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Yet More on the CDS Market

| Tue Nov. 11, 2008 6:09 PM EST

YET MORE ON THE CDS MARKET....I've been meaning to link to yet another Felix Salmon post about credit default swaps, since I know what a fascinating subject they are for everyone, but one thing led to another and I haven't done it yet. Basically, "one thing and another" means that I spent several hours yesterday trying to understand the whole CDS issue better, but I failed miserably. So instead of pretending otherwise, I'm just going to link. Salmon conducted an IM conversation with Robert Waldmann about the CDS market, and part of it went like this:

Felix Salmon: So, have I brought you around to the idea that CDS really aren't a major cause of the current crisis?
As you know, Kevin Drum calls me "disturbingly persuasive"

Robert Waldmann: Ah well that is ambitious. You have convinced me that there is a perfectly legitimate reason which can explain why face value is so huge. As to the cause of the crisis, I remain confused. Stupid CDS tricks could have done it. So could stupid CDO tricks and what all.

Felix Salmon: I will concede that there were indeed stupid CDS tricks

Robert Waldmann: I mean the situtation is I don't understand the new financial instruments and it sure looks like the trader types didn't understand them as well as they thought.

Felix Salmon: But the stupidity was in understanding credit risk, not in understanding CDS.

Well....sure, but this seems like a bit of a dodge. After all, pretty much all financial bubbles are based on mispricing risk in some way or another. It seems like we need to dig a little deeper and try to figure out if there were specific aspects of the way modern financial markets are regulated that encouraged even more risk mispricing than usual.

The question, then, isn't whether credit default swaps are useful instruments. They are. The question is whether there's something about the way they're managed in real life that makes them potentially more dangerous than, say, stocks or pork belly futures. And if so, what can we do to limit "stupid CDS tricks"? Here's one possibility:

Robert Waldmann: OK a reform proposal. CDS must come with collateral even if you find a sucker willing to buy one without collateral (this is a regulatory restriction).

Felix Salmon: Yes yes yes.
That's why I'm so astonished Berkshire Hathaway is STILL writing CDS without collateral requirements.
But a move to an exchange would have the same effect.

If I understand this right, the benefit of requiring collateral is twofold. First, it keeps the CDS market from going too crazy, since CDS sellers can only sell protection if they have collateral to back their positions. Second, it reduces counterparty risk, since even if the CDS seller goes bust there's collateral that's been posted to make good on the swap. The big problem with AIG, for example, which has been the most spectacular example of a financial firm losing its shirt due to CDS exposure, is that they were writing CDS willy nilly without having to post collateral (thanks to their AAA rating). When their rating started going south, and they had to post collateral to make up for it, the company went down the toilet. If they'd had to post collateral in the first place, that wouldn't have happened.

So I guess that's a good start: make CDS exchange traded and insist on collateral posting requirements for all writers of CDS.

But what I still don't have a handle on is the scale of the losses in the CDS market. Clearly, AIG and the monoline insurers lost a ton of money. But Salmon suggests that the broader banking industry didn't. Partly this is because only a small segment of the financial industry were net sellers of CDS protection:

Felix Salmon: There's AIG, there's the monolines, and there's the synthetic CDOs bought by institutional investors.
Given the zero-sum nature of any derivatives market, that means that everybody else, on net, was a buyer of credit protection.

So far, this seems to be right: net losses in the broader financial industry on CDS trades seem to be pretty modest. So far. Unfortunately, though, that still leaves the CDOs, which we don't know much about yet, and it also leaves everyone else, who might be choosing not to settle CDS contracts yet that have big losses associated with them. I have a feeling we might need to wait a while longer to know for sure if the broader CDS market is as benign as Salmon thinks.

But it might be. Obviously it's cheating a bit to single out the particular areas where CDS sales caused big problems and then say, "well, aside from those areas everything was fine" — after all, it's always the case in every industry that aside from the problems there are no problems — but still, if it turned out that the big abuses came from noncollateralized CDS sales and synthetic CDOs, that would make me happy. After all, I'm already on record as thinking that CDOs are the devil's spawn. Anything that heaps more abuse in their direction is fine with me.

Bottom line: I'm still confused. For one thing, an awful lot of smart people seem to disagree with Salmon. I'd like to see some of them engage with his arguments. For another, the CDS market is so opaque that we still don't really know how much exposure is out there and who has it. At the very least, that seems unacceptable. And finally, even if there were only three segments of the financial market that were net sellers of CDS protection, just how much is it going to cost us to bail them out?

One way or another, the losses in the financial markets appear to be far wider than just subprime loans. After all, the size of subprime losses in the U.S. seems to be about half a trillion dollars, but in the past year banks have raised something like $300-400 billion in new private capital and another $200 billion so far in government capital. So that means their overall capitalization levels should be OK. But apparently that's not the case. So where are all the rest of the losses coming from? CDS? CDOs? Currency forwards? What? Does anybody actually know? And if not, what will it take to find out?

POSTSCRIPT: And one more thing. It's really annoying that the plural of CDS is CDS. "CDS market" is fine, and CDS when referring to an individual swap is fine, but why not CDSes when referring to multiple swaps? As in, "Sellers of CDSes should be required to post adequate collateral for each CDS they sell"? What does Wall Street have against plural acronyms?

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Responding to Obama's Win, Michael (Son of) Reagan Says, Go After Dems on Sex

| Tue Nov. 11, 2008 6:08 PM EST

The Obama win is driving some conservatives crazy. On Tuesday, Michael Reagan, talk show host and son of Ronald, sent out an email announcing a new outfit called Reagan Action, which among other things, will seek to "expose" the sexual "corruption" of leading Democrats. And he was characteristically over the top:

Dear Conservative Friend,
My father wasn't afraid to call evil what it was -- and neither am I. He defeated the "Evil Empire" called the Soviet Union -- but now we face a new "Evil Empire." It's called Socialism, and it's taken over our once-free nation through the victories of Obama, Pelosi and Reid.
We MUST do this. Really -- what choice do we have, except to fight back and WIN? As my father, President Ronald Reagan, once said, "We must act today in order to preserve tomorrow."
It's official: America has its first truly Socialist president... and it's the Republican Party's fault.
No, scratch that -- it's the so-called "leaders" of the GOP who are at fault for this humiliating defeat -- and I say it's time to name names and make heads roll in our party. Because, my fellow conservatives, we have been BETRAYED by the very people who promised that, if we would just elect them, they would get into office and vote OUR conservative values.
THEY LIED... THE GOP DIED.

Michael Reagan, who sure likes bold face and capital letters, notes that he is angry with President Bush and

the so-called "leaders" of our party, who promised us that if we'd just vote for who they put up for election, we'd finally get what we wanted: smaller government, lower taxes, dramatically lower spending, pro-life laws, pro-marriage constitutional amendments, pro-American economics... well, YOU AND I put them in power, and they gave us nothing but BIG GOVERNMENT, BIG DEFICITS, and LIBERAL COMPROMISES.

So what's he going to do about it? Reagan is declaring "the NEW Reagan Revolution to bring Conservatism BACK!" And how will contributing to Reagan Action--yes, this was a solicitation letter--bring back conservatism? This new group, Reagan promises, will

EXPOSE LIBERAL CORRUPTION-- With the Democrats back in power in both Congress and the White House, you KNOW that they'll be falling right back into their habits of taking lobbyists' money under the table, trading votes for campaign contributions, spying on and sabotaging Republican legislative plans, covering up their leaders' sexual "flings," and spending taxpayer money on personal expenses like never before. But this time, YOU AND I will be there every step of the way, making sure that no stone is left unturned, every dark corner is filled with light, and every illegal act is paid for with censure, impeachment, recalls, investigations, and jail time for every criminal we expose in Washington, D.C.

And Reagan will also be directing "Reagan Activists to "fill the news media with letters to the editor, guest editorials, and news articles detailing the socialistic and corrupt policies of the new liberal regime."

This is some effort he has planned--mounting an army of Reagan-loving volunteers to go up against the "evil" Obama administration and take the country back from the socialists. And Reagan is even willing to probe the sexual "flings" of Democrats.

Reality check: is the United States now a socialist state about to be headed by a socialist leader? (Let's leave aside the Wall Street bailout.) There are two explanations for Reagan's letter. (A) He's become totally unhinged by the Obama victory, and (B), he's crassly trying to squeeze whatever cash he can out of conservative donors by exploiting their ideological paranoia. Maybe the correct answer is all of the above.

How One Vet Spent Her First Veterans' Day After "The World Changed"

| Tue Nov. 11, 2008 5:31 PM EST

First, I spent it wishing to (all your) gods that my kids were in school. Groundhog Day! Let it be Groundhog Day, a Monday with them in school for all eternity! Is that so much to ask?

Help me Jesus/Vishnu/Yahweh/Buddha/Satan/the Goddess etc.—they were just home for the fricking weekend. One day of freedom and they're my responsibility again? Why am I so heavily taxed? On top of it all, it is cold and rainy here in the tundra we live in, so no ignoring them while they tumble headfirst off unsafe playground equipment, swearing that the more they bleed the tougher they are. Damn.

In desperation, after hours of them trying to dismember each other, and me them, I took them to the home of the anti-Christ and prayed to the god/goddess of the playroom that my son wouldn't headbutt more than three kids per minute and that my daughter would release her death grip on our invisible umbilical cord and let me read in peace for three minutes at a time. In a perfect world, those three minutes would overlap with my son's warfare lulls and visits from irate parents, clutching their wounded progeny.

No such luck.

What was I trying, in vain, to read? Guns, Germs, and Steel:

Explaining what William McNeill called The Rise of the West has become the central problem in the study of global history. In Guns, Germs, and Steel Jared Diamond presents the biologist's answer: Geography, demography, and ecological happenstance. Diamond evenhandedly reviews human history on every continent since the Ice Age at a rate that emphasizes only the broadest movements of peoples and ideas. Yet his survey is binocular: One eye has the rather distant vision of the evolutionary biologist, while the other eye—and his heart—belongs to the people of New Guinea, where he has done field work for more than 30 years.

Guess what he thinks explains Europe's domination of the planet? A) Aryan superiority. B) Nothing but real estate and good luck. C) God's will. D) Yo mama.

What else could follow such a paradigm-shifting book but the pinko A People's History of the United States. To quote Amazon again, this book:

...turns traditional textbook history on its head. Howard Zinn infuses the often-submerged voices of blacks, women, American Indians, war resisters, and poor laborers of all nationalities into this thorough narrative that spans American history from Christopher Columbus's arrival to an afterword on the Clinton presidency.

Addressing his trademark reversals of perspective, Zinn—a teacher, historian, and social activist for more than 20 years—explains, "My point is not that we must, in telling history, accuse, judge, condemn Columbus in absentia. It is too late for that; it would be a useless scholarly exercise in morality. But the easy acceptance of atrocities as a deplorable but necessary price to pay for progress (Hiroshima and Vietnam, to save Western civilization; Kronstadt and Hungary, to save socialism; nuclear proliferation, to save us all)—that is still with us."

Let's just say it's a tad subversive and more than met my "blame America first" quotient for the day.

Second, I took them to a toy store.

I know, I know.

But I was hoping that the mounds of useless, expensive things ALL OF WHICH THEY MUST HAVE OR DIE, on top of their vacation-induced hysteria, would render them unconscious so I could cart them back home, comatose, and chuck them abed. That, or that some childless a-hole would call CPS while I bellowed bloody murder at them and we'd all be put out of my misery.

Again, no such luck.

As we pulled into the toy store parking lot, my freely chosen Little Big Horn, Lee Greenwood's "I'm Proud to be an American" played, reminding me, with its fulsome intro, that it was indeed Veterans' Day and not just a day designed to drive me insane. I did what I always have to do when I hear it: Pull over lest the chills running through me made me an unsafe driver. What can I say? That lowest-common-denominator, knee-jerk, ugly American song 'unmans' me every goddamn time. Does it reduce me, every time, to a quivering mass of patriotic jelly simply because it appeared when I was enlisted? (1980-1985. Commissioned USAF officer 1985-1992.) Or is it because it just pushes so many simplistic American buttons? I'll never know.

All I know for sure? I'm an American. How do I know that? Because I thrill to criticism of my country that is so dead-on it makes me want to cry in the frustration of making it right.

Obama Announces Transition Ethics Rules--And Keeps on Fundraising

| Tue Nov. 11, 2008 4:02 PM EST

The Obama gang can be pretty good when it comes to managing the message. Today, John Podesta, the chief of the Obama transition, announced the ethics rules for the transition. Here they are:

* Federal Lobbyists cannot contribute financially to the transition.

* Federal lobbyists are prohibited from any lobbying during their work with the transition.

* If someone has lobbied in the last 12 months, they are prohibited from working in the fields of policy on which they lobbied.

* If someone becomes a lobbyist after working on the transition, they are prohibited from lobbying the Administration for 12 months on matters on which they worked.

* A gift ban that is aggressive in reducing the influence of special interests.

As he talked to reporters about these rules, the transition team sent out an email to reporters listing these prohibitions. Included in the email were positive reviews of the rules from two veteran Washington experts on government: Thomas Mann of the Brookings Institution and Norman Ornstein of the American Enterprise Institute. They are two go-to sources for Washington reporters on government and reform issues. And here--for reporters' convenience--were we-love-this quotes from the pair.

Mann noted:

The ethical guidelines released today for the Obama transition are tough and unequivocal. They will prevent some honorable people with rich experience from serving in the transition. That is a real cost but it is more than balanced by the strong signal sent by the President-elect. He aspires to attract to government able individuals whose highest priority is to serve the public interest. This is a very constructive step in that direction.

Ornstein said:

Restoring trust in government is a prerequisite to enacting good policy and the tough choices the country needs. This ethics policy for the transition is a far-reaching, bold and constructive step to do just that. The policy may exclude some good people with deep experience in their fields, but it will also exclude those who see government service as a springboard to financial success, or who are more intent on pleasing future potential employers or clients than making tough choices in the public interest. As much as anything, this ethics policy is a statement about the tone and tenor of the Obama administration. It is a good sign.

There--I did just what the Obama camp wants reporters to do: make use of these served-up-on-a-silver-platter quotes.

But there is a question: why does the transition accept any contributions at all? Podesta noted that the Obama transition will cost $12 million, but that the government will only pick up $5 million of this tab. Consequently, President-elect Barack Obama and his supporters will raise another $7 million. According to the new rules, contributions from federal lobbyists, corporations, and political action committees will not be accepted. Individuals cannot give more than $5000. And all donations will be disclosed.

Yet when the top priority for Obama and his aides is preparing to govern, why should any time be spent on raising money for the transition? Given that the nation is spending trillions of dollars to rescue the financial industry, it shouldn't be too hard to fund fully the transition effort. Can't Congress just appropriate another $7 million--which is chump change these days--and let Obama get on with the show?

Word of the Year: Hypermiling

| Tue Nov. 11, 2008 3:58 PM EST

The New Oxford American Dictionary has announced its word of the year: hypermiling. Hypermiling, of course, is maximizing your car's mileage by any means necessary, from simple solutions like driving barefoot (to lighten your lead foot) to putting MPG before mortality and tailgating big rigs (to minimize drag). And when you look up hypermiling in the dictionary, the guy whose picture should be there is Wayne Gerdes, the mileage master who coined the term and whom MJ entertainingly profiled nearly two years ago—way before the lexicographers caught on. And way before the Alliance of Automobile Manufacturers discovered hypermiling and tried to rebrand it as "EcoDriving." Ugh. Hopefully the Oxford word mavens will scrape the bottom of this year's short list (staycation, tweet, hockey mom) before they immortalize that term.

EPA Whistleblower Charges Political Interference in Shutdown of BP Investigation

| Tue Nov. 11, 2008 3:05 PM EST

The environmental watchdog group Public Employees for Environmental Responsibility (PEER) is pushing for an investigation into whether the Bush Justice Department improperly shut down an investigation into a massive BP oil spill in Alaska. The allegations of potential political interference were lodged recently by EPA whistleblower Scott West, the former special agent in charge of the investigation, who retired from the agency in early November after 19 years of service. On West's behalf, PEER filed a complaint on Monday requesting an investigation by the Justice Department's Inspector General.

West's allegations stem from a 2006 spill from a BP pipeline that leaked a quarter-million gallons of oil onto the Alaskan tundra, the largest in the history of Alaska's North Slope. The company ignored workers' warnings that maintenance was needed prior to the spill. An investigation by federal and state authorities ensued, but was cut short in October 2007 when the Justice Department announced it had reached a settlement with BP, in which the company was given a misdemeanor charge and fined $20 million. According to PEER's compliant, this was a slap on the wrist compared with the penalties the oil giant should have received. "The fines proposed by Justice (to which BP immediately agreed) were only a fraction of what was legally required under the Alternative Fines Act. EPA had calculated the appropriate fine levels as several times what Justice offered BP—ranging from $58 million to $672 million." The settlement also ensured that BP executives would not face potential criminal liability, according to the PEER complaint.

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That $700 Billion Wall Street Bailout May Be Closer to $3 Trillion

| Tue Nov. 11, 2008 2:50 PM EST

How much will the Wall Street bailout cost? Remember that the widely-used number was $700 billion. Well, it may be over three times that amount. Bailoutsleuth.com reports that the actual (and perhaps rising) price tag now stands at over $2 trillion:

Adding together the $170 billion that the Treasury Department has currently agreed to provide banks in additional capital, the $150 billion that the Treasury Department and the Federal Reserve are providing to AIG and the $2 trillion that the Federal Reserve has provided banks in emergency loans brings the total assistance to $2.32 trillion.
If the estimated savings from the new tax breaks are included, the assistance would climb to $2.46 trillion. That total does not include other measures not focused directly on banks, such as Treasury Department's $200 billion in support for Fannie Mae and Freddie Mac, and the Federal Housing Administration's $300 billion HOPE for Homeowners program.

Add all of that together and you reach almost $3 trillion. (How many solar panels can you buy for that?) Remember that Bill Clinton came into office and he and his aides encountered deficits much bigger than expected. What's going to happen when Obama moves into the White House and has to contend with the real cost of the so-called rescue? (Yes, the Treasury is supposed to get some of this money back--eventually.) By the way, to provide some context, the current (and falling) GDP of the United States is $14.4 trillion. The total bailout tab is over one-third of the nation's entire output of goods and services.

Netbooks

| Tue Nov. 11, 2008 2:49 PM EST

NETBOOKS....As part of my mission to stay hopelessly behind the curve in technology matters, I just yesterday discovered the existence of a new class of notebook computers called netbooks. I guess they've been around for nearly a year, but my local Micro Center didn't carry any the last time I was there in August. Yesterday, though, they had half a dozen different models, all of them small enough to toss in a purse or tote without thinking twice, but with screens large enough (barely) to get real work done.

As it happens, I've always wanted something in exactly this form factor, so I almost bought one on the spot. But I didn't. After all, I just bought a Mac notebook on impulse a few months ago. And it's not like I compute mobile-ly very often anyway.

Still, they're pretty damn cute. And cheap. And I think I want one. So consider this an open thread. Should I buy one? What kind? Anyone have any personal experiences to share?

When Will We See a Blue Texas? Hispanics Will Decide

| Tue Nov. 11, 2008 2:29 PM EST

immigration_march.jpg

Many Democrats believe it is simply a matter of time until George W. Bush's home state goes from red to purple to blue.

Cuauhtemoc "Temo" Figueroa, Obama's top Latino outreach official, said [Texas] could be taken seriously as a presidential battleground if Democrats could win statewide races there in 2010. "I don't know if it's four years or eight years off, but down the road, Texas will be a presidential battleground," Figueroa said.

The reason is demographics. Across the Southwest, Latino voters are increasingly powerful. In Colorado, their share of the vote went from 8% in 2004 to 13% in 2008. Nevada, 10% to 15%. New Mexico, 32% to 41%. Every 30 seconds, a Latino is added to the American population, the fastest rate of any minority group. By 2050, Hispanics will represent 29 percent of the American population.

In 2008, Latinos voted 67-31 for Barack Obama.

Texas is already 35 percent Hispanic.

You can see where this is going.

Space!

| Tue Nov. 11, 2008 2:14 PM EST

SPACE!....Ross Douthat suggests that any conservatives foolish enough to support Newt Gingrich as chair of the RNC ought to reread the list of fabulous new ideas for the Republican Party that he published in Human Events last May. I don't have a dog in this fight, but I went back and refreshed my memory anyway. Here's one of Newt's suggestions for GOP revival:

Implement a space-based, GPS-style air traffic control system. The problems of the Federal Aviation Administration are symptoms of a union-dominated bureaucracy resisting change. If we implemented a space-based GPS-style air traffic system we would get 40% more air travel with one-half the bureaucrats. The union has stopped 200,000,000 passengers from enjoying more reliable air travel to protect 7,000 obsolete jobs. This real change would allow the millions of frustrated travelers to have champions in congress trying to help them get places better, safer, faster.

Now, Newt loves anything space-based, and he loves to bash unions too, so this is right up his alley. But what's the deal with this space-based air traffic control system, anyway?

Well, it turns out that it's been on the drawing board for a while. The underlying technology is called ADS-B and has apparently worked well in tests in Alaska and other countries. Last year the FAA awarded a contract for part of a GPS-based system to ITT, but not much has been done since then. The entire project is known as NextGen, and according to this AP dispatch from last month, the real opposition to it comes not from the unions, which are skeptical but apparently not dead set against it, but from the airlines themselves, which don't want to bear the cost of upgrading their planes.

I guess this might be more than you wanted to know about this, but hey — I was curious. It was one of Newt's Top Nine ideas, after all. In the end, though, it turns out that the story is fairly prosaic: a GPS-based air-traffic control system might be a very fine thing that would save fuel and allow more air traffic, but it would cost a lot of money, be extremely complex to implement, has some technical issues to overcome, and faces some modest opposition from entrenched interest groups, including both airlines and the air traffic controllers union. In other words, just your standard gigantic federal technology project.

And, perhaps, just the thing to throw into a trillion dollar stimulus bill. Who knows? But part of the rebirth of the Republican Party. I'm thinking probably not.

UPDATE: By coincidence, the Wall Street Journal has a story about this exact subject today. No mention of union opposition at all. You can read it here if you want the latest.