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Hometown: Ann Arbor, Michigan
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Member since: Thu Sep 25, 2003, 01:04 PM
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Counterfeit Value Derivatives: Follow the Bouncing Ball Zeus Yiamouyiannis.



Here is how the counterfeit value derivative con works. It’s a game of “I pretend, you pretend, we all pretend, and the taxpayer will pay in the end”:

1) I’ll create an instrument, say a credit default swap (CDS), an unregulated insurance with no capital requirements, with a certain “notional” value. Notional value is just something I assign. It does not have to be attached to or backed by any real asset or actual money/principal, but I can pretend as if it is. (Notional amount.)

2) As a seller, I will just declare that this swap covers the full value X of this company, contract, etc. if credit event Y happens. I receive lucrative insurance premiums and fees for my unbacked promise. The CDS’s value is based in nothing more than my promise to pay. I don’t have to have adequate capital reserves on hand, but I can pretend as if I do perhaps with some mini-reserves based on objective-seeming risk ratios calculated by my mathematical models. (credit default swap.)

3) As a buyer, you can then buy as many of these CDS’s as you want, even for a single default. If you are really sure something is going to tank you can insure it 30 times over (or a 100 or 1,000) and get 30 (or 100 or 1,000) times the return when it goes bust! In regulated insurance it is unacceptable to insure beyond the full replacement value of the underlying asset. Not so with CDS’s. The seller has gotten 30x the premiums and the buyer gets 30x value in the event of default. As a buyer of this phony “insurance” you don’t have a stake in the affected properties, but you can essentially pretend you do.

4) As buyer and seller of CDS’s either one of us can assign our risks to a third party through another contract, and pretend as if we are covered in case our own game playing blows up in our faces. This allows us to retain even less reserve capital and spend freed-up funds on more high-risk, high-(pseudo) return speculation. (The monster that ate Wall Street.)

5) We can purchase and sell of these derivative contracts to each other at unlimited rates to generate massive volume and huge fees and profits. We can simply hyper-cycle risk and take our chunk each time.

According to the Bank of International Settlements, as of June 2011 total over-the-counter derivatives contracts have an outstanding notional value of 707.57 trillion dollars, ( 32.4 trillion dollars in CDS’s alone). Where does this kind of money come from, and what does it refer to? We don’t really know, because over-the-counter derivatives are not transparent or regulated.

With regulated economic markets, when an underlying real asset is impaired (i.e. the company in question is bankrupt, the mortgage has defaulted, etc.), market value is assessed, default insurance is paid up to replacement or full value, bond holders and stock holders make claims on remaining value and the account is closed. There is no need for bailouts because order and proportion of compensation has been established and everything is attached to the value of the underlying asset.

When the unreal, counterfeit economy intrudes, you now have a situation where a person can put in an unregulated, but recognized, claim to be paid a thousand times over in case of impairment. Say market participants have negotiated for a bankrupt company a 70% payback for bondholders and (36% payback for insurance claims), and I come with not one but rather 1,000 CDS claims demanding to be paid for each CDS....

The Little Economy That Could


If you're looking for an unlikely economic success story, you can hardly do better than Mauritius...All right, confess: If you've heard of Mauritius at all, it's probably because you know it as the former home of the dodo bird. But there are better reasons to look closely at this small island nation in the Indian Ocean, some 600 miles southeast of Madagascar. For in 2011, Mauritius was (again) ranked number one on the Ibrahim Index of governance among African countries. And by no coincidence, it remains one of the top economic performers in the region: Measured in terms of purchasing power, income per person exceeds $15,000 -- more than Turkey or Brazil.


Hardly anybody forecast a happy economic future for Mauritius before it was granted independence from Britain in 1968. To the contrary: the British economist James Meade (who would go on to win a Nobel Prize) concluded that "the outlook for peaceful development is poor" because of its high population density, reliance on a single crop (sugar cane), and ethnic conflict. He might have added that the island was far from markets for its exports, and a daunting plane journey for European tourists in search of sunshine...Whatever the reasons for Mauritius' economic success (we'll get back to that), it came at a steady pace, and in ways that spread the wealth. Between 1970 and 2010, the GDP grew at an average annual rate of 5.4 percent, compared with the African average of about 1 percent... Mauritius... ranks second in Africa (after the Seychelles) on the UN's Human Development Index. And the ranking is reflected in common-sense measures of living standards ranging from life expectancy (74 years) to the portion of the population with easy access to safe drinking water (99 percent).

Mauritius' commitment to open trade and the rule of law (reflected in its ranking on the aforementioned Ibrahim Governance Index as well as the less subjective Index of African Governance calculated at Harvard) do correlate well with growth. But what made Mauritius choose the virtuous path? ...unlike any other African country, the country rapidly developed a manufacturing sector (specializing in textiles and clothing). Second, Mauritius has successfully navigated the vagaries of the global economy, on which it is so dependent. It managed to contain the damage from the oil price shocks of the 1970s, and it took in stride the successive losses of preferred access to rich-country markets for sugar and apparel. The adjustments didn't demand novel policies. Mauritius focused on export growth, maintained a business-friendly climate, pursued effective diplomacy to sustain access to critical global markets, took care to prevent its currency from becoming overvalued, and spent enough on education to create a productive labor force. But it is not enough to listen to the advice of the World Bank and crew. If the policies don't mesh with local politics and institutions, they are unlikely to take root. And here, one can see a powerful synergy between democracy and economic growth. Unlike most newly independent African countries, Mauritius created political institutions that gave a voice to both the rural poor and to ethnic minorities. Also important, Mauritius (like Costa Rica, another big winner in another region full of losers) chose not to establish a standing army. This likely saved it from military coups - and it certainly saved it a lot of money, which was spent on education and infrastructure.... Good institutions led to prosperity. But why did Mauritius, in contrast to so many other post-colonial nations, end up with good institutions? The best answers include historical accident and leadership.

Descendents of the French émigrés who developed the sugar plantations, along with the Creoles whose ancestors had worked the plantations as slaves, initially opposed independence because they feared domination by the majority ethnic Hindus. But they eventually agreed to cede political power in return for guarantees that their property would not be expropriated. Meanwhile the first prime minister, Sir Seewoosagur Ramgoolam, was able to persuade his constituents to abandon efforts to nationalize the sugar plantations in return for this acknowledgment of their majority political status. (His son, Navin Chandra Ramgoolam, is the current prime minister...) Some credit also goes to the outgoing colonial administrators -- and the reality that Britain really didn't have a dog in this fight. Very few British settlers arrived to displace the French planters when France lost the island in the Napoleonic Wars. Thus, in contrast to, say, Kenya, the British felt little obligation to protect stranded colonists. Accordingly, they had some credibility as the honest broker between ethnic groups. And they set the precedent that governments must be party coalitions -- one that has held to this day...Even though Mauritius had ceased to be the crossroads of the Indian Ocean when the Suez Canal opened in 1869, it has retained a cosmopolitan mindset - one of several respects in which it resembles entrepot city-states such as Singapore, Hong Kong and Dubai. This cosmopolitanism came in handy in the process of economic development. Ethnic links to China and India led directly to the rise of the textile and apparel sector and to a financial center, respectively. When outside shocks hit - the oil price increases, loss of trade preferences and subsequent competition from China - Mauritius was able to meet the challenges with policies that allowed the economy to diversify and thrive. And strikingly, the necessary policy responses were implemented over successive administrations, even as the government was engulfed in furious personal and factional politics.

Mauritius is unique in many ways. But this odd little country does offer three lessons in what would sustain growth in other African countries -- if not much insight into how to get from here to there. First, trade is the key to growth. Openness forces economic interests to compete in global markets and deters what economists call "rent-seeking" -- that is, creating pockets of economic privilege and hanging on to them. Second, the malign economic consequences of deep ethnic divisions can be moderated by a political structure that is truly inclusive and prevents winner-take-all outcomes. Third, even in relatively undeveloped countries, democracies can manage painful economic reforms because a sense of inclusiveness makes it easier to impose collective sacrifice....My own candidate for the X-factor is the simple fact that all Mauriciens are descendents of people who came from somewhere else relatively recently. When migrants are successful, perhaps because they are self-selected for initiative, the natives are inclined to resent their success. But just three centuries ago, Mauritius was uninhabited. (The same, by the way, is true of the Seychelles and Cape Verde, which also top the African governance listings.) Consider, too, that in a land in which no one is truly a native, no one can claim the privileges of incumbency that are potent obstacles to compromise and change. The important thing is for everyone to feel included.
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