Blogs

Trading Derivatives

| Fri Oct. 10, 2008 2:09 PM EDT

TRADING DERIVATIVES....Megan McArdle on the banking crisis:

One of the smarter ideas I've heard for trying to prevent this sort of thing next time around is putting derivatives on exchanges. Most derivatives are traded over the counter, in part because US bankruptcy law encourages it: as I understand it, derivative counterparties don't have to get in line with the others, but can seize any collateral they can get their hands on.

Exchange trading enhances transparency, by making it clear what's out there and roughly who owns it. It also moves the clearing risk to the exchange; while exchanges do fail, they do so much less often than financial firms, and if intervention is needed, they provide a centralized locus for any private or public action.

I've been noodling over a list of regulatory changes that ought to be on the table for the next administration, and this is one of them. Credit default swaps, in particular, should be registered like any other security and traded on public exchanges. This wouldn't make them 100% safe (stock markets have bubbles and busts too, after all), but it would certainly make them a lot safer.

On the other hand, I'd like to hear an argument for even allowing CDOs to exist in the first place, whether they're publicly traded or not. It's one thing to chop up securities into different tranches that appeal to different classes of investors — that's just marketing — but with very rare exceptions the overall yield of such an instrument should be nearly the same as the yield of the underlying securities themselves. A little less, in fact, since you have to factor in additional administrative costs. But the fundamental idea behind modern CDOs is exactly the opposite: not merely that they're providing a bit of convenience or regulatory arbitrage, but that if you bundle up a bunch of securities and then chop them up in specific ways, they'll be magically worth much more than the underlying securities themselves. Much more. But this violates a basic law of economics. We'd prosecute for fraud anyone selling a perpetual motion machine, and I'm not sure why CDOs are really any different. Done properly, the market for CDOs ought to be small and sleepy, barely worth anyone's attention. If it gets non-sleepy, that means it's becoming fraudulent. So maybe it's just not worth having at all?

Needless to say, I have no idea how you'd go about banning a particular class of security. And I suppose it's possible that the underlying problem is with the rating agencies, not the CDO packagers — though real life being what it is, I suspect that's a distinction without a difference.

In any case, I'd like to hear the argument. Why should we allow the sale and marketing of CDOs at all?

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George W. Bush: Helping Candidates Lose Election in Other Countries, Too

| Fri Oct. 10, 2008 1:53 PM EDT

Canada's parliamentary elections are coming up shortly, and the majority Conservative party is having a tough time maintaining its lead over the opposition Liberals.

How is the Liberal party making its gains? In part, by tying the prime minister to George W. Bush. Look familiar?

(Via Yglesias)

Paying the Piper

| Fri Oct. 10, 2008 1:36 PM EDT

PAYING THE PIPER....Matt Yglesias says, sure, people were using their homes as ATM machines during the housing bubble, but it's not as if our political leaders were raising any red flags about it at the time. In fact, just the opposite:

Meanwhile, the broad conservative movement spent a lot of time trying to shout down anyone who worried about rising inequality or stagnant wages by pointing out that the trends looked better if you only examined consumption. In other words, if you ignored the fact that people were maintaining consumption growth by piling on more debt, things looked great! And yet, now somehow things don't look so great....

Obviously, the mere fact that conservative politicians, hacks, and operatives were egging this trend on didn't force anyone to accumulate enormous debts. Plenty of people didn't do so. But the underlying ill here is economic policies that sought to substitute an asset price bubble and innovative credit products for real, broadly-based prosperity.

This deserves a much longer treatment, which I'm not going to attempt right now either. But someone ought to. We usually argue about rising income inequality in moral terms, but there's a practical side to it too: when all the economic growth a country produces goes to a very small class of rich people, stupid things happen. The rich can't possibly consume enough to spend all this money, so they start casting around for something, anything, to do with all the cash they have sloshing around. And since, in an ever more unequal economy that nonetheless preaches ever rising living standards, the poor need payday loans to keep up and the stagnating middle class needs HELOCs, that's where their money goes. It still gets spent, eventually, on things like cars and food and new furniture, because that's what middle class people mostly spend their money on, but instead of being spent directly by people who are earning it, it gets funneled downward to them via increased debt and financial legerdemain that extracts more and more money upward from poor to rich with each cycle.

That's not sustainable. Median income growth produces not just growth, but stable growth for everyone, the rich included. Top end growth, almost by definition, produces unstable, unsustainable growth. Modern economies are driven by consumer spending, and if you want consumer spending to increase consistently you have to increase consumer income. All the financial wizardry in the world will never change that.

Social justice aside, that's why the single most important financial statistic for any modern economy is real median income growth. If you have it, you're in pretty good shape no matter what else is going on. If you don't, you're a banana republic. Guess which one we've become?

A Friday Distraction From Finance Doom

| Fri Oct. 10, 2008 1:07 PM EDT

At The Atlantic:

Casanova's first orgasm, Hitler's famous mustache, Bob Hope's last jokes: for every thing, there is a season. Herewith a compilation of great moments in precocity, endurance, and procrastination, organized instructively by age.

You're welcome.

Old McCain Aides Regret New McCain

| Fri Oct. 10, 2008 1:02 PM EDT

John McCain has had a coterie of advisers that has worked with him, off and on, for his entire political career. John Weaver and Mike Murphy are two such men. Despite the fact that they are not working for McCain's current presidential campaign, they are devoted McCainiacs. And both have become disheartened with the direction the McCain campaign has taken these past few weeks.

Weaver, a man the Washington Post once called McCain's Karl Rove, is quoted in the Politico:

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Joe Sixpack

| Fri Oct. 10, 2008 12:38 PM EDT

JOE SIXPACK....David Brooks has a good column today:

Over the past few decades, the Republican Party has driven away people who live in cities, in highly educated regions and on the coasts. This expulsion has had many causes. But the big one is this: Republican political tacticians decided to mobilize their coalition with a form of social class warfare....What had been a disdain for liberal intellectuals slipped into a disdain for the educated class as a whole.

....[Sarah] Palin is smart, politically skilled, courageous and likable. Her convention and debate performances were impressive. But no American politician plays the class-warfare card as constantly as Palin. Nobody so relentlessly divides the world between the "normal Joe Sixpack American" and the coastal elite.

Sure, it would have been nice if Brooks had noticed this a little earlier. And it's not the hardest hitting column on the subject of culture war politics we've ever seen. Still, this stuff isn't easy to write about your own side. It's a pretty decent piece.

Fear-Mongering and Fox

| Fri Oct. 10, 2008 11:59 AM EDT

Various outlets are growing concerned with the anti-Obama anger that seems to have taken over McCain/Palin rallies of late. I'd like to point out that Fox News is doing far, far more to entice hatred and possibly violence than the McCain campaign is. If you take your cues from Fox News, you're likely to think America is under attack by a foreign terrorist agent who holds both a Islamic faith and a communist agenda. Further, you likely believe that this secret Stalinist Muslim will steal the election from god-fearing Americans through his connections to ACORN, the single sleaziest organization on the planet.

Yes, McCain and Palin have drifted into seriously shady territory by implying that Obama is an unamerican terrorist sympathizer. But Fox is way more explicit in its race-baiting and fear-mongering than the McCain campaign is.

As just a bit of evidence, see this Daily Show clip:

McCain's Foreign Policy Advisor and Ahmad Chalabi: How Close?

| Fri Oct. 10, 2008 11:50 AM EDT

Back in the fall of 2002, long before president Bush had told the public of his plans, the man who would become the John McCain campaign's top foreign policy advisor was tasked with a sensitive mission that had come from the White House: to set up a group to lobby for war with Iraq. The group that Randy Scheunemann subsequently set up and became president of, the Committee for the Liberation of Iraq, argued, as did Iraqi exile politician Ahmad Chalabi, that the problem with Saddam Hussein was not just his (alleged) weapons, but the nature of the regime: "We believe it is time to confront the clear and present danger posed by Saddam Hussein's regime by liberating the Iraqi people," Scheunemann said in a press release announcing the creation of the Committee on the Liberation of Iraq, which was celebrated by a party at Chalabi's Georgetown home, according to Chalabi's biographer Aram Roston.

So how close really were Scheunemann and Ahmad Chalabi? In this piece, I asked long-time Chalabi advisor Francis Brooke, among others:

Brooke says he met Scheunemann in 1996 when he and Chalabi were hitting Capitol Hill to try to drum up increased US government support for the Iraqi opposition. Brooke's pitch then was that putting pressure on Saddam Hussein was not just the right policy; it was also a vehicle for attacking Bill Clinton, then running for reelection. "I thought it was a good time to educate the Republican Congress…and give them the ammunition they needed to beat the president up." In Scheunemann and other hardliners on the Hill, Brooke says he found kindred spirits—a clique of Republicans deeply disillusioned with how George H.W. Bush had let both the Cold War and the first Iraq War end without meting out sufficient punishment to America's adversaries. "These people had a great sense of psychic loss that we had not finished the first Iraq War in the most comprehensive way. They hated George Bush the first."
Still, Scheunemann, who then worked for Senate Majority Leader Trent Lott, was initially skeptical. After he and Chalabi made their pitch, Brooke said, "Randy said, 'This is all fine but on the other hand, the CIA and other parts of the US government tell me that the Iraqi opposition is a feckless bunch of people, that can't do anything, have no support inside the country, and have probably been up to no good all over the place.'" Brooke says he encouraged Scheunemann to do his own research, and eventually convinced him.

Go read the whole piece.

Tough Times for Conservative Philanthropist

| Fri Oct. 10, 2008 11:31 AM EDT

After taking a hit of $4 billion in the recent financial turmoil, conservative philanthropist and Freedom's Watch-backer Sheldon Adelson is no longer the third wealthiest person in the United States, according to a revised Forbes' list. Bloomberg:

Las Vegas Sands Corp. Chief Executive Officer Sheldon Adelson's net worth declined by $4 billion between Aug. 29 and Oct. 1, the steepest drop among Americans who lost $1 billion or more during the credit crisis, according to Forbes magazine.
The magazine, in its Oct. 27 issue, recalculates the effect of September's financial news on the wealthiest Americans, those who make up its Forbes 400 list. That list was published on Sept. 17.
Berkshire Hathaway Inc. Chairman Warren Buffett overtook Microsoft Corp. co-founder Bill Gates as the richest American by posting an $8 billion gain to $58 billion during the period, the magazine said. Gates's net worth declined $1.5 billion to $55.5 billion during the 33-day period. He had been first for 15 straight years.

I wrote about the right's frustration with Adelson's tendency to take a hands-on role in projects he funded back in the spring. And Peter Stone profiled the casino mogul in the magazine.