
There may be reasons that Geithner's plan makes more sense than [taking control of insolvent banks], but if they exist, Geithner has failed to explain them....Geithner seems unable to imagine a banking system not run by its current leaders or owned by its current shareholders or engaged in the same arcane securitization practices that led to its collapse.
Barack Obama today declared his abiding confidence in SecTreas Geithner, who "works hard." The people who feel ripped off--and in millions of cases have been ripped off--work hard, too. They need more than a declaration of goodheartedness and good will. They need delivery on one of this administration's promises: transparency. They need some help--hell, I have three degrees and I need help--figuring out what happened and where the remedies lie. It isn't good enough for Obama to say that he's choosing a policy of lesser evils. He needs to explain just what's entailed in "unraveling positions" and "restoring the credit system." Obama has an extrardinary skill for explaining--even painful dilemmas. He should pull up at the fireside and get going.
"Those who lead the country into the abyssCall ruling too difficult for ordinary men." --Brecht
"He should pull up at the fireside and get going."
Absolutely, right now. But I have a bad feeling about this. It's rapidly becoming too late.
Thanks Todd, for some straight talk.
March 18, 2009 5:33 PM | Reply | Permalink
President Obama's got my support to no end, but I am RIP$HIT over this. There's a massive ball of anger out there, and he just gave the Republicans a handle on it.
Todd: Quoting Brecht was a nice touch!
March 18, 2009 6:57 PM | Reply | Permalink
Indeed it is rapidly becoming too late. The car companies, their dealers and suppliers are all losing money with no prospects of that changing. That alone is about 15% of our economy. That collapse alone will bring the system down. The construction industry is devastated. Trucking is down 60%. The list goes on. Next in line will be insurance companies: they are paid in advance (premiums) and they have lost about half those monies through stock and bond market declines. Their huge contingent liabilities, annuities, life policies, etc., have not declined, but their resources to pay those liabilities are drastically reduced. And, guess what, even the credit card companies will soon be in trouble. They have borrowed huge amounts of money to finance the public's credit card appetite. IMO: We are in for a collapse.
I sometimes believe in conspiracies. The ultra wealthy have lost controll of their monopoly game. What is the solution? War.
March 18, 2009 8:07 PM | Reply | Permalink
I would like to hear better truth telling from Obama.
"Now it is generally accepted that the opaque financial system these people devised was crazy."
I'm not sure what this consensus is. My best guess is that many swaps were valued in a way which included a factor of estimated market price for swaps in the essential valuation. That is, the valuation was reflexive in a kind of iterative continued fraction sort of way. Since price is not value this would be inherently unsound as a valuation method even if it could work out in some stable conditions. Price should depend on value, not the other way around.
Is there more to it than that?
"the love of money is the root of all evil" speak directly to the conflation of value and price.
That part of capitalism which chased money for its own sake is a part which needs cleansing.
March 18, 2009 7:28 PM | Reply | Permalink
"Is there more to it than that?", you ask.
Not really, but the one-word description is just as good: Ponzi; or Madoff, if you will, since there never was any 'there' there. It was all just made-up whizbang ephemeral trillions of dollars worth of imaginary wealth that shed a few billion real dollars into the biggest crooks' pockets for a while.
Shifting metaphors, everyone perpetrating the fraud wanted more and more pie, and bigger and bigger pieces of the pie, but the pie was never very big, but just big enough and just sweet enough to keep the dessert tray coming...then when the pie inevitably ran out, and the pie-eaters professed shock - SHOCK, dessert was over, and they all lived happily ever after going to food banks, though they never tasted any pie like that ever again.
And Prince of Ponzi Nation? He lived happily ever after in his new 8500 sq ft home in Dallas, Texas which his wife Princess Laura bought last year, when he joked that he might have been the only person in the country buying a house last autumn, clueless until the end and guilty as sin, a simian simpleton even Simple Simon couldn't love.
Amen. The End.
March 18, 2009 11:23 PM | Reply | Permalink
new 8500 sq ft home in Dallas, Texas
The title to which was subject to a homestead declaration....
Just in case...
March 19, 2009 12:35 AM | Reply | Permalink
Ponzi doesn't apply here, even if some bets were a bit like that. There were real mortgages and relatively really MBS instrument. While the derivatives were gambling instruments, that doesn't make it Ponzi-like.
If you're talking about the irrational exuberance of the housing bubble, it's still not apt but only specious.
March 19, 2009 3:13 AM | Reply | Permalink
Trained as physicists? In this wonderland, I can't tell whether this is a joke or deadly seriousness. Are our nuclear devices designed by economists? I guess there are bombs and there are bombs (sigh)
March 18, 2009 8:04 PM | Reply | Permalink
Amike, your reference to Wonderland is appropriate. We think George Orwell could see a bit of the future? It now seems Lewis Caroll was even more prophetic.
Yep, it really was physicists who designed the derivatives. Must have been a shortage of openings at the new atom smashers.
March 18, 2009 8:15 PM | Reply | Permalink
Are you sure?
My understanding is that the vast majority of quants on Wall Street were trained in calculus/differentiation (economists) and not in differential equations (physicists/engineers).
Big difference!
March 18, 2009 11:48 PM | Reply | Permalink
Some of the math used is very similar to math used in advanced physics, thus the connection.
But Liu (?) had some simplistic formula which apparently was intrinsically unsound but sorta worked under some stable conditions.
March 19, 2009 3:17 AM | Reply | Permalink
I think you mean Li, not Liu.
The problem with using Gaussian copula for modeling/pricing credit derivative risk is that the formula simply does not apply. Among other things, those correlations that do exist (if there are any) appear not to have Gaussian distributions.
As far as CDOs go, though, I have to say that they were actually pretty successful in their goal, which was to distribute risks throughout the economy. The risks were pretty well distributed. (They were simply underpriced in the process.)
March 19, 2009 5:20 PM | Reply | Permalink
Yes, thanks.
I'm not sure who actually misused the formula. It's a handy scapegoat, as far as I can tell.
Interesting that Li moved back to China last year. Mission accomplished? :-)
March 19, 2009 8:50 PM | Reply | Permalink
Looking around the internets ---
The techniques economists learn are suited to optimisation, and equilibrium calculations, but are irrelevant to dynamics. Differential equations, on the other hand, are essential to the understanding of dynamic systems. Steve Keen
The argument would be that it is the lack of mathematical training which forces economists to model the economy statically when the economy is, in reality, dynamic. And see, Mandelbrot.*
* Mandelbrot found that price changes in financial markets did not follow a Gaussian distribution, but rather Lévy stable distributions having theoretically infinite variance.
March 19, 2009 8:44 AM | Reply | Permalink
Fair enough.
Chaos Theory versus traditional Mechanics (quantum or classical).
March 19, 2009 4:30 PM | Reply | Permalink
Point is, what the quants were doing was not economics. They were devising financial instruments.
March 19, 2009 4:39 PM | Reply | Permalink
I respectfully disagree.
For the past thirty or so years finance has been nothing but mathematics -- the wrong mathematics.
March 20, 2009 1:19 AM | Reply | Permalink
In your litany you omitted yet another astounding error, described by the excellent Gillian Tett in yesterday's FT and then picked up by Brad Delong.
And arguably (my argument not hers) that had what lots of us thought was a good result. A lot of low income families got to own their own homes courtesy of these derivatives.
But
.Yikes!
Seems real simple when it's explained,doesn't it?
Pity no one explained it to Greenspan, Rubin and the railroad executive to whom W entrusted the Treasury when there was still time to head this sucker off. Or to us BTW.
March 18, 2009 8:57 PM | Reply | Permalink
I guess my question is what exactly was the nature of the business AIG was doing on the swaps? Were they insuring them? If so they were supposed to have reserves set aside to cover any losses on the risk they insured...or not take the risk. How can any insurer be allowed to take on a risk they have no idea of the value of? To me it sounds like a Ponzi Scheme a la Madoff and Stanford. I assume they collected 'premiums' on the swaps they insured and if they didn't have the reserves to cover the losses (and how could they reserve properly if they didn't know the value of the risks?) that is a case of fraud I would think.
March 19, 2009 12:19 AM | Reply | Permalink
Not Ponzi, more like selling puts on stocks thinking the market is going to go up. When the market falls, the people who bought the puts get to force you to buy the stock (or pay the difference) at the strike price which is then way over the market price. And with swaps and options the leverage can be huge. A $10 drop in share price might be worth $8 and you could buy the put for a buck at some point.
John Paulson did one swap bet and it paid off at 45:1 ... a billion dollars for a $22M bet. (see Portfolio, Feb 2009)
If it's fraud, we should force the "insured" parties to sue AIG instead of just handing over the money as if it were business as usual.
March 19, 2009 3:25 AM | Reply | Permalink
Libertine, the swaps were "insurance policies" with no reserve money to back them up. But AIG didn't care about backing them up, because the purpose of the swaps was never to provide insurance -- that was just a front. Their sole purpose was to make money for AIG and for the brokers who resold the swaps.
Wall Street made tons of money running this scam, until many of the mortgages covered by the swaps went into default. Then the swaps lost most of their value, and AIG went bust along with many of its clients who had played the swap game.
Credit default swaps are ridiculous phony products. Sea Monkeys and X-Ray glasses are blue-chip in comparison.
March 19, 2009 9:24 AM | Reply | Permalink
Swaps act like insurance, but do not require that one set aside reserves in the same way as insurance. Furthermore, anyone can buy a swap regardless of whether they have any "underlying interest" in the thing-being-insured. This creates perverse incentives.
For instance, if I lived in the house next to you, I could (in effect) buy a bunch of swaps on the chance that your house payments stop. I could buy 200 million dollars' worth of insurance on your 200 thousand dollar house. Then I could start storing large quantities of gasoline and oily rags in my garage. Gosh, who knew that gasoline and oily rags might cause a fire that burns down your house too?
March 19, 2009 5:47 PM | Reply | Permalink
This is the part I most object to, government money flowing to crooks and gamblers.
There is only a little evidence of this so far, but there's a whole lot more to be looked at.
March 19, 2009 8:54 PM | Reply | Permalink
Obama has an extraordinary skill for explaining--even painful dilemmas. He should pull up at the fireside and get going.
My fellow Americans.
Tonight I want to speak to you in simple, straightforward language which all of us can understand.
Your leaders' principal concern is their reelection. Their reelection is made possible by large donations of campaign funds. The source of a vast amount of those funds has been Wall Street.
Currently, fear and anxiety stalk the corridors of power. Wall Street losses may, indeed, I do not think it alarmist to say, will, in the not-too-distant future, prevent financial firms from funding our campaigns, adequately.
Imagine a Washington deprived of the leadership of Senators Schumer and Dodd, a Washington where my friend Tim Geithner can look forward to nothing but a posting to the IMF, a Washington bereft of my très coolness.
A trillion or two sprinkled upon the Masters of the Universe is a small amount to pay to forestall the looming peril.
Good night and God bless.
March 19, 2009 12:50 AM | Reply | Permalink
Good night and God bless
Well I, for one, feel better just reading these words in the same paragraph as Prez's name.
March 19, 2009 1:03 AM | Reply | Permalink
>i>Obama has an extrardinary skill for explaining--even painful dilemmas. He should pull up at the fireside and get going.
I never agreed with that, I'd scratch my head when I saw people say it. He's good at oratory and speechfying. Explaining, not so much, often reminded me of Dukakis, sometimes when was tired on the campaign trail and did an interview, often scarily like Dukakis....the lengthy pauses searching for a word, very professor-like demeanor, but not a good profeessor, emotionless droning, and presuming a lot of knowledge in the listener.
Bill Clinton, now that was someone who was very good at explaining in simple terms, and coming up with an explanation of what it had to do with jack and jill sixpack to boot. (And not so good at oratory!) The "slick Willie" nominker came from the "top salesman" qualiities.
In Ryan Lizza's New Yorker piece on Obama's Chicago days, I recall that it was recounted how terrible Obama initially was at getting away from the professorial,droning demeanor, and how that hurt him with election results, and how he had to learn to "preach" to overcome that.
I think his coolness and intellectual demeanor helped to get him elected because many swings were looking for a no-nonsense grown-up in a crisis. But it's not going to help him with "sales," for "sales," especially those regarding populist rage, he's got to go back to the inspiring oratory, if he's not able to show more of a common touch in regular speaking.
March 19, 2009 1:33 AM | Reply | Permalink
aa,
I couldn't agree more, particularly on the Clinton part. I'm sure I'm regarded (rightly and proudly, to be sure) as a Clinton defender and apologist, but I think it's important to say that that attitude doesn't simply come out of thin air.
There's a REASON for it: Clinton's basic explanatory skills were made for a moment like this. What is most needed right now is someone who can help us grasp the essence of this difficult situation, and properly and concisely frame our choices as to how to deal with it.
If that skill presently exists in the current Administration, I have yet to encounter it. I think one of the reasons the relatively piddling matter of these AIG bonuses has become such a big deal, is that it's just about the ONLY issue anywhere in this crisis that the public feels it understands well enough to criticize.
March 19, 2009 5:27 AM | Reply | Permalink
Our government is stealing hard-earned money from every single middle class American, and giving it to dishonest, incompetent rich people. Anyone who considers this a piddling issue is a fool.
The very moment Obama heard about the bonuses, he should have called a press conference and said "I just found out that AIG is using bailout money to pay executive bonuses. I give you my word that I am going to take back every penny of that bonus money by any means necessary. I also promise that that no AIG executive will ever get another bonus until AIG has fully paid back the American taxpayers, with interest."
It takes no skill to speak simple common sense. It just takes honesty and guts.
March 19, 2009 8:44 AM | Reply | Permalink
WRoss,
Of course I'm not suggesting the general 'stealing' theme is not important, and not very much central to our difficulties. Nevertheless, the narrow AIG bonus $$ involved (Charles Krauthammer made this point - I wish I had) is approximately the same as what C.C. Sabathia is being paid to pitch for the New York Yankees (and a bit less than A-Rod is making). This is the factual proportion that we should apply to it, in my opinion. It matters, but it matters a great deal less than a lot of other elements of this crisis that should be getting a lot more impassioned attention.
March 19, 2009 9:19 AM | Reply | Permalink
One_wilson, it appears to me that Krauthammer has no point at all. It doesn't matter how much of the stolen money goes to which rich parasites.
There is nothing complex here. It's just plain robbery, and it is continuing. When the public wakes up, look out.
March 19, 2009 11:55 AM | Reply | Permalink
You need to develop a sense of proportion, WR.
Allocation of scarce resources dictates going after the big problems which are tractable, not spending all your time chasing down jaywalkers and juvenile delinquents.
March 19, 2009 4:29 PM | Reply | Permalink
The rage we are seeing over the AIG bonus fiasco comes not only from the fact that it is one issue that even the least informed can understand. The AIG greedsters have also helped a rapidly growing majority of the public understand with painful intensity that they have been played for dupes for far too long by supercilious incompetents. That the incompetents were so lavishly rewarded even after spectacular failure drives home the insult.
I imagine that the public's rage toward AIGFP is matched only by the intense loathing Wall Street oligarchs must feel toward AIGFP for helping the public understand how thoroughly the public has been manipulated and ravaged.
March 19, 2009 9:53 AM | Reply | Permalink
What would "inspiring oratory" do other than throw gasoline on a smoldering(?) fire.
And we oughtn't overlook the fact that Obama and his minions are bound and determined to keep the terms of these bailouts as far outside the realm of public discussion as humanly possible.
With that goal in mind why would Obama want to do a fireside chat?*
* And too, Americans aren't quite the rubes they were in 1933.
March 19, 2009 9:02 AM | Reply | Permalink
"* And too, Americans aren't quite the rubes they were in 1933."
You mean we're more naive (look at the Iraq invasion sales job) or we're a different kind of rubes?
I'd like to see more, and more effective, leadership from the WH. But I think they're doing pretty well so I'm not giving them a failing grade here, just looking to move them from "above average" upwards a notch at a time.
March 19, 2009 8:52 PM | Reply | Permalink
What you are describing, as is now only too obvious, is an elaborate Ponzi type scam, similar to Bernie Madoff's only far more damaging.
Of course, the government and the media will never acknowledge that truth because such activity has become common corporate behavior. It is systemic.
March 19, 2009 9:09 AM | Reply | Permalink
Announcing and saying that your mates are trustworthy is not enough. Deeds of mass crisis- policies and clear operative decisions must be taken and harshly executed: in the meanwhile Obama is not enacting the 2nd New Deal.
It is too soon to judge, but it just doesn't look good enough, not for this crisis.
The bailouts are necessary to avoid a complete collapse, but presidential -crisis tools must be used to execute reforms that wall St. will not like, and risk with not being elected a 2nd time.
Ahmad Aijad explains what needs to be done and what is not being done yet in simple words:
http://www.youtube.com/results?search_type=&search_query=aijaz+ahmad&aq=f
March 19, 2009 9:23 AM | Reply | Permalink
It is now clear that the AIG bonus payments were pre-approved by the Democrats.
I am so profoundly horrified and disgusted I don't even know what to say.
March 20, 2009 8:14 AM | Reply | Permalink
This information is very useful! Thanks!
Best regards, Katya, CEO of hyper v vista, hitachi iscsi
March 31, 2011 9:38 AM | Reply | Permalink
Si vous etes interesses par le dossier, ou desirez en savoir plus, contactez-moi par mail, et je vous mettrai en contact.
Best regards,Jane, CEO of cluster high availability
April 28, 2011 9:02 AM | Reply | Permalink