Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
Stock Market Investing LESSON - Buying Value - 27th Nov 21
Corsair MP600 NVME M.2 SSD 66% Performance Loss After 6 Months of Use - Benchmark Tests - 27th Nov 21
Stock Maket Trading Lesson - How to REALLY Trade Markets - 26th Nov 21
SILVER Price Trend Analysis - 26th Nov 21
Federal Reserve Asks Americans to Eat Soy “Meat” for Thanksgiving - 26th Nov 21
Is the S&P 500 Topping or Just Consolidating? - 26th Nov 21
Is a Bigger Drop in Gold Price Just Around the Corner? - 26th Nov 21
Financial Stocks ETF Sector XLF Pullback Sets Up A New $43.60 Upside Target - 26th Nov 21
A Couple of Things to Think About Before Buying Shares - 25th Nov 21
UK Best Fixed Rate Tariff Deal is to NOT FIX Gas and Electric Energy Tariffs During Winter 2021-22 - 25th Nov 21
Stock Market Begins it's Year End Seasonal Santa Rally - 24th Nov 21
How Silver Can Conquer $50+ in 2022 - 24th Nov 21
Stock Market Betting on Hawkish Fed - 24th Nov 21
Stock Market Elliott Wave Trend Forecast - 24th Nov 21
Your once-a-year All-Access Financial Markets Analysis Pass - 24th Nov 21
Did Zillow’s $300 million flop prove me wrong? - 24th Nov 21
Now Malaysian Drivers Renew Their Kurnia Car Insurance Online With Fincrew.my - 24th Nov 21
Gold / Silver Ratio - 23rd Nov 21
Stock Market Sentiment Speaks: Can We Get To 5500SPX In 2022? But 4440SPX Comes First - 23rd Nov 21
A Month-to-month breakdown of how Much Money Individuals are Spending on Stocks - 23rd Nov 21
S&P 500: Rallying Tech Stocks vs. Plummeting Oil Stocks - 23rd Nov 21
Like the Latest Bond Flick, the US Dollar Has No Time to Die - 23rd Nov 21
Why BITCOIN NEW ALL TIME HIGH Changes EVERYTHING! - 22nd Nov 21
Cannabis ETF MJ Basing & Volatility Patterns - 22nd Nov 21
The Most Important Lesson Learned from this COVID Pandemic - 22nd Nov 21
Dow Stock Market Trend Analysis - 22nd Nov 21
UK Covid-19 Booster Jabs Moderna, Pfizer Are They Worth the Risk of Side effects, Illness? - 22nd Nov 21
US Dollar vs Yields vs Stock Market Trends - 20th Nov 21
Inflation Risk: Milton Friedman Would Buy Gold Right Now - 20th Nov 21
How to Determine if It’s Time for You to Outsource Your Packaging Requirements to a Contract Packer - 20th Nov 21
2 easy ways to play Facebook’s Metaverse Spending Spree - 20th Nov 21
Stock Market Margin Debt WARNING! - 19th Nov 21
Gold Mid-Tier Stocks Q3’21 Fundamentals - 19th Nov 21
Protect Your Wealth From PERMANENT Transitory Inflation - 19th Nov 21
Investors Expect High Inflation. Golden Inquisition Ahead? - 19th Nov 21
Will the Senate Confirm a Marxist to Oversee the U.S. Currency System? - 19th Nov 21
When Even Stock Market Bears Act Bullishly (What It May Mean) - 19th Nov 21
Chinese People do NOT Eat Dogs Newspeak - 18th Nov 21
CHINOBLE! Evergrande Reality Exposes China Fiction! - 18th Nov 21
Kondratieff Full-Season Stock Market Sector Rotation - 18th Nov 21
What Stock Market Trends Will Drive Through To 2022? - 18th Nov 21
How to Jump Start Your Motherboard Without a Power Button With Just a Screwdriver - 18th Nov 21
Bitcoin & Ethereum 2021 Trend - 18th Nov 21
FREE TRADE How to Get 2 FREE SHARES Fractional Investing Platform and ISA Specs - 18th Nov 21
Inflation Ain’t Transitory – But the Fed’s Credibility Is - 18th Nov 21
The real reason Facebook just went “all in” on the metaverse - 18th Nov 21
Biden Signs a Bill to Revive Infrastructure… and Gold! - 18th Nov 21
Silver vs US Dollar - 17th Nov 21
Silver Supply and Demand Balance - 17th Nov 21
Sentiment Speaks: This Stock Market Makes Absolutely No Sense - 17th Nov 21
Biden Spending to Build Back Stagflation - 17th Nov 21
Meshing Cryptocurrency Wealth Generation With Global Fiat Money Demise - 17th Nov 21
Dow Stock Market Trend Forecast Into Mid 2022 - 16th Nov 21
Stock Market Minor Cycle Correcting - 16th Nov 21
The INFLATION MEGA-TREND - Ripples of Deflation on an Ocean of Inflation! - 16th Nov 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Financial Crisis Solution, Ban Credit Default Swaps?

Politics / Credit Crisis 2009 Jul 15, 2009 - 06:28 AM GMT

By: Money_Morning

Politics

Best Financial Markets Analysis ArticleMartin Hutchinson writes: Ask U.S. Rep. Maxine Waters, D-CA, about credit default swaps and she’ll offer this warning: Ban them now or expect a reprise of the ongoing global financial crisis – which the derivative securities helped create.


When it comes to elected officials, Congresswoman Waters is not one I would typically feel that I have a lot in agreement with. A representative of a low-income district in Los Angeles, Waters is a senior member of the House Committee on Financial Services and has distinguished herself in the past by her sharp attacks on the financial sector and capitalism in general – what her own Web site describes as her “no-holds-barred style of politics.”

However, Congresswoman Waters’ bill to prohibit credit default swaps – introduced last Friday (July 10) – is strangely appealing, even for a crusty old capitalist like myself.

If you want a more pro-capitalist confirmation of Waters’ view (and George Soros doesn’t count) try Warren Buffett’s sidekick Charles T. Munger, who has called the CDS prohibition the best solution, and said “it isn’t as though the economic world didn’t function quite well without it, and it isn’t as though what has happened has been so wonderfully desirable that we should logically want more of it.”

Waters has also pointed out – quite reasonably – that unless credit default swaps are banned outright, “the industry will find a way to loosen standards and widen exemptions for customized contracts and we will be right back to where we are today.” 

When There’s No “Free” in Free Market

As a free-market enthusiast, my natural instinct is to resist such calls. But I have to recognize that, as we speak, we’re actually not operating in a free market. Key U.S. banks were bailed out by the U.S. government last fall, after which such financial institutions as Fannie Mae (NYSE: FNM), Freddie Mac (NYSE: FRE) and Citigroup Inc. (NYSE: C) have been permitted to carry on as though nothing bad ever happened.

Furthermore, a number of big players in the CDS market – most notably Goldman Sachs Group Inc. (NYSE: GS) – were bailed out through the rescue of busted insurer American International Group Inc. (NYSE: AIG). In that case, the government injected $180 billion into AIG, largely to allow it to make good on the CDS contracts it had written – $13 billion of which were with Goldman Sachs.

If Citi, Fannie, and Freddie had gone bankrupt – as they would have done in a free market – and Goldman had lost the best part of $13 billion (which might well have sent it bankrupt in turn) the financial market today would look very different. The financial industry would be rife with unemployment and apple-selling ex-Citibankers would be on the streets of New York keeping bankers’ salaries and bonuses way down from their pre-crash levels.

But such as it is, Goldman Sachs is said to be heading for record profits in 2009, and its partners are expecting record bonuses. The investment-banking firm reported stellar second-quarter profits of $3.44 billion yesterday (Tuesday). [For a related story on Goldman Sachs’ quarterly financial report that appears in today’s issue of Money Morning, please click here.]

If U.S. taxpayers are going to be called on to subsidize the very banks that got us into this mess – just so these institutions can continue to carry on as if it was still 2007 – then another expensive and damaging financial crash is almost certainly in the making.

There are a number of product areas in which such a crash might occur, but for my money, credit default swaps top the list. That makes it crucial for us to at least rein in the derivative securities with the utmost urgency. And Congresswoman Waters makes an excellent point when she says that it may prove impossible to rein in credit default swaps without actually banning them altogether.

If You Can’t Beat ‘Em, Ban ‘Em

Indeed, there are two fundamental problems with CDS securities, neither of which appears easy to solve:

  • First, there is no watertight way of settling credit default swaps in case of default. The current method is by a mini-auction of the obligations on which the swaps are written to determine a settlement price. But this doesn’t work because the mini-auction relates to only a few million dollars of paper, whereas the credit default swaps in question may have a nominal value of billions – hence it’s in the interest of holders to play games at the auction and distort prices. This might not be a problem for non-participants in the CDS market, but it causes huge risks to the financial system – which in extreme cases, must be bailed out by taxpayers, as was the case with AIG.
  • The second problem is that holders of credit default swaps have an incentive to push companies into bankruptcy. In the 1930s, short sales of stock (except on an “uptick”) were prohibited to prevent speculators from driving companies into bankruptcy. Well, the leverage available on CDS securities is much greater than on stock, and in the case of financial institutions, the amount of CDS outstanding is also much greater. That means speculators have correspondingly more incentive to load up on CDS and push a company into bankruptcy.

And it doesn’t end there: Since CDS holders also hold a company’s debt, their position in bankruptcy negotiations is a completely false one. This has already been a problem in the bankruptcies of the Canadian paper company Abitibi-Bowater and the shopping centre developer General Growth; it also caused problems in the massive General Motors Corp. (NYSE: GMGMQ) reorganization.

The stellar bonus prospects of the lucky employees at Goldman Sachs, in a year that has been thoroughly lousy for legitimate financial business, are an indication that we are not currently operating in a free market. Credit default swaps provide a means whereby Wall Street insiders can make huge amounts of money on corporate bankruptcies and disrupt the U.S. economy while doing so.

Until we can be absolutely sure that the poisons of the most-recent global financial bubble have been fully eradicated from the financial system, the safest measure is to ban those financial products like CDS that seem likely to cause the most trouble.

Congresswoman Waters may go too far in wishing to ban credit default swaps altogether. However, I see no reason not to impose a five-year moratorium on the securities.

If, by 2014, the poisons of speculation have been removed from the world’s financial system, and a newly sober Wall Street can convince us that credit default swaps are both useful and sound, the derivative securities can then be reinstituted on a controlled basis, most likely restricted as swaps on “indices” of credit representing an entire sector or country, rather than on single companies alone. That would make it more difficult for CDS dealers to engage in their dangerous bankruptcy games.

Perhaps Goldman Sachs employees can do without that third Porsche – at least or now …

[Editor's Note: When it comes to global investing, longtime market guru Martin Hutchinson is one of the very best – because he knows the markets firsthand. After years of advising government finance ministers, crafting deals with global investment banks, and analyzing the world's financial markets, Hutchinson has used his creative insights to create a trading service for savvy investors.

The Permanent Wealth Invesor assembles high-yielding dividend stocks, profit plays on gold and specially designated "Alpha-Dog" stocks into high-income/high-return portfolios for subscribers. Hutchinson's strategy is tailor-made for periods of market uncertainty, during which investors all too often go completely to cash - only to miss some of the biggest market returns in history when market sentiment turns positive. But it can work in virtually every market environment.

To find out about this strategy - or Hutchinson's new service, The Permanent Wealth Investor - please just Click Here.]

Money Morning/The Money Map Report

©2009 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in