An Unfamiliar (Economic) Game

[marmar]

from The American Prospect:



An Unfamiliar (Economic) Game

Wall Street has become addicted to taking enormous risks and sticking taxpayers with the bill. As a result, financial panics are causing real recessions and returning us to the 19th century.

Howard Gleckman | April 3, 2008 | web only



When a young Jack Nicklaus won the 1965 Master's Tournament, golf legend Bobby Jones said Nicklaus was "playing a game with which I am not familiar." I have the same feeling about today's financial markets.

This is not capitalism as I learned it. Rather, for the past three decades financial engineers have been playing a game with unlimited upside reward and, thanks to the Federal Reserve and the White House, limited downside risk.

The new rules: A $45 trillion market in immensely complex derivative securities, with no regulation, no capital requirements, no transparency, and a Federal Reserve that is so terrified of the consequences of this market blowing up that it seems prepared to bail out the losers at almost any cost.

The perfectly predictable result is a Wall Street willing to peddle increasingly dicey paper in return for the promise of ever-higher returns. Who wouldn't, especially with the Fed prepared to cover your bad bets? The phenomenon has been around long enough to have a name: moral hazard.

Just since the 1970s, we have gone through Michael Milken's junk bonds, the savings and loan crash, leveraged buyouts, Long-Term Capital Management and the hedge funds, venture firms and the dot-com bubble, the private equity craze, and the sub-prime mortgage mess. It's all a variation on the same theme -- smart guys take other people's money, leverage it by as much as they can get away with, buy stuff, securitize it, and then flip the paper for a huge profit.

Unfortunately, the deals get riskier and riskier and finally crater. Eventually, someone gets caught holding the bag. If that someone is big enough -- a bank or even an investment house -- the Fed steps in to bail them out. Even more troubling, the central bank continues to pump liquidity through the whole financial system to keep things afloat. So, to ease the consequences of the bursting dot-com bubble, the Fed made plenty of money available for the mortgage market. That not only kept home prices up, it set off a housing boom, sub-prime and no down-payment mortgages, and finally, kersplat, here we all are. ......(more)

The complete piece is at: http://www.prospect.org/cs/articles?article=an_unfamiliar_economic_game

[DCKit]

1. The tagline from the movie "Rosalie Goes Shopping" applies:

"When You're $100,000 In Debt, It's Your Problem. When You're $1,000,000 In Debt... It's The Bank's."

[slipslidingaway]

2. Thanks, there was some discussion of this topic yesterday...

although I missed a good portion of the BS :) hearing yesterday, I doubt there was much discussion about the growth in these markets and whether or not there should be more oversight in this area.

Here

http://www.democraticunderground.com/discuss/duboard.php?az=show_mesg&forum=102&topic_id=3253766&mesg_id=3253881

and here

http://www.democraticunderground.com/discuss/duboard.php?az=show_mesg&forum=102&topic_id=3253766&mesg_id=3254460


From 2000

"...The last point regarding the derivatives markets that truly gives us pause is how little is spoken about them on Wall Street (despite every major trading firm heavily relying on their use). The striking characteristic of derivatives use is the sheer lack of mandated disclosure. There isn't even an attempt at some type of simplified analysis. Every time the SEC/FASB seems near requiring that firm's account for their derivatives activities in their SEC statements, the proposal mysteriously seems to be scuttled at the last minute. Every time. It's like the great mystery of the margin requirement. Just don't bring it up and it will go away. If you simply ignore it, it's not there. After all, it's a new era. Certain things just aren't discussed..."


From 2008

"...What is obviously apparent, we believe very meaningful, and perhaps little understood in the greater investment community, is the growth in magnitude over the 2004 to present period in the CDS market. From about $1 trillion in notional value outstanding at year-end 2003, we're looking at just shy of $14 trillion in notional exposure as of September 2007 for the US banking system singularly. A near fourteen-fold increase in three and one half years. We ask you, do you see this fact being discussed or at least being mentioned on the "front page", if you will? Do you even see this mentioned in discussions or articles regarding what led up to the current mortgage credit debacle? Do you see Senators and other assorted politicians grandstanding in their demands for investigations about how this could have come to pass? We need to at least think through potential investment consequences if indeed credit default swaps become the next credit market shoe to hit the floor in some manner. Why? Because at the periphery it’s already starting to happen..."