Monday, September 26, 2011

The Wall Street Flamingo

Okay, the title is a little weird, but the subject is not for the birds.  It's just another way of saying that there is a risk associated with all investments, some greater than others.  Of course you knew that, but you may not have known much about the extreme form of gambling, passed off as investment, which brought on the current financial collapse.  Buggsy Siegal would have been jealous.

Buggsy only used a "Tommy Gun" to raise the capital he needed to open the Flamingo Hotel in Vegas. Today's criminal class on Wall Street comes at us armed with far worse than that.  To quote Warren Buffett, they are dealing in "financial weapons of mass destruction."

While it is true that many factors contributed to the worldwide financial crash, the market mobsters who brought it on would have us believe that there were far too many for us to ever understand, or for anyone to do anything about.  That is decidedly not true.  In the short run, most of the mobsters are simply wanting to stay a step ahead of  being tarred and feathered, jailed, or both.  Eventually, they all just want to be allowed to get back to business as usual.  Uhh, that is after they've robbed us stupid coming and going, first by way of public tab bail-outs, and then through wild fire private default and bankruptcy.

It is not an oversimplification to say that the proximate cause of the crash consisted of only two key elements operating simultaneously and in concert.  One is something called an Over The Counter (OTC) derivative.  This "investment" instrument is nothing more than a side-bet between two parties regarding the future performance of an underlying asset.  It can serve as a hedge in the same way a sports wagerer might protect or even beef-up a bet with a counter wager, as the point spread changes.  The OTC designation refers to the fact that it is a private deal between the respective parties and is not traded or recorded on any public exchange, a feature of significant consequence which will be apparent in a moment.  Worse, these derivatives are highly volatile and damn near radioactive owing to a high degree of leverage, which means they are uncollateralized.  The other destabilizing feature of the market which froze and crashed the whole world's financial system was the fact that the banks were permitted to sell 100% of the loans they were making.  And lots of these were "no doc (document) loans," which were worth less than the paper they were written on.  Nevertheless, they were bundled-up with all the rest to be passed off as AAA rated mortgage securities.  And they sold like air conditioners in Florida.

Here's what happened.  The banks wrote as many loans as they could push out the door, in order to get paid back their money, along with a tidy profit, real fast.  The faster they could repeat the process, the more the profit.  And they got pretty damn fast at it.  Meanwhile, the brokers and brokerage houses were busy making fast money as well.  Most of it in derivatives.  Because of the peculiar characteristics of OTC derivatives mentioned above, a tremendous amount of speculative profit was being earned and credited to balance sheets that didn't really exist.  In other words, because of "leverage" in a derivative contract, the actual collateral was tiny compared to the stated value of the deal.  Hence, at one point when things were really rolling, the actual amount of real money involved in these transactions was about 60 trillion dollars, but the notional (or artificial) amount was somewhere in the neighborhood of 652 trillion.  You can see the problem coming, can't you?  These side-bets often were "smart money" being laid against the likely performance of all those bad loans, which the banks were profiting from.  But only the private parties to the deal knew exactly what was really going on.

Long story made short, the "smart money" was right, but in the end just as stupid as it was smart.  The money chalked up to profit in many derivative deals didn't really exist, and so there was a lot of bad paper out there in addition to the mortgages that individual home buyers turned out to be unable to pay.  In essence, the world financial system took it on the chin for at least 60 trillion real dollars and about 600 trillion "notional" dollars.  Not a light blow, however you count it.  But wait, there's more.

First, the Republican right-wing insisted on and got a publicly funded bail-out of the worst financial criminals in history, and now they demand we cut, cut, cut, cut, cut any and all support for what remains of our shattered economic circumstances and prospects.  They even are lobbying ferociously to gut the most important aspects of the Dodd-Frank Act, which was passed in the aftermath of the collapse and would require banks to retain a percentage of the loans they write as part of their own reserves.  This provision would work to insure banks not write worthless paper and pass it off as a top grade asset.  The Act  would also end the secretive OTC type derivatives, by having them all trade on a public exchange.  This would expose inside operators who would profit by facilitating ill-advised trades, while betting against the outcome of the deal.

These are modest but desperately needed correctives to a truly dirty financial system.  But every single stinking one of the candidates for the Republican presidential nomination is pledged to the repeal of the Dodd-Frank Act.  Now, I am not crazy enough to suggest we should declare open season on Flamingos, but I sure as hell think all these birds belong in a cage.

No comments:

Post a Comment