DeRegulation Not Gone The Way of Regulation ?

February 27, 2012

I think there is a common misbelief that the CDS market has successfully in the case of Greece been adequately sanitized and sterilised to prevent contagion; or that the problems re bond markets particularly effecting derivatives and CDO (collateralized debt obligations) particularly synthetic CDO’s are easy to deal with and have been adequately addressed.

The problem is the drift or infection or cross contamination of CDS across markets in general in a domino effect that in the case of interbank lending, for example, increases anxiety especially in the world of investment banking.

Because of the growing market in derivatives, derivatives are the canary in the coalmine that signal alarm in times of economic trauma eg AIG.

There was a CDS collateral problem you correctly identified with AIG, but this AIG problem related to CDO’s about which there is little in the article you link to.

The problem with CDO’s is the doubt related to the underlying assets upon which CDO’s are based; another problem relates to the mark-to-market nature of CDO’s, how markets can suddenly collapse effecting CDO value as everyone runs to the door.

To understand how complex this market is, consider Synthetic CDO’s in the following dribble: cdos-demystified/ Regulatory_concerns_over_CDS

Efforts are being made to stem the tide of problems in the CDS markets.

” A clearinghouse acts as the buyer to every seller and seller to every buyer, reducing the risk of counterparty defaulting on a transaction. In the over-the-counter market, where credit- default swaps are currently traded, participants are exposed to each other in case of a default. A clearinghouse also provides one location for regulators to view traders’ positions and prices.”

To illustrate the importance of these instruments and perhaps a rush of propaganda to state the problem has been defused:

“During the current 2012 negotiations regarding the restructuring of Greek sovereign debt, one important issue is whether the restructuring will trigger CDS payments. ECB and IMF negotiators are trying to avoid these triggers as they may jeopardize the stability of major European banks who have been protection writers. ”

There is a useful thesis here: CDOmeltdown.pdf

OTC’s can be nasty, odious and toxic and to date little has been done to reform the financial services industry and prevent abuse that led to subprime problems in the US. There is to my mind no reason to not suspect that suspect collateral and assets due to the very nature of unregulated derivatives do not lie as instruments of financial destruction across the global financial system.

“…the advent of synthetic CDOs significantly altered the evolution of the CDO market. Rather than investing in cash bonds, synthetic CDOs were created from pools of credit-default swap contracts (CDS), essentially insurance contracts protecting against default of specific asset-backed securities. 15 The use of CDS could give the same payoff profile as cash bonds, but did not require the upfront funding of buying a cash bond. Furthermore, using CDS as opposed to cash bonds gave CDO managers the freedom to securitize any bond without the need to locate, purchase, or own it prior to…”

The arcane world of red codes, clearing houses for sovereign CDS eg in the following, is difficult to compute. C11170_att2.pdf

Greece and Italy have been victim to speculative CDS attack, also highlighted by Merkel, she has spoken against speculation in CDS exacerbating the meltdown in the EMU:

” The OTC derivative market is the largest market for derivatives, and is largely unregulated with respect to disclosure of information between the parties, since the OTC market is made up of banks and other highly sophisticated parties, such as hedge funds. Reporting of OTC amounts are difficult because trades can occur in private, without activity being visible on any exchange. …” OTC_and_exchange-traded

A key insertion in the 2000 commodities futures modernisation Act was that which exempted over the counter derivatives like credit default swaps from regulation by commodities futures regulation commission. This has proved to have been a disastrous mistake whose consequences we still face.

There is huge resistance in the financial services and banking sector to any regulation interfering with opportunity for profit.

Non disclosure, poor reporting, lack of transparency, regulation, unaccountability, unreliability eg see Rating Agencies critique in Harvard Dunlop thesis above, mean nothing is what it seems; what is there, for sure, is one big problem the world has to face as it did under Roosevelt when he brought into effect the 1933 Banking Act Glass Steagall.

De Regulation in the Gramm Leach Blilley act in 1999 dismantled safeguards that contributed to the mess in global Finance of today. The losses in OTC subprime handed onto European banks have been unaccounted for and hidden away. The market in toxic CDS speculation is still out there.

A couple of intriguing takes as part of an ongoing interest on the above I have is to do with the very nature meltdown itself in relation to derivatives and OTC. These financial instruments provide a different component to other defaults through history as they are a recent phenomenom. One aspect of this is what I’d term gravity economics meaning forces in the financial industry cause chaos rather than purely physical, economic forces such as a drop in manufacturing output. This creates a synthetic, unreal economy much like the euro currency as it undergoes a switchover to manufactured illusory economics making you wonder how long the center can hold.

The magic world of LTRO has for the moment defused the derivative instruments of mass destruction across Europe. Interbank lending which in a rerun of 2008 was looking for its european AIG and drying up lending has again begun to move. But the huge takeUp of LTRO by banks throughout Europe will signal a weakness in the euro when this funding dries up. Another weakness will become evident when this funding is used as a fund to further further speculation in financial markets rather than on release of credit into economies where austerity and deflation mean
investment is at risk.

The gravitational pull of resources, financial support to banks and financial institutions, away from the ‘common market’ of credit and business investment and employment, will reveal the euro as the financial black hole the euro currency has become.@DOCM 4:44

Re “This guy knows what he is doing.”

You would be talking about an unelected technocrat there, on a growing list of unelected technocrats across Europe sent in to replace democratically elected governments.

Plus, the guy hasn’t a clue as to what he’s doing. From your link:

“Draghi: ….. But for the interbank markets to function we need a return of full confidence in the counterparty. We can address only the liquidity side of the problem. But then growth prospects have to pick up. After a very weak fourth quarter, economic activity in the euro area is progressively stabilizing at low levels.

Oh, no it aint, its being pulled into a black hole. LTRO can only have a short term stimulus function and when LTRO runs out, eventually the peripherals have to go to market !

Draghi is sucking economies dry to pay for the losses of European banks; failure is guaranteed.

Nigel Farage outlines the democratic deficit here on the path of the euro and the EMU.

Austerity is not working. The EMU is following disastrous policies. Disparities within EMU and between EMU countries are growing. Ireland’s economic policy based on no bank should fail is a political and economic disaster; yet, we’re Draghi’s poster boy, lol.

You can see and hear the air going out of the tyres of the Irish economy; but the cheerleaders who got it all wrong before still lead the blind frenzy of support for the euro, the ‘Compact’, the creation of an Irish vassal state.



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