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TechnoratiLust for Leverage
As America continues to struggle with the single most dangerous economic crisis to occur since the invention of television, television news operations have been unforgivably lame and late in telling in a cogent and compelling way, the story of how and why this has happened to us. Lots of stories about how afraid and worried people are, but not much about the how and why. Perhaps this is because the underlying subject is economics, and it's hard to make "the dismal science" seem sexy, or even violent enough for TV. I understand that part. Even my wife, who is very smart, loving and nurturing, gets a look on her face that usually only dentists see when I try to explain the newest things I have learned about Credit Derivatives to her.
But I know it can be done, and I know the story is important. Because if we don't fix this problem, or if we fix it the wrong way, we are all doomed. Our economy will crater and we will end up having to live on tubers, nuts and grass like our distant ancestors. You know, the ones Gov. Palin doesn't believe in.
So I have a helpful suggestion for the networks. Since all you need in order to bring in a big audience for a TV show is a good title, call this one: "Lust for Leverage." Because that is after all, what caused the collapse. And people like to hear stories about lust. And money.
Now I know that there has been an endless parade of talking heads on the Fox News Channel explaining how this has all the fault of Barney Frank and those awful poor people who wanted to live indoors. But even a cursory glance at some numbers will tell you that this just ain't so.
The total value of outstanding sub-prime loans in this country is about $1.3 TRILLION. Fewer than 20% of those debtors are in default, or behind in their payments. This means that even if all those homeowners in default, never paid another dime, and every single one of those houses covered by all those loans and the land that they were on somehow suddenly just disappeared, the total loss could not be more than $260 BILLION.
So even if those careless indoor loving poor people and their enabler Barney Frank really were the root cause of this mess, and that impossible scenario actually happened, we could have totally eliminated that problem by merely paying off every single sub-prime mortgage in the country that is in default, for a total amount that is far smaller than the $700 BILLION Congress has alloted for the historic bailout.
But of course that is not the case, and all those houses and all the land that they are on are are still there and have some value. And most of those homeowners could make some kind of payments, so the real cost to fix that part is far less than $260 BILLION. So, there must have been something else, something big, at work here. And I am here to tell you what it is. Lust. Lust for leverage. By the big dogs.
While the total value of all those sub-prime mortgages is about $1.3 TRILLION, and the total value of all the Corporate Bonds in this country is about $5 TRILLION, the total value of Credit Default Swaps based on those debts is about $50 TRILLION. And this is where the real problem lies.
What are Credit Default Swaps you ask? They started out as a form of insurance on Corporate Bonds. But they quickly morphed into a form of gambling that Sky Masterson would love. Remember him? He was the character in the musical "Guys and Dolls" who sang "Luck Be a Lady Tonight." He loved gambling so much, he would wager on which sugar cube a fly would land on first. Credit Default Swaps morphed from a reasonable form of risk management insurance, into the same kind of gambling that bets on sugar loving flies. High flying Wall Street Sky Mastersons could buy and sell these totally unregulated "insurance polices" to speculate. That means bet on a hunch. They could even buy "insurance" on bonds they didn't even own. That is like you buying an insurance policy on my house, betting that I am such a dope, I will burn my own house down. Your only downside risk is the premium you pay, but if you win, you win an amount that is equal to the worth of my house. This is not about managing risk, or about capital formation so jobs can be created or new factories built. This is more like roulette. And it's all about leverage.
Because, unlike actual insurance, which is regulated, so If a company, like AIG sold a $100 million insurance policy, it would need to have a $100 million in assets available so it could pay off the policy in case of a claim. Credit Default Swaps are totally unregulated, so sellers of these policies can take a big gamble and write 10 times as many policies and get 10 times as much in the way of premiums as they have in assets and thus leverage by the 10 the power of their money.
But it also meant that they had put bets out there that were worth 10 times the amount of chips they had to pay off on a loss. Even that wasn't enough for the big dogs. They went to the SEC and pressured that poor nebbish in charge to raise the ceiling on leverage in general from about 10 to 1, up to about 30 - 1. That meant that you could bet a million dollars on your favorite sugar cube, even if you only had $33,000 in chips. Under those conditions, a few bad bets, and things get really ugly really fast. Now go back up a few paragraphs and consider those numbers -- $1.3 TRILLION in sub-prime mortgages, $5 TRILLION in corporates debt, $50 TRILLION in gambling debts.
Of course there are more factors involved than just Credit Default Swaps. It's like "Who Shot J.R.?" as you learn about the contributory roles played by Credit Rating Agencies, Bond Insurers, Liquidity Banks, predatory and deceptive lending practices, Commercial Paper, and CDO's with their unsavory Tranches (which sounds like something that might be cured by Amoxycillin but is actually just a big slice of a big bundle of mortgages). Learn about this stuff and I promise you that the next time someone comes up to you and tries to tell you that this mess is all the fault of Barney Frank, Fannie Mae, Freddie Mac and the irresponsible poor, you are certifiably ready to say to them: "Shut up you stupid dope."
Sadly, I didn't learn all this from television, which I think should be helping me learn this because they could use pictures and do a show-and-tell which would make it easier for my little ADD'd brain to follow. I learned about this because I have been listening to radio. There has been a great series of stories on NPR's "This American Life" and "Planet Money." I listen to these podcasts on my iPod when I make my yearly visits to the gym. I highly recommend them. Start with the "This American Life" episode titled: "The Giant Pool of Money " available here.
Then try "Another Frightening Show About the Economy" which you can download for $0.95 here.
Subscribe to the "Planet Money" podcast, but make sure to listen to their archieved episode "A Tale of Intertwined Misery" here.
If this doesn't thrill you because it is just radio and doesn't have pictures, consider listening to it as you stand outside your house and watch its value plumet. It might make the whole thing seem pretty engaging.
16 Comments so far
Show AllTHIS ARTICLE FAILS TO DELIVER - WHAT HAPPENED AND WHY REMAINS ARCANE
"television news [has]...been...lame and late in telling in a cogent and compelling way, the story of how and why this has happened to us...Perhaps this is because the underlying subject is economics, and it's hard to make [it] seem sexy, or even violent enough for TV....But I know it can be done."
There are two problems explaining the crisis - one political, the other technical. Politically, a lot of corporate news 'explains the crisis by saying it was due to greed and folly - liberal news says shortsighted corporate greed, right wing news says shortsighted poor homebuyer greed.
As a non-technical narrative, corporate greed is a good start and rallying point. But what is rarely said, and what is harder to explain is - as Nolan writes - what actually happened, and how deregulation - particular congressional policies and laws - directly created the crisis.
It's not that such explanations aren't 'sexy' - they really are hard to explain simply.
IMO, Nolan's piece does not deliver - starting out by explaining credit default swaps as a "form of insurance on Corporate Bonds" is already above most people's heads.
There have been efforts. Commondreams-linked Dollars and Sense magazine has ongoing coverage, is progressive and tries to be accessible. In one Dollars and Sense piece, Tom Weisskopf links two radio programs on the crisis that sound useful:
"For those who seek a clear and comprehensible understanding of the related housing and financial crises, and are willing to devote a couple of hours to the effort, I recommend enthusiastically two recent shows from Ira Glass’s public radio program “This American Life.” The first, on the housing crisis, is entitled “The Giant Pool of Money;” it is show #355, dated May 9, 2008. The second, on the financial crisis, is entitled “Another Frightening Show about the Economy;” it is show #365, dated October 3, 2008. You can find and listen to or download these shows from the program archive at the website."
http://www.dollarsandsense.org/archives/2008/1008weisskopf2.html
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"Money doesn't talk, it swears." -- R. Zimmerman
boblecht
Have you noticed that as credit (leverage) has dried up, the price of oil has plunged? There must be a connection here. If I can leverage one dollar of real money from 8-30 times to play (gamble) in the futures market, and thousands or millions of others do the same, we artificially inflate those markets until the bubble somehow bursts. Since easy credit dried up, the price of crude has dropped by almost 60%, though oil use has decreased only about 5%. I think the dramatic drop in the price of oil is the consequence of lack of credit with which to gamble on oil futures. That is a good thing right now, but what is to stop the game from resuming? How much of our take home income was sucked into this game the past few years by futures gamblers who imposed "fictional" added value on oil, corn, wheat, minerals, pork bellies and any other commodity for which you can gamble in the commodity futures market? The losses related to easy credit for mortgages is a pittance compared to the amount of money sucked from citizens and redistributed in torrents up the economic ladder to the high rollers gambling on credit in commodity futures markets. The game was predicated on easy credit available to the futures speculators. Billions or trillions of dollars of income was sucked from you and me through this scam as we paid artificially escalating prices for everyday goods and services. Why isn't this illegal? Will it resume when credit becomes available again? How about an article on this issue, Mr. Nolan?
You think oil will keep dropping in prices? This is the result of election season. It'll go right back up real soon. Besides, with people taking it for granted yet again, the supplies are dwindling fast, it won't be long until the oil supplies dry up yet again and then the price skyrockets and since it's getting harder and harder to find oil other than a bloody war or kissing the Saudi royal's asses in exchange for sacrificing our homeland security.
You think oil will keep dropping in prices? This is the result of election season. It'll go right back up real soon. Besides, with people taking it for granted yet again, the supplies are dwindling fast, it won't be long until the oil supplies dry up yet again and then the price skyrockets and since it's getting harder and harder to find oil other than a bloody war or kissing the Saudi royal's asses in exchange for sacrificing our homeland security.
Economics isn't violent enough for TV, only because we don't recognize real violence when we see it.
Sioux Rose
This travesty reflects the SICKNESS of greed. I mean it's fairly amazing that banks, that routinely charge 20% interest on the credit cards they issue (and turn around and pay us 3% on our savings/CDS IF we are lucky), can fail with those odds. To come begging for taxpayer assistance when they screwed a great many taxpayers with all kinds of late fees, and transaction fees, and mortgage fees and fees on money coming and going, to then have to INVENT instruments that only simulate the most remote approximation of "value," well, it's as I said, diseased!
Clear evidence this mess that the LOVE of MONEY is the root of ALL EVIL.
As the Mogambo Guru at atimes.com would say, "We're All Doomed!!!" He would then slyly once again tell us we should all BUY GOLD, or silver, or some precious metal, etc. But wait; gold is plunging, too. Could it be that those who own gold, etc., suddenly are not selling it? Because if the Mogambo Guru was right in his theory, gold et al ought to be going through the roof. Come to think of it, who actually owns gold et al?
-30-
Thank you, Barry Nolan. I've been looking for a nuts-and-bolts model of who is doing what to whom, and now I have it. I'll be firstly culling the story down to one of understandable, repeatable proportion and then reporting on my blog, The American Peasant. The info is there if one will just keep searching for it.
Mr. Nolan makes the mistake of assuming people actually want to know silly little things like facts and truth. But, obviously, most do not - not because facts and truth are boring, but because they are very scary, and because they create a sickening salad of anger and helplessness.
Better to believe some God will stop by anytime now and fix everything... now what did Jen say about Angie again?
“Nader Rips Mae and Mac,” declared the Milwaukee Sentinel Journal on June 16, 2000. “Ralph Nader, warning of a potential taxpayer bailout similar to the savings and loan crisis, urged lawmakers to cut government benefits to mortgage-market giants Fannie Mae and Freddie Mac — which he called ‘poster children for corporate welfare.’”
June 15, 2006
"The Demons of Greed are Loose"
Why a Global Economic Deluge Looms By GABRIEL KOLKO Counterpunch.org
"What are credit derivatives? The Financial Times' chief capital markets writer, Gillian Tett, tried to find out. She failed. About ten years ago some J. P. Morgan bankers were in Boca Raton, Florida, drinking, throwing each other into the swimming pool, and the like, and they came up with a notion of a new financial instrument that was too complex to be easily copied (financial ideas cannot be copyrighted) and which was sure to make them money. But she was highly critical of its potential for causing a chain reaction of losses that will engulf the hedge funds that have leaped into this market. It for reasons such as these, as well as others, even more opaque, such as split capital trusts, collateralized debt obligations, and market credit default swaps, that the IMF and financial authorities are so worried. Banks simply do not understand the chain of exposure and who owns what. Senior financial regulators and bankers now admit as much....."
"Stephen Roach, Morgan Stanley's chief economist, on April 24 of this year wrote that a major financial crisis was in the offing and that the ability of global institutions to forestall it -- ranging from the IMF and World Bank to other mechanisms of the international financial architecture * are utterly inadequate.
The entire global financial structure is becoming uncontrollable in crucial ways its nominal leaders never expected. Instability is increasingly its hallmark. Financial liberalization has produced a monster, and resolving the many problems that have emerged is scarcely possible for those who deplore controls on those who seek to make money, whatever means it takes to do so. Contradictions now wrack the world's financial system, and if we are to believe the institutions and personalities who have been in the forefront of the defense of capitalism, it may very well be on the verge of serious crises."
Thanks for the Kolko quote, i'm so sick of the mantra "no one could see this coming..."
Excellent summary article. Everyone should remember those numbers.
And to make your mind even number, think about this one: beyond the $50 TRILLION in credit-default swap "value", the total "value" of the entire derivatives market has been estimated at 20 times that high - that's right, a QUADRILLION imaginary dollars chasing around out there in the giant paper casino constructed by these oh-so- brilliant "Masters of the Universe", with (incidentally) the real economy tied to the flapping tail of this biggest of all "big dogs".
Ain't no way that gigantic over-inflated balloon is ever gonna be slowly and carefully and fairly deflated, folks.
What makes such notions possible is the poor science underpinning the concept of "economics," which should be paired with "alchemy" in the occult section of the library. Adam Smith in Wealth of Nations advanced the view that what constitutes value in economy is not land, as his French physiocrat predecessors supposed, but labor. Publishing in 1776, Smith had no means for discussion of labor itself, so he substituted the concept of "corn," the value of which he could discuss with Procrustean adjustments to fit his theory. In 1850, however, Lord Kelvin promulgated the laws of thermodynamics, the second of which warns that it is impossible to obtain from a transaction more labor than is input. Profits, therefore, cannot exist within the transaction, but must come from victims of the transaction. Leverage transactions attempt pre-emptively to draw off the "profit," emptying the purse as the transaction change hands and bringing victimization all the way to the financial sector. Since these forces control economy and government, we are compelled to bandage their wounds – at the expense of the original victims! The only solution is for the government to nationalize retail and mortgage banking and strictly regulate the rest – holding the threat that they too might be nationalized over their heads.
For George Wanker Bush, "leverage" will be attempting to open the mason jar holding his stash of coke, or lifting the toilet seat, or dickering with the Chamber of Commerce about how much they MUST pay him for a speech about the "free market" of vampires running the blood bank, or how many soldiers it takes to lift an aluminum coffin and put it on an airplane.