Saturday, March 07, 2009

Casino Capitalism

This phrase was originally used to describe gambling on the stockmarket but takes on a new and very literal meaning with some of these 'credit default swaps' as described on Moon of Alabama.

Some of these CDS dont have an underlying asset and thus have no connection with the real economy, anymore than gambling at a casino has any connection with real work and value creation (except that it can lead the the ruin of jobs, careers, families and lives - or in the case of CDS, the ruin of the financial sector and the real economy along with it.)

'Credit default swaps' or 'derivatives' are simply a bet or a gamble. And you can bet on anything you like, eg, I'll pay you a dollar now, and if it rains 5mm or more between 4 and 5pm tomorrow, you pay me $100. If you say ok or negotiate a new agreed price, we have a contract.

They can have a useful insurance or hedging purpose, eg a premium paid in case my house gets burned down by a bushfire. But you dont have to own the asset hedged or insured. So what if 20 people who dont own my house also make a bet? There will be a very big payout in total if there is a fire. And they'll have an interest in fire, wont they? Perhaps go for a country drive, carelessly dispose of a cigarette or two, or have a barbecue during a total fire ban?

b:

We are now several month into this and some people still do not 'get it'. I'll try to give a slow but simple answer.

AIG signed insurances against bond defaults in form of Credit Default Swaps in a notional value of more than $450 billion. Some insured bonds defaulted and AIG paid out for these insurances. As it did not have the money to do so, the Bush and Obama administrations decided that the taxpayer should pay.

Up to November $150 billion were given to AIG and on Monday another $30 billion. But AIG still has $300 billion of CDS exposure and will likely make more high losses on that.

When Lehman Brothers went bankrupt -a 'credit event' - people who had insured their holdings of Lehman bonds asked their insurers to pay for their losses. Such a credit event was also triggered when Fannie and Freddie were taken into receivership.

AIG which had written insurances for the debt of those entities faced a big payout and the taxpayer had to cough up the money.

What is the moral justification for this [the taxpayer funded bailout when AIG couldnt pay]?

It was morally okay because the people and institutions insured by AIG were justified to expected the payout as their 'assets', i.e. Lehman bonds had really lost value. They had hedged a real risk like you do when you pay for fire insurance on your house. Insured you are right to expect a payout when your house burns down.

But their is another group of people and institution who got money from the taxpayer through AIG.

This second group never ever owned a Lehman or Freddie or Fannie bond. But they also had bought insurance from AIG against the default of these bonds. These people never invested in 'assets'. They payed a small monthly fee to AIG for a lottery slip and when Lehman failed they had a huge win. They went to AIG, pointed to the 'credit event' and demanded the payout. AIG obliged and the taxpayer gave the money.

Some may ask:

"While it is easy to understand the moral case for bailing out real bondholders that insured against default, what is the moral case for paying out to people who made pure bets? These people never owned a fire insured house at all. Why do they get taxpayer money when my house burns down?"

"If they had be given back the money they payed for the lottery slips, i.e. the small monthly insurance premium, that would probably be understandable, but why do the taxpayers pay out the lottery win when the private lottery organizer is bankrupt?"

Simple answer to those simple questions: Because the administration says so.

There are big numbers behind this.

Of a total of $600 billion real [Lehman Bros] bonds owned by lots of people only $150 billion were credit insured. When Lehman bonds defaulted, owners of $450 billion of its debt lost all their money.

Owners of $150 billion of that debt did not lose any money. They were payed out the insurance they had contracted and the insurers (backed by the taxpayers) carried the loss.

The total economic loss was $600 billion, $450 billion by bond owners and $150 billion by insurances. $600 million left the monetary system - poof.

But on top of that there were written insurances with a notional value of $250-$350 billion that insured people who never had the insured asset but were only playing the lottery. These people demanded money from the insurer and indeed they were payed.

This part of the 'event' did not have a real economic loss. No money left the system.

Instead money was payed from the insurer toward the insurance holder, the buyers of CDS'. As the insurer was backed by the taxpayer every one and his/her children now pays for the enormous lottery win for a few people, who had risked very little. This is money that is moving from the bottom of the society to the top in unprecedented amounts.

What is the moral justification for this?

There is none.

Who are those people who are getting huge payouts from the taxpayer for risking little?

AIG still has $300 billion in CDS exposure. If the Lehman quote of 1/3 real insurance and 2/3 lottery bets is the same with those CDS, which is likely, than a few rich people are waiting for a $200 billion free payout from the taxpayer.

Geithner does not want you or anyone else to know who profits from this scheme without having risked any real money. His rich friends do not want you to know that they are racking in billions of dollars in lottery wins that cost them little money and that the taxpayers are paying out because the private lottery operator went bust. They will pay off Geithner when his job is done and he finally gets kicked out.

People in the known and within the business are not likely to explain this... This is money moving from many persons at the bottom to very few at the top.

Geithner and his masters fear that if the public knew or understood that, they would probably only get the costs of the lottery slip disbursed - if at all.

They want the big one. AIG has still $300 billion at risk that you and your kids will have to pay for.

They want it. And they are getting it. And there is nothing you can do about that.


In comments b spells it out even more brutally:

The whole thing is not about what's cheaper but how do [the rich elite] make the most money out of it.

The Lehman bust made, as explained in my post above, some folks about 200-300bn in cash without having invested much more than a million or two. Did anyone of those people thought of how to make the bust "cheaper" for them - sure they did. If they could have gotten $200bn for a $1 investment they would have taken it.

I am devastate that otherwise intelligent people like you do not get this yet.

IT WAS A SCAM. Lehman was made to go bust because some people made A WHOLE LOT OF MONEY from the Lehman bust - not millions - hundreds of billons!

They "insured" themselves against the bust, then arranged it and the taxpayers paid the "insured" sum. What is so hard to understand with that?

From the taxpayer view there was never ANY need to pay anything at all. Those really insured against losses of assets they owned might have a moral case - might!!!

Those "insured" and never owned the "insured" asset never had a justifiable case to get anything from their bet.

The later make up for two thirds of what the taxpayer is paying out.

Why are the taxpayers, we and our children, paying for these?

---
"Saving Lehman" was never an option. The setup was clear for anyone who could read the market.

The question was and is how to save the taxpayer from taking the losses others take as profits.


If this is true, and I do feel some scepticism that it is as baldly manipulated as all that, then this is simply epic financial and political corruption.

b's solution is to Declare all Credit Default Swaps Null and Void. In comments to this post b is able to point out that a number of informed commentators are also calling for a similar solution to the derivatives nightmare which threatens to bring down the global financial system.

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