Supporting Swap Desk Spinoffs Just Got Easier

The following guest post was contributed by Jennifer S. Taub, a Lecturer and Coordinator of the Business Law Program within the Isenberg School of Management at the University of Massachusetts, Amherst (SSRN page here).  Previously, she was an Associate General Counsel for Fidelity Investments in Boston and Assistant Vice President for the Fidelity Fixed Income Funds.

It’s about time. Yesterday, by a vote of 96 – 0, the U.S. Senate passed a ground-breaking amendment to the financial reform bill. Introduced by Senator Bernie Sanders of Vermont, this amendment would require an audit of all emergency actions taken by the Federal Reserve since December 1, 2007.  In addition, the amendment mandates that by December 1, 2010, the Fed reveal those who received $2 trillion in zero or near zero interest Fed loans and what those institutions did with the money.

This was the second recent “yes we can” show of bipartisanship. Last week, by a 96 -1 vote, the Senate approved an amendment introduced by Senator Barbara Boxer of California. The Senator described its purpose was to “protect taxpayers” through the creation of an “orderly process to liquidate failing financial firms and ensure that Wall Street pays to clean up its own messes.” Whether the amendment can live up to that promise is a good question. The answer depends less upon government intervention once a firm nears collapse and far more upon government prevention of the excesses that lead both to widespread failure and government support.

Moreover the impact on the American taxpayer of failing banks goes well beyond government spending. And as articulated here by Simon Johnson, cross-border complexities prevent the efficacy of a seemingly elegant US-based resolution mechanism. As the S.A.F.E.R. economists opined, “It’s Prevention, Stupid.”

So, where am I headed with this line of thought? Here goes. These votes where 96 Senators, across notoriously rancorous party lines, support something, should send a signal. The way I interpret the signal is that these elected officials understand that voters want transparency and voters want to avoid bearing the costs of financiers’ excesses. Thus, it is quite logical that the Senate should also overwhelmingly support preventing the very riskiest behaviors that required the bailouts. The Senate should support refusing to provide a Federal Reserve or FDIC or other lifeline to firms engaging in the high-profit, high risk behavior that enriches their executives, threatens the firms, creates systemic risk and cause widespread disaster.

At the top of that list are swaps. Swaps have been at the heart of major financial crises since the bankruptcy of Orange County. The Long-Term Capital Management meltdown, the failure of AIG and the Greek debt crisis, share this common component. Thus, it was a welcome moment in the reform process when Chairman Dodd included in the Senate bill, Senator Blanche Lincoln’s proposal to require banks that receive Federal assistance to spin off swaps desks.  A very useful interview of derivatives expert, Michael Greenberger on the Lincoln amendment can be found on Mike Konczal’s rortybomb blog.

While some important voices, like White House economic adviser, former Fed Chair, Paul Volcker and FDIC Chair Sheila Bair have raised objections to aspects of the plan, the title of the recent Huffington Post opinion piece by economists Jane D’Arista and Gerald Epstein makes the counter-argument concisely, “Banks Must Be Barred from Dealing Derivatives: It’s Not a Normal Part of the Business of Banking.” The authors explain:

“The controversial part of the amendment – section 716 – would ban Federal Reserve assistance through a credit facility or the discount window or loan or debt guarantees by the FDIC to any dealer in swap contracts. This would mean that banks that are insured by the FDIC – including the large banks that now dominate the market – would have to spin off their derivatives desks. Like the Volcker rule itself, the intent is to remove risky activities from the core banking functions that are essential to the economy and to ensure that those risky activities will not trigger the need for a bail out to prevent systemic collapse in the future as they did in the 2008 crisis.”

As a practical matter, this would affect the top 5 players who control about 90% of the swaps market, including Goldman, Morgan Stanley, Bank of America, Citigroup and JPMorgan.

Another swaps amendment that deserves overwhelming support was introduced by Senator Byron Dorgan of North Dakota.  The Dorgan amendment would ban naked credit default swaps. A credit default swap is like a home insurance policy.  With an insurance policy, the buyer pays the seller premiums. In exchange the seller agrees to cover the buyer’s losses if there is some bad event occurs and damages the home covered under the policy. Similarly with a CDS, the buyer pays the seller a premium based upon a percentage of the underlying asset, typically on a quarterly basis. In exchange, the seller will compensate the buyer if there is a bad “credit event” such as a default  involving the reference bond.   With a naked CDS, the buyer is purely betting on the default of the bond or other reference credit.

If this were insurance, this practice would be prohibited, as laws prevent the purchase of coverage if you don’t have an insurable interest.  And, if it weren’t for federal preemption of state gambling laws in 2000 with the passage of the Commodities Futures Modernization Act, states could refuse to enforce these contracts, or treat them as unlawful gambling.   It’s particularly ironic that conservative organizations are championing naked CDS when the existence of these instruments depends upon trampling on states’ rights.  The language of the CFMA made this clear when it stated that “it shall supersede and preempt the application of any State or local law that prohibits or regulates gaming or the operation of bucket shops.”

Additionally, given the harm caused, including let’s remember the $180 billion taxpayer-funded bailout to AIG ($60 billion of which was paid through to bailout counterparties including $12.9 billion to Goldman Sachs), it is stunning that we have not had a moratorium on these instruments.  From that safe vantage point, we should then do a study where we can intelligently assess whether the yet-to-be-quantified benefits outweigh the tremendous harm.

And, here’s a parting thought. The Senate may dazzle us with a 96–1 vote promising voters no more bailouts. That’s terrific. Thanks. But, hello? We still own about 80% of AIG. And AIG has not yet paid back its loans from the Fed. So, let’s get serious. Yes. I am glad that 96 senators agree that with regard to future messes, Wall Street should do its own clean up. But as for now, like the oil spilling into the Gulf, the mess continues and we have not been repaid.  And, the mess, millions of jobs lost, double digit unemployment, massive cuts to state and local services, caused by the reckless practices on Wall Street remains. Thus, I welcome another bipartisan vote to spinoff the swap desks and ban the most dangerous swaps, since the financial sector has shown it cannot stop its toxic sludge from spilling into our economy and it has not completed the cleanup.

67 responses to “Supporting Swap Desk Spinoffs Just Got Easier

  1. Are we talking here about interest rate swaps, credit default swaps, or both?

  2. Lincoln covers all.

  3. Erich Riesenberg

    Interest rate swaps?

    Is there a provision for requiring bank holding companies to actually have say half their balance sheet in retail banking?

  4. Hooray for Jennifer S. Taub !

  5. as with the posters above i find it disconcerting that the mainstream press keeps conflating swaps with CDS. “Swaps” are IRS which are never going to be spun off just as treasury dealing desk won’t be.

    I think the unanimous vote can be explained by the fact that the anti fed hysteria finds its origins in the ron paul / tea party right, while democrats have been pushing for reform on the left and are naturally inclined to support re-regulation.

  6. Have there ever been any studies that quantify the economic gain achieved by financial innovations like CDS and various other instruments that didn’t use to exist? I’d love to know whether there has been any attempt to measure the gains vs the costs.

  7. Thanks for the insights.

  8. When I hear that 96 senators support something, I think something all right, but it’s sure not that something real was done for the public interest and against kleptocracy. After all, it is, um, a kleptocracy.

    On the contrary, while I don’t expect that anything worthwhile will ever be passed in this kind of legislature again, if it were it’d more likely be something like a 51-49 bloodfest.

    The Sanders cave-in amendment is a good example. A “one time only” perusal of the history of the defunct Fed facilities while open market operations remain sacrosanct against democracy going forward? What a joke compared to what’s needed. We’ll see what happens in conference with the vastly superior Paul-Grayson amendment.

    At best, if everything falls just right and we get the right kind of outside-the-system opinion-making commentary, maybe what even an anodyne audit uncovers can serve as a political catalyst for a renewed democratic counteroffensive on this fortress of fraud and robbery.

    As for “resolution authority” scams, we know that even ones that on paper look strong are really paper tigers (as the PCA law which we already have already was in 2008), let alone the kind that can get 96 votes.

  9. MJ Sullivan

    The reason why it is illegal to take out an insurance policy on someone else is because you then have an incentive – and, presumably, an ability – to take the person’s life and then cash in on the insurance policy.

    In the case of credit default swaps, being “naked” means you hold an insurance policy on an underlying bond that is not in your possession. In this case, how exactly are you able to manipulate the bond price in such a way that it causes a default, and allows you to cash in on the CDS, if you don’t hold the bond? Only by actually owning a bond (in significant quantities, I might add) would a CDS holder be able to force a default, either by engaging in a massive sell-off that drives down the price of the bond, or, through bondholder representation, voting for the company to enter bankruptcy. Being naked here does not advantage the CDS holder.

    Besides that, how exactly would regulators prove when one is “naked”? What if you held a single unit of a bond, but 100 times that amount in CDS? Would you be naked? With the amount of bond issuance that is bought and sold each day, it is completely unrealistic to expect regulators to monitor and enforce the volume of bonds required in order to qualify to hold CDS.

    So while I agree that swap desks need to be spun off and FDIC insured institutions should not be engaging in derivatives trades as a swap dealer, the banning of naked CDS is ill-informed. The real root of the problem in credit default swaps is those who hold the bond AND the CDS, and use both to manipulate the market.

  10. Nice post, but from where I sit, it looks like the Democrats and the Republicans are going to white wash financial reform just like they did health care reform. No breaking up the TBTF banks, no regulation of the shadow banking system, no real reform.

    At this point only one person, the President, speaking loud and clear from the bully pulpit could make a real difference, and he’s not going to speak up. He’s surrounded by the same people that deregulated Wall St and have ignored fraud and corruption: Rubin, Summers, Bernanke, and Geithner.

    Unfortunately, the longer we kick the can down the road, the more badly this will end. So far, there are only riots in Europe along with disparaging remarks about how the Greeks are crooks. I’m sorry folks, but the people rioting in Greece are the people that lived by the rules and expect their pension to be paid. They cannot help it that their government was corrupt and allowed the rich and powerful people and companies to avoid paying taxes.

    Sound familiar – it should, that’s exactly what’s happening in America too. The rich and powerful haven’t been paying their fair share of taxes for thirty plus years, and now our governments are unable to pay pensions to people that worked hard, lived by the rules and earned their retirement.

    Instead we watch our government bail out failed Wall St mega banks with trillions of tax payer dollars after these same mega banks trashed state and local government pension funds and budgets, smashed small businesses, and imploded the world economy.

    Sooner or later, the most Americans will understand that they’ve been massively looted, and the riots will spread.

    Obama needs to decide why America exists. Does it exist for we, the people, or not? The ball’s in his court, and so far he’s acted as if America no longer exists for the people. Too bad, because terrorists or terrorism could never bring down America, but a government that doesn’t act to support the people of America, can be the end of America.

  11. engineer27

    The true irony here is that after working many hours and spending large sums in an attempt to keep from having to spin out their swaps trading units, 10 years hence they will be thanking Congress for forcing them to become immensely profitable organizations not weighed down with an unwieldy Investment or Commercial Bank to lug around.

    Let’s all hail the Nanny State(TM), forcing Bankers to do what’s good for them, despite themselves!

  12. The “FDIC” is almost broke, and asking for higher premiums on the small,medium,and large banks as I write. The big five can just up their reserves internally themselves,thus offsetting the reserves needed with profits from their “Swap Trading Desk”. Where’s the public going to go? The big banks own (BAC) Mastercard,and Visa (JPMC) whole,…so where do they get credit cards? There is a solution that’s less radical offered up by Chambliss (R-Ga)that’s practical,and more consumer friendly. Remember this. The next melt-down will be our last! Don’t you think the Big Banks know this? It’s in everyone’s interest to get it right,especially the “Big Banks”!

  13. If this sordid financial mess and shenanigans were done in revolutionary America in the late 1700s, there would be a real revolution!

  14. Glen, that’s also the trends research forecast:

    http://geraldcelentechannel.blogspot.com/

  15. This proposal, along with the Volcker rule, are just half-measures intended to do what must be done (re-instate Glass-Steagall) without actually doing it.

    Bottom line is that any institution that has access to the Fed discount window and FDIC insurance should be in the business of taking deposits, making loans, and nothing else.

    I’d go a step further. Any ready substitute for bank deposits (e.g., money market funds) needs to be declared a bank and regulated as such.

    I’d also limit the access of non-bank capital market funds to bank loans. If you want to gamble, have at it, but do it with your owners’ equity.

  16. Wow. This might actually be the most ditzy blog post I have ever read.

  17. MJ — yes, the legislation contemplates what you describe and would prohibit owning more in notional value in a CDS than value of the underlying. See the link the amendment in the body of the post.

  18. Actually, the purpose of insurance is to protect against loss – your own loss in particular. Therefore, reason for the insurable interest rule was to make sure that people did not use insurance policies to gamble. Some forms of insurance were banned because they were viewed as gambling. Hence the rule which allows insurance to exist (social good) while disallowing a form of gambling (social ill). It is not at the root about preventing the creation of incentives to do harm to the thing that is insured, although that is certainly another good reason for the rule it seems to me.

    I think prohibiting naked swaps is the right way to go because that transaction is 100% speculative – a form of gambling that given the recent history has no social benefit but very high social costs.

  19. BG, why don’t you just hit the highlights?

  20. Finally showing our true colors, eh, Bond Girl???

  21. There certainly are 100% speculative naked swaps, but what if I am an trade creditor of a firm and want to hedge my payment risk? Why can’t I buy CDS on the firm’s bonds, though I don’t own any?

  22. Apparently, Ted. Indirectly calling the poster a ditz is not ditzy?

  23. Sure.

    “At the top of that list are swaps. Swaps have been at the heart of major financial crises since the bankruptcy of Orange County. The Long-Term Capital Management meltdown, the failure of AIG and the Greek debt crisis, share this common component. Thus, it was a welcome moment in the reform process when Chairman Dodd included in the Senate bill, Senator Blanche Lincoln’s proposal to require banks that receive Federal assistance to spin off swaps desks.”

    Orange County, LTCM, AIG, Greece: Which one of these is a bank?

    Hey, I have a great idea. How about we name-drop a bunch of market participants and pretend like we are talking about the same exact thing? And let’s pretend some of these problems are about derivatives and not leverage, because we obviously do not know the difference.

    This post says a whole lot of nothing.

  24. Many terrific points by Miss Taub. Just 3 I would like note as especially outstanding observations.

    All 3 of these financial Crises were largely involved with and centered around swaps
    1. Orange County
    2. Long Term Capital Management
    3. AIG and the 2007–2009 Economic Nightmare

    Also Miss Taub notices something missed by many. We constantly hear Republicans touting the importance of states’ rights (basically, the right of individual states to make their own laws without the federal government always trumping their laws). Guys like Phil Gramm, Dick Armey, Mitch McConnell, and Dick Shelby will spend ALL day talking about states’ rights. But when it comes to laws for large bank oligopolies and laws for swaps, well, all of the sudden those principles on states’ rights get thrown out the window like an empty beer bottle.

    And the 80% we are STILL owed by AIG. Similar to BP (British Petroleum) they want all the profits, and the U.S. Government to clean up their mess. This is an outstanding analogy made between BP’s mess and AIG’s mess. Where is the “clean-up”??? 100% privatized profits, 100% U.S. taxpayer losses. Lloyd Blankfein’s dream come true. 100% profits for Goldman Sachs, 100% losses for the U.S. taxpayers. NO Mr. Blankfein, that’s not how it works.

  25. Re: @ Bond Girl____Derivatives are used to enhance leverage,…ironically leverage is created by derivative vehicles, each complimenting the other for the evolving dynamic financial markets of today. Unfortunately we can’t run away from your urbanist backwater prose too yesteryear regarding these modern times. PS. May the “Swaps be with You?”

  26. A Credit Default Swap is not insurance. The concept was very carefully designed not to be insurance. For starters, if the CDS were legally insurance, it would be offerable only by state regulated insurance companies. If a CDS were insurance it would not be sold or even brokered by Wall Street. On top of that, if a CDS were insurance, every issuer of protection would be required to carry reserves against loss. The CDS , on the other hand, requires the counterparties to post liquid assets between themselves as as agreed to serve the same or better purpose than statutory assets held by insurance companies. AIG itself is a holding company. None of it’s insurance company subsidiaries offered CDS protection. Instead, a wholly owned non insurance subsidiary sold the CDS protection to people like Goldman Sachs.

    If the CDS contract were insurance, every state levying insurance premium taxes would be trying to collect the premium tax. They would have successfully litigated that premium tax was due on CDS proceeds to protection issuers. Obviously too, the states would be suing for jurisdiction if they thought the CDS contract were, in fact, insurance under their laws.

    No state treats the CDS as insurance, so far as I can determine. The states could bring the CDS into their insurance definition by legislation if they felt they should do so.

  27. Furthermore, if these trades take place within what is basically a shadow banking system, what has changed?

    Somehow, when financial reform became a populist movement people forgot where the real bailouts took place.

  28. Re: @ art____Naked Swaps ie.) CDO’s are a viable product with no skin in the game,taken to the limits of “Euphoria”. Synthetic CDO’s are pure unadulterated gaming instruments given life by the infamous, “Basement SEC Secret meeting~Five-Years Ago” with the Terrible Six-Pack featuring Hank Paulson” getting the Thumbs-Up?

  29. Bayard Waterbury

    This is a part of the pablum that the plutocrats are tossing to the masses around the banquet table. It is the chance for the all-important “we’re really doing something” sound bite. Financial reform, let’s face it, will be like health care reform. Not changing the actual playing field, but replacing the markers every five yards with ones every ten yards. Nothing really changes, because, unless Lincoln’s bill passes without crippling amendment, much remains as it is. I hope that somehow I am surprised, but I certainly don’t expect to be. Note how watered down Bernie’s sterling amendment was, and note especially that the White House was one of the big influences in changing it. But, Simon, keep leading the choir, we’ll certainly continue to sing in the key of “S.”

  30. But you can’t even make blanket statements like that – that is part of the problem with name-dropping here. The market participants named used different kinds of derivatives and wildly different strategies.

    Greece’s currency derivatives were basically direct loans. It did not even matter that they used currency swaps at all; they just needed something they could price arbitrarily. Any negotiated contract would do.

    LTCM lost money primarily on interest rate swaps arbitrage, but the issue was the haircut on the funding they used for those trades. It would have been an issue with any bet.

    Both are issues with leverage. The leveraged position was achieved differently. In neither case was it necessarily tied to the derivatives.

  31. Bayard Waterbury

    But, most of us know, Ted, that Lloyd is doing God’s work. How can you be so negative about those who are so sinless!! hahahahahahahahahahahaha

  32. Bayard Waterbury

    Nice post, Jerry!! So, please explain why a CDS is not actually insurance. All hedges are insurance, but not by structure. The CDS is insurance by structure. Please explain why not.

  33. Bayard Waterbury

    Art, I don’t think that anyone has ever argued that certain swaps (like the one you mention or interest rate swaps and some commodity swaps) aren’t a viable, reasonably purchaseable product. Au contraire. I don’t believe that they should be outlawed. But they must be regulated and sorted between the truly meaningful, beneficial ones and the lethal ones. And, in sofaras including them in synthetic CDO’s, that, my friend is a truly absurd piece of schmutz.

  34. Bayard Waterbury

    Bond Girl, none of them are banks. None of them would have been involved with swaps if their banking “buddies” hadn’t gotten them started. The addiction to “creative” banking products leads to abuse, and ultimately overdose. And, by the way, no one would have been involved in much of this were it not for the actions of Moody’s and S&P. I don’t see any conspiracy but a oneness of mind amongst the greedy and amoral.

  35. Thankfully, us “simpleton populists” still have you here, to play semantics and clarify the meaning and definitions of words for us, along with the Harvard/Yale educated Miss Taub who worked at that small town brokerage known as Fidelity Investments.

    You can clarify words and meaning for the hyper-educated Miss Taub, but also all of us simple populists. YOU are very special Bond Girl.

  36. Bond defaults are enormously correlated; most risk in credit markets cannot be eliminated through diversification. Because of this, CDS cannot be insurance in any meaningful sense, so the analogy is flawed. The long side is making a long investment, the short side is making a short investment.

    Proposals like this aren’t anti-speculation, they are anti-short speculation. The main goal of those who are anti-shorts is not reform, but perpetuation of a broken financial system.

    Unless you believe that the global financial and political dynamic represented by Greece, AIG, etc. was perfectly stable and appropriate and unjustly harassed by a bear raid, you should be thanking CDS speculators for forcing these entities to acknowledge their true cost of capital.

  37. What about the magnification effect that naked swaps allow for? The fact that their mere existence means that there’s more insurance on a particular object of supposed value than actually exists. It’s just a game of musical chairs with one chair and a huge number of competitors.

    How is that anything other than pointless gambling? How does it contribute anything useful at all to the economy at large? Why does it even need to exist?

  38. For practical purposes the legal definition of insurance defines who may or may not offer insurance protection. The basic reason a CDS is not an insurance contract is it is based on a one off contract. Insurance, by definition, is the pooling of premiums of the many to cover the known to be incurred individual losses over time. In the meantime, the insurance company runs the scheme and gets to keep the investment income from holding the premiums.
    A CDS is a private one on one contract to pay for the loss of the party buying protection.

    One bets it will have a loss against another that bets it will not. Not much different than a single roll of a slot machine when you get to the down and dirty. Similarly with an illegal pinball machine. The sucker puts roll after roll of dimes in the machine to raise the odds and points earned. If he wins he gets a dime a point. If he loses I the pinball machine get to keep all the money. Similarly for numbers. Give me a dollar and if your 1-999 number wins you get $600.
    Each of these examples is one on one. Insurance, at least in theory, is a pooling of interests among many against a loss of the few when you do not know who the few specifically are.

    The real problem is that investing due to a lot of factors is really naked speculation or gambling. You cannot invest high tech long term for survival of your nation on the basis of gaming.

  39. The key to understanding the continuation of disruptive and chaotic events is the realization that nothing has been fixed, no remedy put in place, no reform agreed upon, no liquidation of impaired bank assets completed, and no work toward a more stable system.

  40. The great thing about people like “Bond Girl” is they will spend all day whining about the “welfare queens driving the welfare Cadillacs” (which I personally have never seen). But when it comes to welfare banker Daddies in the BMW (paid by TARP) on their way to the American Banker’s Association meetings, “Bond Girl” would rather we just turn our heads the other direction and start whistling like she does.

  41. Indeed. The only reason to oppose the use of naked short CDS is if you oppose liquidity and price discovery, which most legislators do. Because price discovery will end the gravy train of massive services and low taxes on which those legislators depend for reelection.

    The goal of legislatures the world over is to get through this crisis with no real reforms and rebuild the bubble of leverage, so they can start devising the next debt-funded entitlement program.

  42. Brad Thrasher

    This is more than a limited financial audit. It also contains a limited management audit with respect to conflicts of interest, board appointments and adherence to stated policy regarding regarding the programs within the financial audit.

    While it is limited in scope and for now, only a one time audit, it is in the least a start. It could be a whitewash but at least it will be published.

    It will take at least a generation to wrest power and influence from the paper money boys.

    As for the 96-0 vote, look no further than Bennett in Utah and Crist in Florida. And it isn’t just Republican incumbents who are running scared.

  43. Interesting the things the working man will do when he hasn’t been hypnotized, brainwashed, and ingratiated by the “money honey” Bimbos of CNBC. But then who knows, maybe those 1930s farmers actually read the full newspaper from front to back. Crazy eh???
    http://www.ritholtz.com/blog/2010/05/bread-circuses-greece-vs-us-riots/

    By the way, for anyone who missed it and needs a good laugh, watch this CNBC video. There’s one fool (well, maybe two if you count his buddy trying to pull him out of the frying pan) on this video link. See if you can pick out which one of the six is the fool. Hint: It’s not the blonde.
    http://grahambrokethemold.blogspot.com/2010/02/cnbc-cheerleading-team.html

  44. garbage

    nobody received $ 2 trillion in near zero interest loans

    the “lecturer and coordinator” should learn to read a balance sheet and the information available from it before shooting off such nonsense at the mouth

  45. In banning naked CDSs you’d effectively destroy the market for CDSs. Those who wanted them would buy upon issuance, since there would be little or no informational advantage given away. Anytime after that, buying a CDS would clearly signal that you think the firm is going to crash – giving up information to the seller, who will be sure to charge accordingly. While now buying a CDS can mean closing a position, speculating or insuring, wih a no-naked-CDS rule buying a CDS can only mean needing insurance. Marketing making would be impossible, since there would be no way to cover an open CDS position without buying the underlying. So buying a CDS would mean paying enough to buy someone else out of their insurance or getting someone to issue and sell you an insurance contract while signaling them that risks have greatly increased by wanting insurance.

    This would make the debt of weaker issuers more expensive, since it would become much harder to decompose the risks in the bonds without a liquid CDS market. The ability to buy correctly priced insurance in the market at any time increases the interest in buying bonds in the first place.

    I do think that central clearing with proper margin and collateral requirements is essential for the stability of CDS markets and financial markets as a whole. But banning naked CDSs is a bad idea.

  46. This is, far and away, the stupidest article I have ever seen on this site. The problem with swaps is the accounting and the labyrinthine set of interconnectivities that they generate when not centrally cleared. Central clearing is necessary. Guess which bit of the Lehman Bankruptcy actually went through pretty much EXACTLY as it was theoretically supposed to, and didn’t collapse any other institutions? Yeah, it was their centrally cleared interest rate swap portfolio cleared at London Clearing House. After 2 days all the other banks were re-hedged without any major disasters. Spinning off desks and looking at gross exposure (i.e. total notional of derivative contracts) is a total red herring. As usual lately Baseline has missed the point entirely.

  47. greenbubba

    How about, they remain legal in Nevada and Atlantic City?

  48. engineer27

    Hey, you left out the Native Americans. Are you racist?

  49. Hi anon — I appreciate the feedback from all, including yours. The $2 trillion is an aggregate figure. No one is suggesting that a single institution received that amount. There’s very useful data published by the Federal Reserve on this, including testimony by Ben Bernanke re emergency actions taken by the Fed since 2007 and the current Fed balance sheet as compared to 2007. In addition, this data by Nomi Prins may be of interest to readers. http://www.sitemason.com/files/fucka4/sub052010.pdf

  50. This “yes we can” attitude in the Senate is almost purely a function of incumbent fear. Already both Republican and Democrat incumbents have been beaten in primaries.

    The remainder are getting the message: Either you do something (almost anything!) for the country or we will can your sorry arse now or in November!

    …and it’s about time.

  51. Re: @ Bond Girl____Back to the basics: CDS’s – two party dirivative that works like an insurance policy – protects the “Protection Buyer” against default in return for the payment of a premium, “The Protection Seller” – committed to reimburse the buyer of any losses due to the non-performance of the CDO’s { CDO’s – SPV/SIV created to sell interest bearing bonds to investors ie.)hedge funds,insurance companies,high net worth individuals,and other institutions} if it/they default. Note: CDS’s ensures that the CDO’s would be low in terms of credit risk,and entitle too an investment grade rating of “AA & Higher” to allow institutions too invest. Please be advised that “Naked Swaps” fall under the same SEC regulatory rules as “Naked Shorting” as being illegal (absolutely no skin in the game) because of the very fact it allows manipulators a chance to force down said entities without regard for normal supply/demand patterns (very similar to what is happening with Gold as a hard asset backing up the “Faux Fiat Currency” as our world’s economic foundations sadly are built on today)! I’d also like to mention the “Repo-Play” ,that seems to have gotten little attention as of lately, which allows said entities the right to borrow, using these bonds as collatoral? Finally,..we must realize the usefulness of “Dirivatives” in todays world’s financial markets._____”Contract Types”:….Equity (equity swap/DJIA-Futures);…Interest Rates (interest rate swap/Eurodollar-Futures-Euribor Futures);….Credit (Credit Default Swaps-Total Return Swap/Bond Futures;….Foreigh Exchange (Currency Swaps/Currency Futures);….Commodity (Commodity Swaps/WTI crude oil futures – weather dirivatives – Iron orefoward contract – Gold option)…these are all complex exchangables that just can’t be “Wished Away”,thankyou. PS….OC – Greece – LTCM -AIG (subsidiary not part of company created the crises,but where were the insurance reg’s) ,all brought their own problems upon themselves…far from being coerced.

  52. There is really a simple but loaded set of questions involving the current financial system.

    Is the present system unchecked self destructing to itself and the nation itself?

    If yes, is the unchecked present financial system able to be checked given the power the insiders presently possess?

    Given that the present power holders of the present system can be checked and replaced , what are the effects on the political system? Is the present actually operating political system itself checkable.

    Given that the present political system is itself ridden with political polarity, what would be the achievable political changes that would sufficiently prevail to overcome political polarity.

    Very difficult questions come together and not solving all will lead to collapse of the present political and financial system. The USSR died but every component still exists on a more local level. What went on between the end of the USSR and present will be enacted in the US in it’s own peculiar way. Change will happen, a failed system exists or all the comment about TBTF and on and on and on has no merit. People are mad at something. They are not conjuring totally out of the atmosphere. It seems to me, for good or bad, that the powerholders restore status quo ante to keep their power which is impossible. Irrevocable change has occurred.

  53. Ya, those is plural pronoun last time I checked. Wow, I thought I was vicious sometimes.

    Obviously it’s not that any of Miss Taub’s facts or arguments are wrong, it’s the fact she has the guts to go after the goose that lays the golden eggs that has some in a tizzy. If these large banks can’t get money for long-term capital projects and infrastructure through the regular offering of bonds, what can they do??? The apparent answer is: Trade securities with phantom capital and tell people it’s a way to control risk—even Warren Buffett would have to admire that creativity. Heck, Buffett might be envious somebody found a bigger screw on the planet than the insurance business. And to try and control that or regulate it!?!?!?!? Heresy!!!!!!!

    After all now, if BP had been properly regulated, what would the U.S. Coast Guard, Fishermen, and coastal businesses between Louisiana and Florida do for fun for the next 10+ years??? It will only cost American taxpayers Billions of Dollars. Why should we inconvenience a few boys on an oil rig with regulation for that small account???

  54. Just don’t tell them they’ll be apt to lose more money on swaps, or you won’t be able to tear them away from it. Focus on the life destroying aspects of slot machines and they’ll never look at a swap.
    —Chief Smart Aleck

  55. Brad Thrasher

    Huh? I checked out your links and am totally confused. What does either have to do with the topic of a limited scope one time audit of the Fed?

    Ted K., I enjoy a bowl of herb as much as the next guy but I never blog and enjoy simultaneously.

  56. So:

    1) the senate GS & MS to stop being bank holding companies only a year or so after the Fed offered them the opportunity to become them;

    and

    2) Taub says banks shouldn’t have swaps desks and Greenberger says “[don't worry,] banks won’t be able to sell swaps, but will still be able to buy them”. The logic that selling a “swap X for Y” is the same as buying a “swap Y for X” seems to be beyond the ken of our esteemed Professor and derivatives expert.

    This is going to a) push the big holding companies to be, shock-and-horror, investment banks (no change there); and b) make not one whit of difference to the swaps exposure the remaining holding companies can “buy”.

  57. I must admit I am shocked at those who think CDS is not a form of insurance – at least functionally when it isn’t “naked” – and that banning naked CDS would somehow disrupt the financial markets in any meaningful way or that it would destroy the market for CDS altogether. What did we ever do before this innovation was created by imaginative Wall Street executives who wanted to make a buck?

  58. That’s why regulating derivatives as gambling instruments is banned by the CFMA of 2000.

  59. I guess the correct answer would be, don’t be a creditor to people or firms you doubt will pay off the final payment. I know that’s a difficult concept to wrap your head around, but you and the oh so clever Blankfein can mull that over on a weekend if you’re not busy bilking the American taxpayer/saver.

  60. I was commenting on the last two sentences in YOUR comment DUMB_SS. I wasn’t commenting on the original post, hence why I used “reply”.

  61. These are NOT bi-partisan votes.

    Grow a pair and call them by their right name.

    These votes are not a signal of sudden Senate comity.

    They are clear evidence that people are pissed enough that their even their normally timid representatives finally get what their contituents are demanding, party be damned.

    That’s a very good, healthy step. Highlight that. Don’t subsume that message as a slight improvement in the dysfuntional bi-partisan family dynamic that we lament as something that must be cured. BS. Bi-partisan splits are only significant to Beltway insiders. The rest of us could ,frankly , give a sh**.

    Politely describing these votes as bi-partisan undermines your key thesis, that something needs to be done, the people demand it, and that they find congressional machinations tiresome and impotent.

    The uni-partisan vote is a wake up call to Congress, but also to you. Slap yourselves in the face a bit and lose the captive (bi)partisan/non partisan bias for a minute. This is big.

    Don’t undermine your case by falling into the bi-partisan trap.

  62. Brad Thrasher

    Again, Huh? What does an armed citizenry holding off the Sheriff sixty years ago have to do with defeating incumbents this election cycle?

    And WTF does a discussion of how we fund real estate have to do with either armed resistance or organizing to defeat incumbents?

    I’m a DUMB_SS? No TedK, when people lack the ability to stay even remotely on point I become an impatient pr#ck. Sheesh, you can’t even do name calling accurately.

  63. How is your comment about “insurance” in any way related to the comment to which you replied?

  64. A standing ovation to you sir!

  65. It’s a new millenium baby! Might be time for another!

  66. My impression is that States Rights has long been used by Republicans as a vehicle for other purposes. The Repubs main priority is to line-up in support of the interests of big business. Only to the extent that invoking States Rights can serve their primary agenda do the Repubs use that. So I am not a bit surprised. The very specific pre-empting in Phil Gramm’s 2000 law had very little to do with States Rights and state insurance, but it had very thing to with allowing for NAKED CREDIT DEFAULT SWAPS! Naked Credit Default Swaps must be eliminated! That Clinton signed this bill may be his single most offensive act as president. Without naked credit default swaps we certainly would have had the economic crisis/recession of 2007-2011(?). But … the magnitude and severity of this crisis can be solely attributed to naked credit default swaps.

  67. It is possible that Bernie’s amendment could be made a permanent Fed requirement via future congressional action.