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Tracking the new financial WMDs

danps's picture

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Blogger George Washington (emph. in orig.):

Remember, credit default swaps didn't bring down the economy because they are toxic while all other financial vehicles are pure as the driven snow. CDS brought down the economy because they were the choice du jour of the looters.

If we outlaw CDS (which I have argued for in the past), then the looters would create some other instrument for looting.

Given the absence of moral hazard on Wall Street, and the consequent perverse incentives to gamble, it should not be provocative to write that we are most likely just between financial meltdowns.

The US government has formalized what was long merely assumed: that the biggest financial institutions are too big to fail. The big boys know that when it comes time to pay off losing bets they will be covered by OPM, baby - Other People's Money.

As Washington writes, it is just a matter of seeing what the next game is. We may be in the middle of one right now with the foreclosure mess (Foreclosure Fraud has done an amazing job documenting and analyzing it). There are too many stories to keep track of - people without mortgages being foreclosed on, houses getting sold multiple times, people being thrown out of their homes multiple times, it just seems to go on and on.

The best measure of just how much trouble the banks are in may be the tale of H.R. 3808, the Interstate Recognition of Notarizations Act of 2010. Consider its blink-and-you-missed-it trip through the Senate. The Senate: the same body that has bottled up 420 (and counting) bills passed by the House, is crippling the judiciary by refusing to confirm judges, and is deliberately, actively harming America's national security by working for months in bad faith on a new arms treaty with Russia - only to sabotage it when it was ready to be ratified. Read how H.R. 3808 was treated by that Senate:

After languishing for months in the Senate Judiciary Committee, the bill passed the Senate with lightning speed and with hardly any public awareness of the bill's existence on September 27, the day before the Senate recessed for midterm election campaign.

The bill's approval involved invocation of a special procedure. Democratic Senator Robert Casey, shepherding last-minute legislation on behalf of the Senate leadership, had the bill taken away from the Senate Judiciary committee, which hadn't acted on it.

The full Senate then immediately passed the bill without debate, by unanimous consent.

If that does not convince you the fix is in, nothing will. When they need to straighten up and fly right they do so very prettily, no?

All of this is mostly about trying to once again dump losses on taxpayers, though. It is post-speculation cleanup. What about the next bubble; where will it come from? Commenter gizzardboy very helpfully pointed me to a series of recent articles on exchange traded funds (ETFs). These are mutual funds based on a basket of stocks in an exchange. So, for example, you could buy a single "share" in the S&P 500 - something that reflects the value and movement of all 500 stocks - by purchasing it from an S&P 500 ETF.

In an ETF analysis a couple of months ago, Bogan Associates considered the possibility of collapse. The paper argues that since many ETFs have a great deal more outstanding shares than the underlying value of the funds themselves, a run on one of them would cause it to collapse. And of course, if that causes other ETFs to take on the stink of death it could spark a chain reaction that would indiscriminately take down whole chunks of the industry - healthy and unhealthy alike.

The paper was noted by Herb Greenberg, which prompted Michael Johnston to jump in to defend them. He does so with a tone of haughty disdain (people linked to Greenberg "apparently without doing much research," he sniffs) and it actually works against him: Snorting dismissal is the first refuge of unsupported privilege.

He does a good job sketching out the basics of how ETFs operate, but as gizzardboy emailed there is not much discussion of naked short selling. (Here is a fairly anodyne description of naked shorting; here is a less sanguine take.) Essentially, ETFs are subject to the same manipulation and speculation as any other financial instrument. Is it their turn as choice du jour? We are assured by people in the industry like Johnston that they are solid, safe investments, but such assurances have shaky records of late. And as Congress has shown, it is more than willing to put taxpayers on the hook for the next bailout before the public even knows it's up for a vote.

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Submitted by jawbone on

our Corporatist politicians. And, of course, new avenues for looting are devloped and/or manipulated as we read.

My frustration is that we seem unable to break through to the general public, thanks to the role of our "vaunted free press," the Mainstream Corproate Media, aka MCM, (which incorporates public broadcasting, as much of its funding now come from big corporations) which also enables the MOTU's.

IIRC, ETF's were the recommended vehicle for the non-inside Wall Street investors, especially novice investors or those with little time to try to manage stock investments, per the Motley Fool guys.

But: Essentially, ETFs are subject to the same manipulation and speculation as any other financial instrument. Is it their turn as choice du jour? We are assured by people in the industry like Johnston that they are solid, safe investments, but such assurances have shaky records of late.

And what are people supposed to do to prepare for the present and future fights for reductions in SocSec benefits? (Promised in grisly terms by Alan Simpson, one of the Obama appointed co-chairs --There will be hair and eyeballs all over the floor,” he said. There Will Be Blood! Not just a movie anymore.*)

Congress had to have had a role in allowing businesses to do away with defined benefit pensions, so pols have that on their hands already. All to force people to "play" in the markets, all the while telling them they're not "gambling," just being prudent investors. They were told they could manage the amount of risk. Surely anyone working in a larger business has attended the brief seminars where they were told about the stages of exposure to risk? "And shortly before retirement, you will want to change yout investment mix to reflect your need for more security as you approach retirement." How's that working out ya, early Baby Boomers??

But, more and more, we're seeing that that The Fix Is In, and it is more and more fixed to reward the insiders at the top of the economic pyramid.

What's a person to do? With interest on savings below 1%?

*From Simpson interview to Monitor Breakfast:

He predicted a government that approaches shutdown in April of next year.

This is going to be beautiful politics - The brutal kind,” he told reporters in Washington at a forum put on by the Christian Science Monitor. “I love those,” he said, with a twinkle in his eye and a jokester tinge to his voice.

“The debt limit, when it comes in April or May, will prove who’s a hero and who’s a jerk and who’s a charlatan and who’s a faqir,” said Simpson. “And there it will be right there. Because they’re going to say, these new guys, some of them, and I’ve met a good deal of them and boy they’re sharp cookies,” he said, adding a message to new Congressmen.

“Compromise is not a filthy word,” said Simpson. “It doesn’t mean you’re a wimp when you learn to compromise. You either learn to compromise and legislate or go home – my personal view – anyway there they are and they’re going to say I will not vote for the debt limit extension until you cut this. Say, you can’t do that. you can’t possibly do that. well, then I’m not voting for it. and they’ll say well the government will close. Which they’ll say that’s what I came here for. Oh, I can’t wait. It’ll be something and I’ll be watching.”


“They’re sending these anti-tax people,” Simpson said of voters. “I can’t wait for the blood bath in April. It won’t matter whether two of us have signed off on this, or 14 or 18. When debt limit time comes they’re going to look around and say what in the hell do we do now? We’ve got guys who will not approve the debt limit extension unless we give them a piece of meat, real meat off of this package, and boy the blood bath will be extraordinary. And they’ll say how the hell do you get meat off this package.” (My emphasis throughout)

This guy is entirely too happy and excited about screwing us over, eh?

Submitted by Hugh on

The bubbles in the US are and have been since housing went in stock and commodities. The carry trade in dollars is just another aspect of this.

ETFs are just superposed on them. The broader ones are pure beta (passive investment management). More specialized ones are beta masquerading as alpha (active investment management).

That they have a lot of share outstanding reminds me of Goldman Sachs' Blue Ridge and Shenandoah funds in 1929. What we are talking here is leverage. And what it means is if the market turns sour, the losses are multiplied by the degree of leverage. For example, if a firm is leveraged at 20:1 and there is a 5% drop in the markets, or the portion of the market they are invested in, their entire equity is wiped out. That is their investors would lose everything.