[GJM] CREDIT DERIVATIVES?
robert searle
dharao4 at yahoo.co.uk
Thu Sep 14 09:09:36 MDT 2006
Dear All,
I am not sure whether this has been sent
before. However, I have sent it just in case I have
not.
R.Searle
---------------------------------
Feasta is the Foundation for the Economics of
Sustainability based in Ireland Feasta is
the Foundation for the Economics of Sustainability
based in Ireland
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Bankers Fear World Economic Meltdown From:
Richard Douthwaite
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Bankers Fear World Economic
Meltdown Posted by: "Richard
Douthwaite" richard at douthwaite.net
rdouthwaite2001
Tue Aug 1, 2006 10:25 pm
(PST) Dear All:
I've trimmed the article below a little - you can
see it all on the Counterpunch site. The
Introduction to Schinasi's book can be downloaded
free from the IMF site -
http://www.imf.org/External/Pubs/NFT/2005/SFS/eng/sfs.pdf
Two graphs are particularly interesting, showing
how financial institutions' claims on the rest of
us have grown by four times the amount that major
economies have grown since 1970. Will these
claims stand up, or are they so large that they
have to be repudiated? And if they are
repudiated, what happens to people's pensions and
savings?
Best wishes,
Richard.
==========
Bankers Fear World Economic Meltdown
By GABRIEL KOLKO
Posted on
http://www.counterpunch.org/kolko07262006.html on 26
July, 2006
(Extract)
In March of this year the IMF released Garry J.
Schinasi’s book, Safeguarding Financial
Stability, giving it unusual prominence then and
thereafter. Schinasi’s book reveals and documents
in great and disturbing detail the IMF’s deep
anxieties. Essentially, “deregulation and
liberalization,” which the IMF and proponents of
the “Washington consensus” advocated for decades,
has become a nightmare. It has created
“tremendous private and social benefits” but it
also holds “the potential (although not
necessarily a high likelihood) for fragility,
instability, systemic risk, and adverse economic
consequences.” Schinasi’s superbly documented
book confirms his conclusion that the irrational
development of global finance, combined with
deregulation and liberalization, has “created
scope for financial innovation and enhanced the
mobility of risks.” Schinasi and the IMF advocate
a radical new framework to monitor and prevent
the problems now able to emerge...cut...
The potential for much greater instability – and
greater dangers for the rich – now exists in the
entire world economy. The global financial
problem that is emerging is tied into an American
fiscal and trade deficit that is rising quickly.
Since Bush entered office in 2001 he has added
over $3 trillion to federal borrowing limits,
which are now almost $9 trillion. So long as
there is a continued devaluation of the U.S.
dollar, banks and financiers will seek to protect
their money and risky financial adventures will
appear increasingly worthwhile. This is the
context, but Washington advocated greater
financial liberalization long before the dollar
weakened. This conjunction of factors has created
infinitely greater risks than the proponents of
the “Washington consensus” ever believed possible.
There are now many hedge funds, with which we are
familiar, but they now deal in credit derivatives
– and numerous other financial instruments that
have been invented since then, and markets for
credit derivative futures are in the offing. The
credit derivative market was almost nonexistent
in 2001, grew fairly slowly until 2004 and then
went into the stratosphere, reaching $17.3 trillion by
the end of 2005.
What are credit derivatives? The Financial Times’
chief capital markets writer, Gillian Tett, tried
to find out – but 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 Tett 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. Warren Buffett, second
richest man in the world, who knows the financial
game as well as anyone, has called credit
derivatives “financial weapons of mass
destruction.” Nominally insurance against
defaults, they encourage far greater gambles and
credit expansion. Enron used them extensively,
and it was one secret of their success – and
eventual bankruptcy with $100 billion in losses.
They are not monitored in any real sense, and two
experts called them “maddeningly opaque.” Many of
these innovative financial products, according to
one finance director, “exist in cyberspace” only
and often are simply tax dodges for the
ultra-rich. It is for reasons such as these, and
yet others such as split capital trusts,
collateralized debt obligations, and market
credit default swaps that are even more opaque,
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 this. The
Long-Term Capital Management hedge fund meltdown
in 1998, which involved only about $5 billion in
equity, revealed this. The financial structure is
now infinitely more complex and far larger – the
top 10 hedge funds alone in March 2006 had $157
billion in assets. Hedge funds claim to be honest
but those who guide them are compensated for the
profits they make, which means taking risks. But
there are thousands of hedge funds and many
collect inside information, which is technically
illegal but it occurs anyway. The system is
fraught with dangers, starting with the
compensation structure, but it also assumes a
constantly rising stock market and much, much
else. Many fund managers are incompetent. But the
26 leading hedge fund managers earned an average
of $363 million each in 2005; James Simons of
Renaissance Technologies earned $1.5 billion.
There is now a consensus that all this, and much
else, has created growing dangers. We can put
aside the persistence of imbalanced budgets based
on spending increases or tax cuts for the
wealthy, much less the world’s volatile stock and
commodity markets which caused hedge funds this
last May to show far lower returns than they have
in at least a year. It is anyone’s guess which
way the markets will go, and some will gain while
others lose. Hedge funds still make lots of
profits, and by the spring of 2006 they were
worth about $1.2 trillion worldwide, but they are
increasingly dangerous. More than half of them
give preferential treatment to certain big
investors, and the U.S. Security and Exchange
Commission has since mid-June 2006 openly
deplored the practice because the panic, if not
chaos, potential in such favoritism is now too
obvious to ignore. The practice is “a ticking
time bomb,” one industry lawyer described it.
These credit risks – risks that exist in other
forms as well – seemed ready to materialize when
the Financial Times’ Tett reported at the end of
June that an unnamed investment bank was trying
to unload “several billion dollars” in loans it
had made to hedge funds. If true, “this marks a
startling watershed for the financial
system.” Bankers had become “ultracreative
in
their efforts to slice, dice and redistribute
risk, at this time of easy liquidity.”
Low-interest rates, Avinash Persaud, one of the
gurus of finance concluded, had led investors to
use borrowed money to play the markets, and “a
painful deleveraging is as inevitable as night
follows day
. The only question is its timing.”
There was no way that hedge funds, which had
become precociously intricate in seeking safety,
could avoid a reckoning and “forced to sell their
most liquid investments.” “I will not bet on that
happy outcome,” the Financial Times’ chief expert
concluded in surveying some belated attempts to
redeem the hedge funds from their own follies.
A great deal of money went from investors in rich
nations into emerging market stocks, which have
been especially hard-hit in the past weeks, and
if they (leave then the financial shock will be
great -- the dangers of a meltdown exist there too.
Problems are structural, such as the greatly
increasing corporate debt loads to core earnings,
which have grown substantially from four to six
times over the past year because there are fewer
legal clauses to protect investors from loss –-
and keep companies from going bankrupt when they
should. So long as interest rates have been low,
leveraged loans have been the solution. With
hedge funds and other financial instruments,
there is now a market for incompetent,
debt-ridden firms. The rules some once
erroneously associated with capitalism -- probity
and the like -- no longer hold.
Problems are also inherent in speed and
complexity, and these are very diverse and almost
surrealist. Credit derivatives are precarious
enough, but at the end of May the International
Swaps and Derivatives Association revealed that
one in every five deals, many of them involving
billions of dollars, involved major errors – as
the volume of trade increased, so did errors.
They doubled in the period after 2004. Many deals
were recorded on scraps of paper and not properly
recorded. “Unconscionable” was Alan Greenspan’s
description. He was “frankly shocked.” Other
trading, however, is determined by mathematical
algorithm (“volume-weighted average price,” it is
called) for which PhDs trained in quantitative
methods are hired. Efforts to remedy this mess
only began in June of this year, and they are
very far from resolving a major and accumulated
problem that involves stupendous sums.
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
global institutions to forestall it– ranging from
the IMF and World Bank to other mechanisms of the
international financial architecture – were
utterly inadequate. Hong Kong’s chief secretary
in early June deplored the hedge funds’ risks and
dangers. The IMF’s iconoclastic chief economist,
Raghuram Rajan, at the same time warned that the
hedge funds’ compensation structure encouraged
those in charge of them to increasingly take
risks, thereby endangering the whole financial
system. By late June, Roach was even more
pessimistic: “a certain sense of anarchy”
dominated the academic and political communities,
and they were “unable to explain the way the new
world is working.” In its place, mystery
prevailed. Reality was out of control.
The entire global financial structure is becoming
uncontrollable in crucial ways its nominal
leaders never expected, and 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. The Bank for International
Settlements’ annual report, released June 26,
discusses all these problems and the triumph of
predatory economic behavior and
trends “difficult to rationalize.” The sharks
have outfoxed the more conservative bankers.
“Given the complexity of the situation and the
limits of our knowledge, it is extremely
difficult to predict how all this might unfold.”
The BIS (does not want its fears to cause a
panic, and circumstances compel it to remain on
the side of those who are not alarmist. But
it now concedes that a big “bang” in the markets
is a possibility, and it sees “several
market-specific reasons for a concern about a
degree of disorder.” We are “currently not in a
situation” where a meltdown is likely to occur
but “expecting the best but planning for the
worst” is still prudent. For a decade, it admits,
global economic trends and “financial imbalances”
have created increasing dangers, and
“understanding how we got to where we are is
crucial in choosing policies to reduce current risks.”
The BIS is very worried.
Given such profound and widespread pessimism, the
vultures from the investment houses and banks
have begun to position themselves to profit from
the imminent business distress – a crisis they
see as a matter of timing rather than principle.
Investment banks since the beginning of 2006 have
vastly expanded their loans to leveraged
buy-outs, pushing commercial banks out of a
market they once dominated. To win a greater
share of the market, they are making riskier
deals and increasing the danger of defaults among
highly leveraged firms. There is now a growing
consensus among financial analysts that defaults
will increase substantially in the very near
future. But because there is money to be made,
experts in distressed debt and restructuring
companies in or near bankruptcy are in greater
demand. Goldman Sachs has just hired one of
Rothschild’s stars in restructuring. All the
factors which make for crashes – excessive
leveraging, rising interest rates, etc. – exist,
and those in the know anticipate that companies
in difficulty will be in a much more advanced
stage of trouble when investment banks enter the
picture. But this time they expect to squeeze
hedge funds out of the potential profits because
they have more capital to play with.
Contradictions now wrack the world’s financial
system, and a growing consensus now exists
between those who endorse it and those, like
myself, who believe the status quo is both
crisis-prone as well as immoral. If we are to
believe the institutions and personalities who
have been in the forefront of the defense of
capitalism, and we should, it may very well be on the
verge of serious crises.
Gabriel Kolko is the leading historian of modern
warfare. He is the author of the classic Century
of War: Politics, Conflicts and Society Since
1914 and Another Century of War?. He has also
written the best history of the Vietnam War,
Anatomy of a War: Vietnam, the US and the Modern
Historical Experience. His latest book, The Age
of War, was published in March 2006.
He can be reached at: kolko at counterpunch.org
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