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The next accident

Robert Peston | 08:02 UK time, Tuesday, 23 September 2008

New York State wants to bring law and order to the last wild frontier of global finance, the credit default swaps market.

Wall St, New YorkIt's yet another attempt to close a stable door after a galloping herd has not only bolted but has already crossed the state line.

Credit default swaps are - in essence - contracts to insure debt, especially debt in the form of bonds, against the risk of default.

They began life as a sensible initiative by banks to reduce the risks they were running in lending to companies. Banks used them to lay off the risks of default to specialist insurers and other financial firms.

But as with all good things in global finance, especially the unregulated things, the market then binged on these credit derivatives.

Their use exploded with the boom in collateralised debt obligations made out of subprime loans, because the vendors of these toxic securities took out credit-default-swap contracts to secure cherished AAA ratings - or to turn poo into gold (most of it's since turned back into poo, occasioning great pain for the banking system).

And, in the corporate markets, credit default swaps became an instrument of pure speculation. If hedge funds wanted to speculate on the fortune of a big business, they would often buy and sell these credit derivatives as an alternative to shares.


Well this was - for a while at least - a huge, liquid and unregulated market, a true Wild West, almost free from the nosey attention of sheriffs and regulators who take an annoying interest in what goes on in stock markets.

Anyway the notional value of extant credit derivatives, in terms of the underlying value of the debt insured, was something over $60,000bn at the end of 2007, or more than five times the value of the entire US economy.

However many analysts say the better measure of the size of market is the $2,000bn fair value of outstanding contracts - because that's an attempt to assess potential losses and gains.

Both numbers are big, even if one of those falls into the too-big-to-fathom category.

Perhaps the more important point is that over just the past three years, the size of the market has increased by 15 times.

Which simply tells you that a lot of stupid contracts have been written at the wrong price, since in the two years to August last year most bankers and financial firms were pricing financial risk as though it were a myth from a bygone age.

Anyway it was AIG's exposure to credit derivative contracts that did it in just a few days ago: one of its subsidiaries had to find a colossal amount of cash in a hurry under its credit derivative contracts, because of a contractual requirement to post collateral after its credit-worthiness was marked down by rating agencies.

All of which is to explain why the New York Governor David Paterson issued a statement yesterday saying that his state will regard as insurance, in a formal sense, those contracts sold to investors who own bonds they want to protect from default.

It will therefore require proof from the entities selling the insurance that they have the resources to actually pay possible claims under the relevant contracts.


I'd laugh if I didn't want to cry.

Paterson is implying that many of the writers of credit default swaps don't have the means to make good on their liabilities, that they were taking a punt, hoping to make easy money from insurance they thought would never be claimed on.

It's one of those "emperor's new clothes moments" that leaves me almost lost for words (almost).

To state the bloomin' obvious (as is my wont), we should be worried about this because we are entering a pronounced economic slowdown in which many companies will have difficulties servicing their debt.

And so we will start to see a raft of claims under credit derivative contracts, to add to those already triggered by the collapses of Lehman, Fannie and Freddie.

If the insurers can't pay, well that could lead to losses and pain all over the place, for hedge funds, for pension funds and for banks - which may still be living in the fools' paradise of thinking that their balance sheets are stronger than they are, thanks to all that lovely insurance they've taken out.

PS. Yesterday was a truly horrific day for the US Treasury.

First it learned that investors aren't in love with its bank bailout plan, because of the way that all those liabilities damage the credit-worthiness of the US.

Second, the opposition of influential legislators to the $1.1 trillion bailout has demonstrated in the reaction of markets that no bailout would be worse for the financial system than an unaffordable bailout.

It's going to be another hairy day.


Page 1 of 2

  • Comment number 1.

    Dear Robert,
    I have to disagree vermently about this being an accident, This was no accident it was plotted, instigated, and applied, by the Bankers to sort the men out from the boys, and to make billions at the expense of the feneral public,

  • Comment number 2.

    Hi Robert
    Another thought-provoking blog. It is yet further demonstration that the spivs had NO concept of risk, or even a concept of what is was they were doing anyway. On another level, no real difference to the thousands of idiots who over-borrowed to buy over-valued property as "property investors", both in their own homes (a great investment, we cannot loose etc) or as B-T-L (ditto). In all cases, there will be some rich pickings for somebody when the carcasses have finally stopped twitching, and no doubt then it will all start again.

    But no, it will all be different next time won't it, El Gordo and his little Darling are riding to our rescue, creating a fair market place and giving everyone a voucher for internet access. Yippee.

  • Comment number 3.

    A hairy day indeed, and all the more so for a certain Gordon Brown. What a great background to his most important speech as Prime Minister.

    At least he won't be saying "No return to Boom and Bust"

    Cheers Gordon

  • Comment number 4.

    It very much reminds me of what happened during the wall street crash. After black thursday of 24 Oct 29 crash, all the bankers got together and devised a rescue plan ... they then proceeded to bid for blue chip stocks well above market rates and thus the slid halted ...this worked in the 1907 crash, but failed in 29 ... after the rise that resulted, folks considered their options over the weekend and then proceeded to sell again ...

    Plans to manipulate the market (even if it is $700B) will end in tears ... and so now we have this on-going CDS mess

  • Comment number 5.

    Dear Robert,
    This was no accident the Bankers planned and implimented this to make billions. The Greedy few have created carnage in the money markets, and got away with it.
    Every 10 to 12 years there is a black Friday, or Monday, and you only have to look at History to tell you, Bankers create this scenario for personal Gain.Look at the Economic war fare History of Thread Nedle street and Montague Norman who created the Great Depression, this is Historical Fact, then read Secrets of the Federal reserve, it completelu confirms Money Blocs and share dealings create this senario, and at a pre determined time the Bubble is forced to burst

  • Comment number 6.

    There is no Get Out of Jail Free Card then. The USA's, and through its interconnections and globalisation the whole World's economy, is up the proverbial without a paddle or even a canoe.

    On Today (Radio4) the former Comptroller General of the US mentioned his estimate of off-balance-sheet funding of the Government (American) as about 40 trillion dollars.

    The edifice is collapsing and a 'tiny' 700 billion dollar Poulson rescue plan, whilst being too expensive, is also far too small to 'rescue' anything.

    The idiots, for I cannot describe them fairly in any other way, have through their uncontrolled greed destroyed the global economy. They have killed globalisation.

    The obvious and unpalatable solution is to admit the obvious and hunker down in some place that is away as far as possible from the USA economy.

    First step is to stop the hot money circulating NOW. Exchange Control should be introduced (I see no other way) where international payments should be only for settlements of contracts to supply goods.

    We, the UK (and Europe) needs to protect our home market and banks from this appalling disaster in the USA. This is like watching a train crash in slow motion.

  • Comment number 7.

    I'm quite enjoying the Peston Daily Show.

  • Comment number 8.

    Youch! Roostin' Chickens time!

    For the great unwashed like myself, it is easy to see why bankers are in a mess.

    They have forgotten the basic rules of lending. Make sure you understand the risk BEFORE you lend. The same maxim applies to all derivatives (including CDS and CDO instruments). No use pleading ignorance now. Too late!

    The US Gov't is taking the stand others are failing to do, which is try and sort the mess out by state intervention. Not great, but better than anyone else in the world's leading economies is prepared to do. For that at least, they deserve some credit. The Asian and Middle Eastern soverign funds are sitting on piles of US Dollars and T-Bills. They see this mess as a Western problem, which needs fixing. If the US stands idly by, the world is a poorer place and a more dangerous one for everyone. These cash holders want the US plan to succeed just as much as we do, otherwise, to whom do they sell their raw materials, oil and goods to?

    We need a dumping ground bank and the Us Authorities are doing railroading this in now, just like the RTS solution for the Savings and Loan fiasco that the US endured alone in the late nineties. The global stock markets do not like it because it further depresses asset values in all classes, as all institutions holding toxic debt count the true cost. Well tough! This situation needs a huge line in the sand drawn for banks and financial institutions to count the real cost once and for all, and to start afresh, with tighter, more effective, and better policed regulation. The days of easy money, for now, are over.

    Like any good medicine, for it to work effectively, the patient must get more ill before it gets better as the medicine starts to work. This will mean all of us will suffer and see our savings and investments and pensions plummet in value. For those nearing retirement, this is a bitter pill to swallow, and may force many to continue working longer until there is a sensible time to retire.

    For the rest of us, it is a wake up call. A home is a sanctuary not an investment. Our savings should be protected in case of job loss or other unexpected events. Our jobs represent our value contribution to the economy and our self esteem and place in the world.

    Sounds cheesy. It is. However, that is what we, the great unwashed all survive by. Work to live not live to work.

    For the hubristic greedy souls in the City that have cashed up before the walls came tumbling down, a time to reflect. Personally, I don't think they understand or care about the general public, until they are directly affected themselves. Sadly, the clock (and bonuses paid on bogus performance targets it would appear in hindsight) cannot be turned back and reversed.

    We all enjoyed great debt and investment freedoms in the past 10 years. Now we get the hangover, for perhaps many years.

  • Comment number 9.

    Paulsons plan may introduce some transparency, however he isn't going to like what he sees. Heads he wins, tails he loses.
    The gallows featured prominently in the wild west. Time for a comeback?

    A hairy day indeed.

  • Comment number 10.

    Proves again, you cannot leave children in charge of a sweet shop !

    The stomache ache is however being shared all round.

    A 'rescue' has to happen, unfortunately, there is now no choice.

    This bail out actually is more to protect depositors and pensioners than shareholders.

    All the shareholders have taken huge losses.

    Except certain hedge funds who have exploited the carnage.

    Regulation must be stronger in future.

    It must define legal financial instruments and not allow the willy nilly invention of new financial instruments.

    This would prevent the circumvention of financial safeguards.

    Otherwise, the immature children of financial services will just take over the shop, yet again.

  • Comment number 11.

    Its now over a year since the start of the credit crunch. So the institutions can't say they haven't seen that problems are on the way.

    My understanding is that the credit default swap market has not ceased during that year. So have they covered their positions in the last year? If not, why not?

    A competent bookie lays off his risks. Until a year ago they may have underpriced risk as it paid bigger bonuses by doing so. But they are now fully aware of the risks. If they haven't sorted it out are they just incompetent, or relying on being too big or interconnected to be allowed to fail or is there something else?

  • Comment number 12.

    Everyone should read 'Closing the collapse gap' by Dmitry Orlov.

    Google it. Sit down with a tea or coffee, and see what is coming.

  • Comment number 13.

    #8 - PrisonerNumber6

    I'm not sure they're "pleading ignorance".

    I genuinelly think most of them are (and were) really ignorant. They had no idea what their companies were doing, at the highest level, but were happy to keep quiet while they received huge bonuses for the work the boffins did!

    While I appreciate that the nature of Insurance, as a business, is to pay out less than you actually take in, surely there were some kind of oversight committees who had responsibility for ensuring that these Insurance companies could actually cover their payments if it all went south?

    Didn't the banks check that the companies they were paying such large fees to were adequately funded?

    Once again, where were the risk analysts? The Risk Directors?

    One of the big criticisms of Northern Rock was that it's Risk division was incapable of doing its job. I didn't realise it was an industry wide epidemic.

    If these companies survive this year, every person with "risk" in his job title needs to be replaced.

  • Comment number 14.


    Yes, a very good suggestion, and a terrifying (and all too plausible) read.

  • Comment number 15.

    Main problem is only US trying to sort it out and others not doing much. Also counties that subsidies petrol should be reported to WTO as its an subsidies exporters and restrict imports; this will help US and EU economies.

    If people want free trade it should be fair trade to all.

  • Comment number 16.

    #6 John_from_Hendon - "Exchange Control should be introduced (I see no other way) where international payments should be only for settlements of contracts to supply goods."

    What an excellent idea !! All the excuse that any country ever needed to deport all those British expats for taking jobs that locals should be doing !! After all, they are not supplying goods !!

    Oh, and service companies like those that built Beijing's Birds' Nest and Water Cube should be deported along with the rest for the same reason !!

    And since Britain now manufactures extremely few goods for export, it will go bankrupt in no time flat !!

    Who needs terrorists when we have friends like you ??

    Re. the credit swap crisis - a major contributory factor in this crisis is the fact that insurers lost sight of the difference between premium and realised profit !! They pay out massive commissions based on premiums received rather than realised profits from the contracts. This encouraged their sales people to go out and write ever more wildly extravagant insurance contracts with total disregard to the inherent risks involved. When the crunch came and they found that Premium, minus the massive commissions left very little net income to cover the reimbursements required under those contracts !! The Micawber Principle applied here with a vengeance and the resultant "unhappiness" is what did AIG in big time !! Welcome to cash-flow underwriting !!

  • Comment number 17.

    #15 - Absolutely right. Countries that subsidises petrol should be reported to the WTO !! Let's start with the good ol' US of A, shall we ??

    Unfortunately, the Brits subsidise the government for every litre of petrol we use instead of the other way. How stupid we are ??

  • Comment number 18.

    It looks as those in the US government who are not involved in banking and the mess the bankers have created have seen the light. In the 1860's people bought Confederate Bonds, apart from their historical value and interst they are worthless. Just a thought

  • Comment number 19.

    Insurance firms that haven't got the funds to pay out need insurance to cover that risk.

    So I'd be glad to insure them for (let me think) let's say 20 million pounds. They can just send the money to me via Robert Peston, and relax. I'll be here in the unlikely event that they need to claim (honest, guv) and I have no intention whatsoever of moving to South America as soon as the money hits the bank.

    Sheesh ... talk about being gullible. And banks actually hired people like that?!?

  • Comment number 20.

    Dear Robert
    When all is said and done, and the logic and illogic of it all has passed under the Bridge, the most noticable event in all that is that The Primeminister and Alistair Darling do not have a clue as to what should be done.
    When a man like Brown hits pensioners ,the poor, and pension savings, for tax, then you know he has no other care in the world other than being Primeminister that above everything else is Browns Objective,
    The country can fall apart around him for all he cares. After all who pays for his Holidays in the USA.?

  • Comment number 21.

    Aaaaaaaaaaaaargh! I've been saying it's all going to be about credit default swaps since last September. I posted then that while the potential face value of worthless MBS was $1trillion, the value of the CDS market was twice that at $2trillion. However...

    The Poulson Plan should fail, even to be implemented, for several reasons.

    Article 8 Poulson sole discretion over that $700billion. With no oversight, no recourse to Law. Poulson would be above and beyond the Law. Even the President does not enjoy such a privilage. Congress cannot now will not allow that.

    Poulson is NOT intending to buy Wall St's merdé at a punative discount. He has stated his intention to pay top dollar. He has to as only by doing so does the Plan help to recapitalise the banks. Problem is, this therefore means the Plan's stated intention is to give $700billion of US taxpayers' money to the very same people responsible for crisis. US taxpayers are not happy and in an election year have more than one way of expressing their disquiet to their representatives in Congress and the Senate.

    The $700billion ...while being possibly too little to actually take in all the toxic MBS stuff, nevermind the wave of oncoming CDS merdé, it is enough to is trash the dollar. Even before the plan is implemented oil takes a record breaking leap in value. If the Plan is implemented expect that record to be broken....regularly.

    And make no mistake, China and those other soveriegn wealth funds have a huge intrest in the value of the USdollar. It is after what they have sitting on the table infront of them. China holds about a trillion dollars alone. I wonder if Poulson is taking calls from the Chinesse ambassador today?

  • Comment number 22.

    You are becoming more descriptively imaginative in your use of language day by day. Would make a great read if the whole fiasco was not such a gigantic metaphor of human greed.

  • Comment number 23.


    Have just read "Closing The Collapse Gap", as you suggested. Wow, thats sobering reading!

    I think Orlov might have exagerated the "permanent" collapse of the U.S. economy, but most of what he says makes sense; and at least they have an exportable entertainment industry to keep the west coast employed.

    We in the UK don't stand much of a chance, as the U.S.s "little brother", do we...

  • Comment number 24.

    The opening of the markets was a good thing, but only so lonag as the government understands how business works. This government, and looking at parliament any other future cabinet of any party, consists of full time (its certainly NOT a Profession) politicians, who let this happen and now have no idea what to do.

    "Brokers" used to know what the intrinsic value of a business behind a share was, but this paperchase of exotics is far beyond any underlying value calculation they would have used. The recently miuch amligned "Traders" are now seemingly being herded one way or another simply by those who can position large packages of product into the market at an up or downtick on current price - whether owned or borrowed it does not seem to matter as long as liquidity is low.

    If the paper is worth very little then it should be sold for that price, and if an investor with capital thinks it will go up then it should buy a lot of it! If the product has no buyers then the originator of the package, however toxic, should be sought and forced to buy it back - surely as a fraudulent sale of a non existent product - if necessary by issue of its own shares or through a central funding group, at the reverse auction bid low price. If they have to borrow capital from the FED or other central funding organisation that should surely be at commercial plus rates, long term, 50 years plus, and somehow illegal to repackage/offload - just to remind them of what occurred when they were the masters of the universe!

  • Comment number 25.

    Nice article Robert.

    But even though you reserve your deepest sarcasm for the notion that those insuring must have reserves to pay if the insurance is called, I would go further.

    I would call it mindblowing levels of chronic stupidity that calls into doubt the entire worth of the US financial system.

    Thats the best interpretation.

    Even worse is the notion that people knew the risks but were incentivised by a totally corrupt bonus system to ignore them for persopnal gain.

    Either way, its Del Boy or Rodney.

    We are getting into the sphere that you really are to blame yourself from now on if you trust these muppets with your money.

  • Comment number 26.

    re 12.

    Entertainiing read, but the analysis amounts IMHO to an anarchists manifesto.

    You go ahead and knit your own nuclear bunker if you want to, but the rest of us are still going to have to rely on some form of functioning system, so don't give up yet.

    I suspect the yanks will have to swallow hard and cough up Paulson's protection money, and watch the economy reset to thrift mode

  • Comment number 27.






  • Comment number 28.

    First it was forgetting about profit and cash flow : DotCom Bubble

    Now it's forgetting about risk and consequences.

    The finance service industry is held up as the future for this country with world expertise.

    Bring back good old (and not so old) manufacturing at least they did not damage us all.

  • Comment number 29.

    I'm not sure the problem was "turning poo into gold". The problem was that at the time its wasn't poo - they created "gold" out of thin air instead.

    The money that poured into the housing markets here and in the USA pushed up the prices of houses so that the banks didn't have to worry about a default on the mortgage because they could repossess the house and it would be worth more than it was when they lent on it. And anyway, all this money caused a boom that meant few had problems paying their mortgage, and interest rates were kept very low by the government too.

    Unfortunately the UK and US housing markets were operating like an massive Ponzi/pyramid type scheme, where house price rises free up banks balance sheets so that they can lend more, further pushing up house prices so they can lend even more.

    This kept on going for a few years with ever rising prices and the banks booming. Until eventually (like all Ponzi schemes) it failed, because they ran out of people to lend to, so they started lending to people who had no income, and lending them the massive amounts of money required to buy overpriced houses.

    It was at this point that what was previously "gold" became "poo". The cycle above is now running in reverse, with each house price fall wiping billions of banks balance sheets further limiting their ability to lend, which leads to further house price falls.

    How low will it go? I'd be surprised if house prices don't halve. I think we may well find them at 40% of the peak.

  • Comment number 30.

    I'm perplexed by societies that would refuse to allow companies to operate within them that employ, to use a more extreme example, slave child labour, yet deem it acceptable to allow imports of goods made by companies that employ precisely the same "tactics"! But it's not just the question of child labour, it's all the rules and regulations that are imposed upon domestic companies.

    How is that free trade? In reality anything manufactured abroad ought to be subject to the same rules and regulations as would apply to a company operating internally. Only then are they truly competitive.

    I'm not advocating protectionism here nor the abolishing of all rules and regulations for domestic companies. I do think certain rules and regulations are a requirement of a decent society, but I also think many are the product of an overbearing and intefering government.

    We need less of them. We need to encourage the competitive thrust that many small companies, where individual failures are contained, rather than the cartel environment of a few large companies where failures are massive and subject to a domino effect.

    It's what got Britain out of the mess the last Labour government left it in. It's what's needed to get it out of this one. And ultimately it's what's needed to prevent the collapse of the world economy.

  • Comment number 31.

    Imagine the worst road crash ever...every time you think its over another vehicle piles in...and all being played out frame by frame in a neverending nightmare.

    Couldn't all the economic brains see that the whole point of the bubbles created by the free market is that they exist because there are no rules or regulations, hence they grow in a vacuum where everything and anything is possible, their oxygen is personal greed.....

    This has been so obviously where they would end up that I'm amazed that everyone is so shocked.

    Back to my car crash...each solution dreamed up in Washington, or in these blogs, is merely like offering water and help to the first cars in the crash, without doing anything to stop the mass of cars still crashing at the back....

  • Comment number 32.

    Comment 8 : PrisonerNumber6

    Our jobs represent our value contribution to the economy and our self esteem and place in the world.

    An astute point. But, if value contribution and self esteem are linked, how many people are sheltering behind the concept that the value of ones contribution is measurable by the amount one is paid?

    Isn't the reality that only part of the world's activity is linkable to wealth creation, and that the large and increasing remainder relates only to gaining posession of wealth already generated by someone else?

    Maybe the true challenge for post-industrial societies is to eradicate the concept that success at value-transfer is equivalent as a social contribution to success at value-creation.

  • Comment number 33.

    Excellent post !! You should take some time off to write a book about all this - a sort of 'Bonfire of the Masters of the Barbarians at the Door', with the by-line 'Terrifying - because it's True..'

    I remember many moons ago sharing a train journey with a well-to-do chap who was a Lloyds of London 'name'. We got chatting about the fiasco then descending on the insurance market.

    He told me they were threatening to sue him for the debt he had incurred [remember they had signed up for 'unlimited liability]. But his defence was to force them to 'prove the debt' and show how the debt had been incurred.

    They couldn't easily do this, and bankrupt him, because of all the shenanigans and bad practice over re-insuring risks and the less than 100% honest way the syndicates had been run.

    Shades of this about the current crisis - the 'accounting' has been all to pot, and no one seems to understand that the 'profit' these people have 'booked' can evaporate into thin air if there are a string of unforeseen events.

    Rather like the 'Kobe earthquake' triggering the stock market shock which unravelled LTCM, there will always be an event which is beyond our crystal ball, and which breaks the weak link in the chain.

  • Comment number 34.

    @ #26

    I would refer you to this article from 2004:

  • Comment number 35.

    I still find it bizarre that amongst all this talk of what's collapsed and how much taxpayer money is going to be thrown at the problem, there's still no talk of who's going to take responsibility.

    The bankers involved in the criminally negligent activities are mainly educated at the global top 10 universities - so we can assume they know what they're doing?

    The 'Flaming Ferrari's' (James Archer, Adrian Ezra, David Crisanti) were sacked, denied their £5 million bonuses and barred from banking in 1999 and the damage was temporary and caused no lasting damage. How come the FSA had teeth then but doesn't now?

    Robert starts off by talking about New York bringing law and order to the last wild frontier. What rubbish! If you want law and order, stop the bailouts and let's see some heads role.

    All this commentary sounds incredibly tame.... I'm furious! I'm fed-up listening to all this rubbish.

  • Comment number 36.

    I seem to remember news articles about the great debt time bomb as we (to quote some of the comments) "the great unwashed" borrowed overall a large amount of money. And it is this poor debt management that has just escalated up the scale. The problem for the US is that the Senate and House are taking their time to sort it out and as they have elections coming up the final plan will be a compromise between the best (yet painful solution) and vote winning one. In ecology this would be considered a bottle-neck situation where only so many survive. Sometimes afterwards the diversity remains limited sometimes you get a certain degree of of diversification. Unfortunately this is just the downside of free markets/capitalism and has to be expected. Maybe now we should look into Europe more, help stabilise and rebuild our own doorstep. Re-assess our cross-Atlantic ties.

  • Comment number 37.

    Don't worry! I'm sure that the insurers will read the small print and find a reason not to pay out, as they usually do. After all, the idea of insurance is that we pay them, not the other way round.... isn't it?.....

  • Comment number 38.

    Hang on... I don't get it.

    Paulson is transparently admitting he intends to pay top dollar for "assets" (if we can still call them that) that are patently worth less than he wants to pay for them. Is this not just throwing a large chunk of US taxpayers money away for nothing?

    Surely he should be negotiating the lowest price possible, to get value for money? Why should the banks continue to be rewarded for their own mistakes? This type of behaviour will encourage them to believe their balance sheets are still worth something!

    I understand that the more money he can get into the system the better, but just overpaying for worthless assets isn't the way to do it. He should be demanding a sizeable piece of the bank and its infrastructure.

    If I was a US taxpayer, I'd be furious!

  • Comment number 39.

    Nice article Robert
    can you explain O'neil from Goldman Sachs on bloomberg this morning comments that because the US will be buying these assets at distressed levels that if they rise the US could make a profit , and that the $700 billion cost is nonsense unless you value the assets at zero , or have I hit the nail on the head

  • Comment number 40.

    Stan O'Neal walked away from Merrill Lynch with a compensation package of USD 161.5 million. As the former CEO and Chairman of the Investment Bank, he should be held directly responsible for the huge losses.

    As part of the legislation going through the US Congress to purchase the toxic subprime debt owned by US and foreign banks, measures should be included to reclaim the excessive bonuses and remuneration packages paid to the executives of the failing banks.

  • Comment number 41.

    The issue is not how big the CDS market is, but
    to whom money is owed if the inevitable happens.

    Is there any way to find that out?

  • Comment number 42.

    Actually, I have a bucket with a hole in it in my shed. Do you think Hank Paulson would consider giving me $1bn for it?

    Its actually worth absolutely nothing, but at least it's not, in of itself, likely to make a loss!

  • Comment number 43.

    "Annual income 700 billion dollars, annual expenditure 699 billion 999 million dollars, result happiness. Annual income 700 billion dollars, annual expenditure 700 billion, 1 million, result misery."

  • Comment number 44.

    The regulators will do all they can to point the finger of blame at the those they should have been regulating.

    Let's keep the blame here firmly where it needs to reside.

    The truth is that the moral hazards associated with banking sector have been known, written about, analysed and understood for donkey's years. The banking industry is an essential function in any economy but is prone to specific moral hazards because it is run and staffed by human beings - to be a banker is not to be uniquely evil - just human.

    The role of banking regulators is to regulate to reduce the moral hazards. They were either:
    1. Asleep on the job.
    2. Doing the governments bidding
    3. A bit of both.

    In any case banks were dancing to the tunes that the regulators and Governments were playing.

    The song that I can't seem to get out of my head is the one that goes "we have banished boom and bust forever" - I think it might have been a Greenspan/Brown/Blair composition.

  • Comment number 45.

    Comment 13 : apollo_mcqueen

    "Once again, where were the risk analysts? The Risk Directors?

    One of the big criticisms of Northern Rock was that it's Risk division was incapable of doing its job. I didn't realise it was an industry wide epidemic.

    If these companies survive this year, every person with "risk" in his job title needs to be replaced."

    Maybe you'ld like to ponder this?

    Consider all these people trained as a risk assessors, employed in risk assessment over long careers, promoted maybe to board level in the companies that employ them - just how likely is it that all of them, simultaneously, should have suffered an identical brain-seizure that caused them to overlook the possibility that house-price inflation may not continue unarrested into the future? Remember, to all these people, risk is the central feature of their daily work - it's not just some piddling feature easily forgotten in putting together a deal. To all intents and purposes it IS the deal.

    How much more likely is that they have been subsumed by the orthodoxy of the age? When the sales department is pumping out new products that make millions in profit and bonuses, how many times do you have to be called a jeremiah, a spoilsport, a negative influence, before you button your beak and keep your (minority) feelings to yourself? How long is it before you start to doubt the relevance of true risk-assessment in the new world order? Even if your mind continues to tell you that the whole thing is a con, how long can you maintain your personal well-being from outside the mainstream?

    This is the fault as I see it. As society increases the dividends for personal compliance, so it destroys the checks and balances of critical thought, and we are left as individuals with no real option other than to follow the herd, wherever it goes, and hope against hope that it's not leading us to the precipice.

  • Comment number 46.

    39 and 40 both make good points.

    The cost to the US taxpayer would only be $700bn if all assets purchased were, and remained forever, worthless. This is improbable, for two main reasons. First, Paulson's 'reverse auction' would mean buying at heavily discounted prices. Second, the US would become mortgagee of houses, meaning that funds could ultimately be recovered through repossession as and when the housing market hits bottom.

    The snag here is that $700bn may be nowhere near enough. Essentially, the calculation is total negative equity multiplied by the discount rate at which CDOs can be bought. We won't know the negative equity number until the housing market bottoms. Rising unemployment may have knock-on effects here.

    The political implications - a Republican (or indeed any) US government nationalising much of the banking system - are staggering, but then so is the sheer magnitude of the problem.

    My own view is that the chances of the Paulson plan succeeding are not high, but it's the only credible plan on the table.

    The next big danger is that the dollar might crack. The oil price is suggesting that this is very likely.

  • Comment number 47.

    Colateralised default swaps ,an unregulated rumour mill heckliing beyond the reach of the law

    Now available on CDS

    Trick one

    On the good ship lolly "pop"

    On the good ship lollipop.
    Its a sweet trip to a cAAAndy shop
    Where bon-bonus lay
    On the sunny beach of Peppermint Bay.

    Lehmanade stands everywhere.
    Crackerjack bonds fill the air.
    And there you AAAre
    Happy landing on a chocolate bAAAr.

    See the sugar bowl do the footsie roll
    With the big bad devils wall st cake.
    If you eat too much ooh ooh
    You'll awake with a tummy ache.

  • Comment number 48.

    This comment has been referred for further consideration. Explain.

  • Comment number 49.

    And all the time everyone is looking at this mess the EU ushers many more laws into effect, taking away our civil liberties one by one.

    Why is no one talking about the new european arrest warrant anywhere in the press?

  • Comment number 50.

    It's not just about a lack of risk managers.

    What really concerns me is that most of these banking types seem to be minus the "intuition gene"...

  • Comment number 51.

    Re the second wave.

    My finance masters thesis, (2006), considered whether availability of cheap credit and also financial innovation (specifically the CDS market) had caused historical levels of corporate leverage and that this would lead to historical levels of corporate default during the next recessionary cycle?

    Conclusion: catastrophic levels of corporate default will occur if a recession becomes twice as severe as was experienced during the early 1990's. However certain sectors, such as building and construction, are significantly exposed to moderate recessionary impacts. So, seems bout right so far.

    The most interesting area is the impact of the CDS, did they cause imprudent corporate lending? During research my attempts to raise this point with senior MD's of various Investment Banks (who had responsibilities for credit derivatives) were completely and utterly refuted. Without their support and the necessary (private)deal data I was unable to academically test this point of my thesis.

    I had not even considered that the global banking and insurance infrastructure could become so chaotic and unstable that there could were risks of defaults on the credit defaults.

  • Comment number 52.

    So this dramatic drop in the market is whose fault exactly.
    Short sellers??
    Errr No.
    So what excuse will the Government find now?

  • Comment number 53.

    Ah, how little we really understand about the banking system. To really get a feel for the truth behind the lies just read this quote from Sir Josiah Stamp (former Governor of the BofE). It really makes me smile when we hear that there are only 2 options - borrow more or tax more. Who are we borrowing from - the banks?

    "Banking was conceived in iniquity and was born in sin. The Bankers own the earth. Take it away from them, but leave them the power to create deposits, and with the flick of the pen they will create enough deposits to buy it back again. However, take it away from them, and all the great fortunes like mine will disappear and they ought to disappear, for this would be a happier and better world to live in. But, if you wish to remain the slaves of Bankers and pay the cost of your own slavery, let them continue to create deposits." - Sir Josiah Stamp

  • Comment number 54.

    Robert, the Rocket Scientists got us into this LaLa Land, with some help from the Bankers. Surely they must be able to reverse engineer this situation? Can't they??

  • Comment number 55.

    #16 ishkandar

    I do not think that it is at all reasonable of you to say that reluctantly advocating Exchange Control is terrorism.

    The World managed quite well up to the eighties with exchange control in place so in your view we were all terrorists up until the 1980s?

    It is only after the abolition of Exchange Control that the World's finance community destroy its own and the Worlds asset base by playing sill so-and-so's with ' bubble' schemes.

    The fact is that the probability of international cooperation is almost zero on a global scale to curtail these insane schemes that are brining down the world's economy. So how would you fix the problem of hot money simply moving to the worst regulated country, if not by Exchange Control?

  • Comment number 56.

    If Paulson, King and company only pay the true mark to market price of all thsi toxic mess then all taxpayers are not in any consequential damage. However if as can only be suspected teh taxpayer is getting plugged in at par ( 100%) then this plan shoudl fail.
    Let the banks write off their self created damage over 10 year but don't hit the taxpayer.
    We all know their is insufficient capital to cover these insurance policies so the marekt needs to reprice at 'true' market values all its assets.
    The sooner we get some honesty in this mad scenario the better.

  • Comment number 57.

    I'm beginning to wonder if theres anything to rescue here.
    It becomes more apparent by the day that the wealth generated by the markets was non existant and merely appeared so through creative accounting - it would appear that everyone has claimed ownership of the same money and even insured it at a company claiming to own the same money.
    If there was any wealth generated by the markets over the years since deregulation its long gone. And wealth accumulation supported the illusion.

    I think the rescue plan may be inventing a new economic term here: "Re-inventing the flat tyre." Its going to need a lot of inflation to give the impression its working properly.

  • Comment number 58.


    Why do I get the distinct feeling that, like me, you are starting to gibber at the wall-paper?

    This whole business has become so utterly mind-boggling that one can only wonder at the nature of the human race which has managed to construct such institutions of complicated insanity.

    There is no certainty any more. So there is nothing that one can do other then let the whole sorry business work its way through.

    I very much doubt that Paulson's Bank of Default will work but that is not my call, thankfully. I will though light a candle as it is getting dark outside even at midday.

    Need `The End' be bitter?

  • Comment number 59.

    Robert, absolutely spot on. with your references to "the Emperor's new Clothes" and to "turning poo into gold" you have said pretty much what I have been thinking over recent weeks.

    I always counted myself fairly lucky to have survived the negative equity etc of the early 1990s unscathed, and right now it feels like 1991-1992 all over again. I really cannot understand why these so-called investment bankers and their like have not bothered to apply 2 fairly simple tests:

    1. Can the borrower repay?

    2. If it is necessary to take security, does the present value of the security leave an acceptable margin over the amount at risk? (Clearly no if you are offering 125% loan to value ).

    If I get an annual bonus, it has always been worth rather less than one weeks pay. I have always been very suspicious and cynical about these city types churning other people's money around and spinning their cut off into their pockets. Envy is not a good thing, but come the revolution...

    Finally, can someone please explain what benefit ordinary hard-working people who do not work in the City or Wall Street will get out of their governments pumping international telephone numbers of money into schemes to rescue these idiot/greedy bankers from their stupidity? Will it really be a lot worse for you and me if our governments do not blow our money like that but to let these banks go to the wall instead?

  • Comment number 60.

    #45 - ExcellenceFirst

    Thanks for the scenario. I think the issue was more that the Risk Managers (perhaps even at board level, as you say) were aware of the risks and identified them at first, but their warnings weren't heeded because Sales or Marketing can should louder and are "sexier" to the Execs. After this happened often enough, they just stopped trying.

    They continued to draw their (often very large) salaries, aware that they weren't doing their job properly and that the companies they work(ed) for were negligent.

    It's this willingness to carry on regardless which is the crux of the problem. Certainly an "average" risk assessor can't argue with the CEO but a Risk Directors job is to get the point across at a board level.

    "Risk" is often inextricably linked to "Audit", whether internal or external. Everyone at a mid to senior management level in every company I've ever worked for has detested "the auditors", but we all have to listen.

    Certainly much of the blame lies with the board and CEOs for ignoring any warning they might have had from risk assessment, but if you're employed to do a job and you're aware you're not doing it, then you should look for a new job. How can it be fulfilling otherwise?

    One comment to emerge from the NR fiasco was that the Risk division had recovery and contingency plans for ALMOST every eventuality, including if the US or Asian money markets "froze", but hadn't considered the credit crunch could ever occur. I'm not being funny, but if its your full time job to assess risk, this is a criminal oversight.

    Of the 2000 staff to leave NR, along with the directors, they all should have been the first to go (at least from Director down to Senior Manager level).

    In fact, if anyone from NR is reading this, could you confirm if they did?

  • Comment number 61.

    Stan O'Neal's payment was contractual. if they did not pay, they wiould have to shell out more to lawyers before they lost the case.

    People forget tht CDS's improved liquidty and investment by distributing risk. The theory and the practice bear out.

    But as ever, the devil was in the detail. The models quantifying the risk were untested and some theortically controversial. Even worse some writers did not have strong or functional risk functions, some risk finctions were there for show. The regulators failed to giv sufficient backing to the Basle 2 ccord that would have examined models and have capital stacked against the risk. The cost of this capital would have limited the volme of CDS written. However, the regultors did not, the chief culprit being the US. The FSA was not paying enough to attract bright minds that could identify the risk and estimate the potential impact. Why would a bright spark want to earn £55,000 when he or she could earn £90,000?

    The banks were employing mathematicians and physicists who are very good in thei discipline but their effectiveness in the financial world that deals with the lesser predictability people's actions and reactions has now proven to be less than desrable. ndeed there were models that were spurious without any explanatory power with regard to the actual underlying behaviour. One factor for spurious models was the view that the advance in computing power bringing in speed to a level that appeared to be an artiicial intelligence that could adapt to changes. This has been proven wrong too.

    The models problems is not new it happened to UBS and Nat West within the past 18 years.

    The problem with a central authority controlling CDS is that CDS are not homogenous and therefore difficult to define and control, much less model becuae of different clauses that describe what constitues a default for that contract and what the payment is going to be. The CDS exchange only managed to capture a fraction of th market as CDS tend to the OTC contracts that are somwhat bespoke.

  • Comment number 62.

    Right, this 700BN. It's not 'real' money as such It is actually an estimated value of debts with interest that contain toxic waste.

    The US govenrment 'buys' all these debts and sits on them. Most of them will come good, a percentage will not. The US govenment believes the default will be in the region of 70BN even after bad debt recovery. To that end, the 70BN is underwritten with - GOLD.

    This is where the problems lie. Parts of the market and congress believe that the 10% default rate is to low, and some parts don't believe that the US government has 70BN in gold to under write it anyway.

    For it's part, the US government will not allow an audit on it's gold reserves and insists that this is done 'on trust'.

  • Comment number 63.

    I suggest some new legislation making it illegal to sell a financial product or derivative that cannot be explained in one sentence to someone on the Clapham Omnibus.

  • Comment number 64.

    56: Robert

    Good point. You are surely right that asset re-pricing is the only solution. But wouldn't that crystallise the asset/liability chasm, triggering immediate meltdown? I'm inclined to agree with post 58 as well; it is becoming utterly mind-boggling.

  • Comment number 65.

    Post 51.
    I worked in the embryonic CDS market and can assure you it was never envisaged that credit default swaps would be used in the way they have been since 2002. They were never supposed to be a leveraged substitute for corporate bonds.

  • Comment number 66.

    In the attempt to address large bonuses via an apparent avenue of gaining poltical capital or apparent demonstrating a lack of understanding, both Gordon brown and Alaistair Darling fail to mention that if banks had to allocate moe capital to the risks taken by bankers, the cost of that capital (that should increase in a somewhat exponential manner due to the scarcity of capital) would have gone towards curbing the size of the bonuses.

    I do hope that the PM does not adopt the same rescu package as the Fed as Britain will be subsidising to solve a US induced problem. The amount of home grown sub-prime is minimal and a larger portion was held in US books such as that in Lehmans.

  • Comment number 67.

    This (credit crrrrunnnch) was waiting to happen for about 3 years. When the going was good no one wanted to bell the cat. The banking industry did not want to act as it was making money, the future was not their worry, JUST BONUSES. The stock market is least bothered about the fundamentals of what passes through it and so can not be expected to act. The government (let's talk about UK only) with the clunking fist BROOOOON in charge could not act as it not have a clue.

    Above all, it was the press which put BROON on a pedestral even when it was blindingly obvious that all the BROOON initiatives were failing.

  • Comment number 68.

    I get the gut feeling that it is the nature of Capitalism to self destruct - it contains an inbuilt contradiction. Didn't some German write about this about 150 years ago?

  • Comment number 69.

    I may be being naive but why dont the government put this money into the bottom of the tree.

    Use the money to help homeowners to stay in their homes by nt paying the mortgage entirely, and taking ownership of the house.

    As far as I can see there are 3 benefits

    The homeowner has a roof over their head

    The taxpayer has an asset that is at least worth something.

    The money flows aroung the system and there is no longer any toxic debt, so the banks have no more concerns.

    It also takes away the risk of the banks simply sucking up taxpayers money and asking for more, and also evicting people, who will be a drain on taxpayers in years to

  • Comment number 70.

    These wild swings on the stockmarket are starting to become tiresome - last week "We're doomed!" followed by Friday's "We're saved!". Now it seems "We're doomed!" again.

    Is anyone actually looking at underlying fundamentals, or just over their neighbour's shoulder?!

  • Comment number 71.

    This comment has been referred for further consideration. Explain.

  • Comment number 72.

    When I was a lad the bank manager was the grumpy be-whiskered old man that looked disapprovingly over his half rims as he read out the words 'overdraft' and then told you off for not 'minding your finances'.. But as I got older, the managers changed, got younger, until it was a just a series of spotty youths grinning as the 'computer says yes'.. I suspect it's time for an international 'computer says no..' and the regulator to assume the role of the grumpy old bank manager, no fun, but it did stop you getting into too much trouble..

  • Comment number 73.


    The phrase (or collection of phrases) describing CDO's as 'poo turned into gold' is MY phrase.

    You have plagurised my phrase and turned it into your own.

    I want to set the record straight and also secure my other credit crunch phrases, which include:

    1) Where there's muck there's credit

    2) CDO's described as a 'black bag of poo'

    3) Likening the CDO market to the con that used to be a regular occurence where items were sold at auction in black bags not knowing what was contained within.

    4) Reverse Midas touch

    5) A fools market

    6) If the wind changes, your debts will stay like that.

    Please do not use any of these phrases in the future.

  • Comment number 74.

    Is it just me that thinks this 'bail out' will wreck the US economy?

    Inflation will skyrocket, seen the price of oil lately?

    Scary stuff methinks.

  • Comment number 75.

    Don't tell me you are surprised Robert because I don't believe you. If we know dodgey practice was going on with mortgage fraud and inflated income figures being filed in the UK it is obvious much more has been going on in the UK than we have sight of. As this culture was imported from the US it is bound to be rife there too.

    The US politicians may bitch and squeal, and the banks may bluster and the investors shudder but at the end of the day Paulsons Toxic Bank will have to go thru, where else is the money going to come from. It is the least cost route from what has been said. Fear is a driver. If it goes ahead it saves a lot of bacon elsewhere but as the root of the problem is in the US it is inescapable that the root of the solution has to lie there. Perhaps then, when the excuse for current UK problems is cleared, the UK's vulnerbility can be addressed.

  • Comment number 76.


    Can someone please explain to me what the adverse impacts of widespread global inflation are? Its often said that Governments and central banks should do their utmost to limit inflation, but is high inflation really worse than some of situations predicted on this blog?

    It seems to be a couple of hours of Zimbabwean-esque inflation would sort out this problem nicely.



  • Comment number 77.

    The treasurer secreatary is an Ex Sachs head, he is still thinking like a an investment banker first.He had no interest in the wider economic affects of his egoist demands. The bailout is so unaffordable and that is so obvious by now.

    Hankson's is creating the biggest hedge fund in the world with tax payers dosh on CDO that the banks had not profited from. He is waitung for those toxic bonds to mature likea good port.....and then make a profit....oh yet and how long will that
    To hedge $1,000,000,000,000 madness...incredulous.......another Ponzi scheme in the making

  • Comment number 78.

    Post 45

    A pleasure to read.

    Anybody pointing out there is a problem in a tunnel vision business is usually sent to Coventry or shouted down by the crowd. Or even told they should move on however subtly because they do not share the corporate vision and mission. It is not just shoot the messenger it is destroy the message as well. The bigger the business the worse it is. The situation is even worse if documented warnings are realised as it is evidence of failure in line management and reporting, a hot potato. What results is a ultra short term focus. Not everywhere obviously, but it does occur. As not all situations go sour by definition as risk is seldom 100%, when failure does not occur it just reinforces the culture.

  • Comment number 79.

    The corrupt will fail, the honest will rise. What's to moan about?

  • Comment number 80.

    76: Simon

    Initially, inflation is attractive, because the real value of debts (government and private) diminishes. It has been called "the great seducer" because of its initial attractions to politicians.

    But the longer term effects are dire. Interest rates rise, because they need to be above inflation or real interest rates are negative, and capital becomes unavailable. Saving can be destroyed; "I'll spend my money now, while it's still worth something".

    Those on fixed assets and fixed incomes get wiped out (this is what destroyed Wiemar society and paved the way for Hitler).

    Worst of all, inflation is self-feeding and self-accelerating, n.b. Zimbabwe. Ultimately, it destroys currencies. It's a drug; the need for more and more of it is corrosive, and breaking away from it gets both more painful/difficult, and more essential, as it accelerates.

    So inflation isn't the answer.

    The problem in the current situation is that price inflation has been stable, which lulled the authorities into taking their eye off the other ball, which was ASSET inflation. There is a linkage here; low price inflation creates low interest rates; low interest rates prompt asset inflation.

  • Comment number 81.

    Great stuff from Robert Peston.
    It's amazing how the Financial industry comes up with fancy names for disastrous products.
    "Credit default swaps"?
    That can have some of my mess and I'll have some of yours.
    All the fancy terms come down to the same thing these days.....housing debt.

  • Comment number 82.

    A couple of months back I read an article which quoted an academic study which said that Merchant Banks had at the time (pre Lehmans collapse) written off more this year more than they had previously made in profit in ALL previous years. That is, there recent losses excceeded all the profits from the past (I have also read of similar claims about Airlines operating in the USA). Incredible I know. Did anyone else read this or have a link.

    Closing the 'Collapse Gap': the USSR was better prepared for collapse than the US
    by Dmitry Orlov

    Is indeed an interesting read

  • Comment number 83.

    Many people are expecting a colapse of the dollar ,which would inflate the value[to solvency, infinity and beyond] of the $7000000000000 toxic waste repository bank that paulson wishes to set up .

    The bonus system that is set up for the "bank" opperating the smoke and mirrors SHOULD BE INDEXED FOR INFLATION LEST A COLAPSE OF THE DOLLAR CONVERTS the toxic waste into a valuable asset transfered to non taxpayers through the nominal bonus structure/scheme .

    Given the Seriousness of the crisis and issues of public confidence requiring immediate action , cochairmanship of the new bank should be given to Paulson[who grew rich from shaddow banking] and Roubini [Who warned about shaddow banking]

    Both seem to be public minded in their own way

  • Comment number 84.

    Robert (or anyone, really)

    Why is this problem so enormous?

    Sure, there was tons of lending to poor Americans who now can't pay their mortgage and, sure, the value of US real estate has crashed ... but that just sounds like it should be pretty bad - some really big losses all round - not this "meltdown" scenario.

    What am I missing? ...

    - leverage?
    - securitisation ?
    - confidence?

    What, please?

  • Comment number 85.

    Further more,

    Up until now the global credit crisis has primarily focused on consumer and mortgage credit issues. This on its own is a massive economic problem, but my gut feel was that via huge balance sheet write-downs in the banking sector, the shocking reality checks of the recent banking collapses and the drastic US federal intervention, the issues were close to being bottomed out. Thereby providing some much needed certainty as required for a gradual recovery, including time for markets and regulators to incorporate the various lessons learnt.

    However, a second wave of issues related to systemic problems in the corporate debt and CDS market will destroy this optimistic view. If compounded by a run on the dollar, there will be no long term US recovery and we will finally be in uncharted economic territory.

  • Comment number 86.

    This comment has been referred for further consideration. Explain.

  • Comment number 87.

    The market is demanding action now. Therefore, I think Hank’s plan should be broken down into bite-size legislative chunks and split between its two constituent parts i.e. a distressed asset buyout and a capital injection of last resort.

    This week the US/UK governments should formally announce they will stand behind their banks, the liquidity provisions must be continued, the rolling US Treasury note plan should be approved in principal giving Hank the power in the US to spend the first couple of tranches on buying up distressed debt in the market (not in a reverse auction). Subsequent tranches can be subject to later congressional approval.

    Next week congress can then start hammering out a holistic solution. To approve the subsequent Treasury note tranches, to allow Hank to buy up more distressed assets, and for the UK/US governments to underwrite the necessary rights issues required to recapitalise our banks and if the shares are not taken up by investors to then give the taxpayer some equity protection in return for the government’s investment.

  • Comment number 88.

    No one seems to be addressing the scale of this problem - if not least for the amount of panic it would create.

    Paulson and the US Treasury have had to step in with this $700B bailout because there was literally no other choice. By the way, it doesn't stop at $700B - that's just the figure that can be outstanding at any one moment - Paulson can hive off $500B here and there into the Treasury - the actual limit is limitless - and it needs to be.

    For example, AIG has been bailed for $85B. So we are told. But some analyst are coming in with a figure closer to $1Trillion needed for AIG. And that's just one company.

    I started looking in to the shadow banking system 2 years ago, and at that time it was calculated there were $400T in exotic financial devices like CDO's, CDS's and SIV's floating about in the worlds financial system, last year it was revised to $675T, last week I read an estimated $1100T. Thats $1.1 quadrillion. This is a figure so huge that the average person, let alone the reckless bankers that instigated this crisis, cannot comprehend it.

    We have all been living a financial lie for the last 10 years. The 'equity' in our ever-rising homes has been a lie. The financial day of reckoning is happening RIGHT NOW in the USA, and it will be here in the next 6-12 months, possibly sooner.

    Call me a doom-monger, call me pessimist, say I'm talking down the UK, say I'm unpatriotic, call me what the hell you like, but at least start THINKING about the unthinkable now, then if it happens, you won't be a paralyzed by the sheer impossibility of it all.

  • Comment number 89.

    Comment 60 : apollo_mcqueen

    Thanks for your observations on my earlier comment.

    I'm sorry, but I think your view of the world is much more wishful thinking than how things actually are.

    "[Risk Managers] continued to draw their (often very large) salaries, aware that they weren't doing their job properly and that the companies they work(ed) for were negligent."

    Ok. So you're a family man with a decent income and you know, you just know, that your company is making a huge mistake. You make representations to your superiors and they ignore you. What do you do next?

    Wouldn't the first thing you'ld do be to recognise how far out of the flow you actually were? And so wouldn't you look for any line of thinking you could adopt that would allow you to rejoin the mainstream? Including that maybe, just maybe, the mainstream were correct to adopt the ethos that modelled risk-spreading equated to risk elimination? You know, despite your conscience screaming out the reservations of everything you've learned over the years, there's just enough of a chance of it being correct for you to go along with it, and continue to be able to pay your mortgage, and your wife's living expenses and the kids' school fees ... ?

    After all, who are you to buck the system?

    " "Risk" is often inextricably linked to "Audit", whether internal or external. Everyone at a mid to senior management level in every company I've ever worked for has detested "the auditors", but we all have to listen.

    I used to be an auditor, so I know exactly what you are saying. Basically auditing used to be about testing the validity of arguments and the honesty of the people making them. It was in recognition of the fact that most people:-

    (a) don't actually have a clue how to get things right, and

    (b) are duplicitous with their arguments so as to favour their self-interest.

    Nowadays, it seems, the primary function of having an auditor is to give the misleading impression that the business is actually being audited.

    " ... but if you're employed to do a job and you're aware you're not doing it, then you should look for a new job. How can it be fulfilling otherwise?"

    Yeah right! But most people are employed not to do a job, but to fill a position by giving the appearance of doing a job. This must have been quite clear to them when they took up their position - and, for many, one of the main attractions of the job in the first place. So what grounds are there for them to feel unfulfilled? Other than perhaps becoming expected to do something constructive, for a change.

  • Comment number 90.

    Rather than pay the institutions to stay afloat out of taxpayers money, why can't the debt of those who initially have been forced to default on their loans be paid off instead?
    Then introduce a system for spanking those institutions responsible for high risk ventures by introducing a repayment structure for the original state repaid debt?

    I understand that us normal folk who pay our debts might not be happy with defaulters having their debt serviced, but at least in the longer term the institutions responsible would be forced to make reparation.

  • Comment number 91.

    Can someone please explain to me why the US cannot simply let the banks which have been so stupid fail?

    If Paulson really wants to spend his 700bn, why not let the banks sort the mess out and use the funds to step in and garantee the deposits of those people whose banks go bust. That way, the people who made the mess are the ones to suffer and the people who actually saved instead of speculated are the ones who are rescued.

    Any banks which have been sensible enough not to lend more than they can afford to loose can then pick up the pieces and make loans based upon the solid foundation of all the rescued deposits.

    Sounds fair to me

  • Comment number 92.

    For several years I've been doing the things advocated by Dmitry Orlov (see slide 27) in the article recommended above "Closing the Collapse Gap". In other words becoming as self-sufficient as possible and eliminating as much waste as I can as I could see the writing on the wall so to speak. It can be a painful process, facing up to reality instead of the collective delusion we've been living in. I think this is why people have been turning off the TV in disgust when GB/TB before him et al start spouting forth. (see yesterday's and Sunday's comments on this blog). We've all had enough of the lies and delusion.

    More important in a way has been the complete lack of integrity around and that was why I have walked out of several jobs. I just couldn't face being part of such a system. It's not only financial services, it's everywhere! Most people stay and put up with it as they need money to pay their bills. Some are lucky if they actually enjoy their work.

    One really positive outcome could be that global warming may stop as we stop pumping CO2 into the atmosphere as industrial output slows and people are forced to stop using their cars. Also it's surprising how little you really need to live on when you stop working so much and eliminate all debts. It gives you more time to really keep an eye on it all and you can do your own chores including childcare, gardening etc and keep healthier into the bargain. No need for expensive gyms either.

    It's much healthier all round but not what our governments want us to do. Well I say tough. They can carry on with their antics if they like... to give us all a bit of a laugh but don't expect us to take them seriously!

  • Comment number 93.

    As is often the case Robert Peston’s blogs are the starting point for a variety of points that people want to make. This is fair given the complexity of the issues, their interdependence and the sheer confusion that currently surrounds them. Most people don’t seem to understand the issues – and even senior bankers have confessed they didn’t understand what their underlings were actually doing: and why should they? It made profits – enough said!

    But there comes a point where the Gordian Knot must be cut. We’ve seemingly hitched our wagon to the wrong horse – a one trick pony that has suddenly lost its appeal – so where so we go from here?

    A few posters have praised the US government for at least trying to do something – implicitly and explicitly criticising other governments for not doing something. Leaving aside the morality of expecting ordinary US taxpayers to bail out Wall Street – especially since there is no move to re-impose higher taxes on high income earners on Wall Street (Oh yeah! That’s why you should be expected to pay at least the same rates of tax as your cleaners – so the state has the money to bail you out of the inevitable!)

    The problem for the US is that – and here goes a new historical parallel for you - the US government now finds itself in the same position as successive British governments culminating in the late 1970s. Over several decades UK Governments had nationalised a number of industries. They also began to support private companies with state aid. Stripping away any ideological window dressing, these nationalisations usually took place for pragmatic reasons, often to do with impending bankruptcy, and were made against a background of and acceptance of the role of an interventionist state. British Rail is a good example – and given the current level of public subsidy to the privatised railways which is running at close to ten times in real terms what it was when the railways were publicly owned, it was actually a well run infrastructural enterprise. As I remember at the time, the principle and only substantial objections made about BR by those wanting to privatise it were mostly to do with the quality of its sandwiches. (Infrastructure – which I guess we could define as anything like roads and rail, hospitals, schools and universities etc, that people in business say they must have but are generally reluctant to pay for.)

    I don’t really want to get into a big debate about the merits of nationalisation or state support for industries or individual companies – but like the US now, British governments found themselves in a position where they were unable to let industries fail because they believed that the cost to the wider UK economy would be too great: there would be loss of international prestige; that it threatened the value of Sterling; that it would threaten our Balance of Trade etc. Instead, and again like the US, they were pinned to the dyke like the desperate little Dutch boy, every spare digit rammed into another leaking hole in the dam.

    In our case, the Gordian Knot was unravelled in a most dramatic fashion by Margaret Thatcher. Industries were allowed to fail, and while I can’t help feeling there was sometimes merely an ideological veneer covering a prejudice against people who actually made stuff, it had a huge impact on the economy. The very things which earlier governments of both parties had feared would hurt national prestige were now paraded: Balance of Payments deficits? Mine’s bigger than yours! Devaluation? Bring it on! In fact while there was huge amounts wrong with Thatcher’s solution – and much of the banking deregulation for example has lead us directly to the current predicament both here and (thanks to her acolyte Ronald Reagan) in the United States, she was right to recognise unsustainable policies that needed bursting. (In turn of course her policies also led to several other bubbles – especially housing and commercial property in the late 1980s.)

    For Paulson and the Bush government, they need to see that no amount of money they throw at it can head off the collapse in an unsustainable market. The profits of the banks over the last ten years have been illusory – only when it came to paying bonuses were they turned into real cash and it would be interesting to see where recipients of the bonuses have actually put them: into a tranche of CDOs or CDSs? "Actually no, old chap, I put it onto a building society and you know I’m getting 6 percent interest!" There has simply been one bubble built on the fallout of another, with sharp practice thrown in for good measure: while the rest of the population were appalled at the collapse of Enron et al – how many on Wall Street and the Square Mile were full of downright admiration for the sheer ingenuity of it all.

    No, as painful as it is, it cannot be done, any more than it would have been right for Greenspan’s Fed to try and sustain the value of shares exchanged at the height of the dotcom bubble – though they tried with excessively low interest rates that fed directly into the next bubble – of housing both in the US and here. The Wall Street tail cannot be allowed to wag the dog. The general health of the economy – which contrary to many – is not just Wall Street - has to take precedence; as in the UK where much maligned manufacturing still contributes far more to GDP than the financial sector. Indeed I always find it funny when Germany and Japan are described as economic basket-cases while enjoying current account balances of 185,000 million dollars and over 200,000 million dollars respectively.

    However, the US is doubly hamstrung – its domestic currency is the world’s first choice as a trading currency. Devaluing the dollar for domestic benefit – terms of trade, boosting exports, raising the price of imports etc - has an international impact. In the early 1970s, the dollar was devalued, oil exporters with huge dollar reserves found that overnight the value of their dollar holdings had been slashed – so the price of oil went up to compensate. Last summer, the dollar fell – and while we were transfixed at the sight of Brits hitting Macy’s with their newfound buying power – up went the price of oil.

    The option is actually to let the overexposed banks go down; to regulate the survivors; to lose the ideologically-charged and inflammatory language and accept that a pragmatic mixture of state and private does work; end the attempts to force developing countries to follow rigidly and arbitrarily imposed free trade rules of development – it is simply mendacious to ignore the fact that the industrial development of every rich nation, the UK, Germany, France, the USA, Japan, China etc, was incubated and fostered by harshly enforced protectionism; focus the state money on homeowners and ordinary families – 20 families each able to buy a Toyota family car for example, contribute a lot more in ‘trickle down’ and multiplier effect than one banker buying a top of the range Beemer; in the end we have to suffer some of the inflation that we’ve been storing up for so long – and maybe we’ll even learn to use less oil in the process.

    As an aside – many of your posters seem to pin to blame on Gordon Brown, Blair et al and I suppose that’s one of the benefits of hindsight – indeed I look forward to some comments, in a few months of course, from St David of Notting Hill and his teenage sidekick George of just what they would have done then to clean up the mess. But seriously and to be fair, if a Labour government had tried to head off the economic catastrophe now taking place by, for example, encouraging a slowdown in the housing market, what howls of anguish would we have heard from these self same people? Just remember what happened when someone in government timidly suggested the Masters of the Universe might pay a fair rate of tax on their earnings: it wasn’t even argued they should pay a higher rate of tax than the ordinary family – just the same as us, or even that of their office cleaners. And the papers, the CBI and the rest went ballistic – seems like we can’t win.

  • Comment number 94.

    Robert does love to trot out random numbers for dramatic effect, but the $60 trillion notional value is about as useful a statistic as what it would cost the insurance industry if all our houses spontaneously combusted at the same time. It just isn't going to happen. (Touch wood).

    As for the phrase;

    "However many analysts say the better measure of the size of market is the $2,000bn fair value of outstanding contracts - because that's an attempt to assess potential losses and gains."

    Well I certainly don't understand it, and I am not sure if Robert does either. But if he is trying to say that some people say that the eventual combined losses may be as much as $2 trillion, well that is no more than a semi educated finger in the air.

    Easy though it is to be patronisingly negative about the whole situation, my money would still be on the Fed and the financial markets solving this between them, which is not to excuse getting into this pickle in the first place.

    The Lloyds insurance market had to re-invent itself and find new ways of raising capital not that long ago. (And there were some pretty apocalyptic predictions then). The banking market will do the same.

    84. Sagamix

    The simplest way of looking at it is to understand that the collateral of choice for interbank lending - the main source of short term bank liquidity - had overwhelmingly become mortgage backed securities based on the US (and to a lesser extent UK) mortgage market. This collateral has become tainted by sub-prime and therefore the interbank lending market has become completely frozen up. Hence Northern Rock, HBoS and others effectively running out of money.

  • Comment number 95.

    Comment 78 : glanafon

    Thanks for your kind words.

    I'd expand your comments to say that of course criticism of "corporate vision" usually results, at best, in zero promotion, so that over time we have ended up with organisations in which the most capable are guaranteed to be at the bottom, and where ther's a good chance of a high level of nincompoopery at the top.

    Judging by recent events, it doesn't seem to be working out too well, does it?

  • Comment number 96.

    I was always told "only ever invest what you can afford to lose" - but not it seems if you'ra a banker ( I think thats how it's spelt). It was like playing 'Virtual Trader' for those guys. Heads you win, oops it's a two headed coin, so heads you win!!. I retire in five years by which time I hope all this mess is sorted out and my investments and pensions start to show something worthwhile to look forward to. I have some colleagues who retire in just over a year and I fear for them in retirement. A few people much wiser than me have been saying for years that hedge funds and all this short selling etc;will end in tears one day, and it has big time. Promises are an intangible, but bankers operate a double standard. You go to a bank for a loan or credit, they want collateral, a banker goes to another banker different story, as if they are all honest christian human beings - they're not. Once again the man in the street is 'cannon fodder'.

  • Comment number 97.

    Re: No 52 (paanewc)

    Indeed it would be hard to blame the short sellers for today's drop. In fact I think the optimism last friday was a bit overdone. I wonder how much of it was attributable to short sellers being forced to buy back their short positions, as opposed to any kind of renewed confidence in the whole system?

    but should we use the stock market as a barometer of economic health?

    I've had enough as far as my PEP mortgage is concerned. Taken out in Feb 97 it was supposed to have provided me with enough to pay off my mortgage with a healthy additional sum to boot. But the market is now lower than it was closing just a matter of months after I took it out and the prospects of an alarming shortfall seem to increase by the day. I've changed to repayment.

    It does trigger the thought that actually the stock market has stunk for some time now. If you take month end closing figures as a guide and April 1984 as a starting point, the index has increased itself by 25% again seven times (using each such increase as a new base). The last time this happened was at the end of March 1998 which showed an increase of 128% above the close at May 1997. For all the problems associated with 1987 and 1992, that still averages out at just under a year for each increase.

    Now we have been waiting over 10 and half years and still counting for such an increase. The market is currently nearly 45% short of achieving the next "25% again" increase and indeed is over 13% LOWER then it was the last time this was achieved.

    Yet for all that everyone's been saying that the last 10 years or so (prior credit crunch) have represented an unparalleled period of growth!

    Is the stock market any barometer of economic health? If so, it would appear things haven't been too good under New Labour, not just Gordon Brown.

  • Comment number 98.

    a few excerpts from the bbc article "the politics of the bail-out" that scare the hell out of me:

    "Just one in four voters (28%) back the plan for a $700bn bail-out, while 37% are opposed and the rest are undecided, according to a new poll by Rasmussen Research conducted over the weekend."

    "One reason for the scepticism about the bail-out is that most people do not yet personally feel affected by the crisis. More predict that their own finances will improve next year than those who say they will get worse, despite their overall pessimism."

    "James Horney of the left-leaning Center for Budget and Policy Priorities, acknowledges that the growing size of the federal deficit - which could double to $600bn to $900bn in the new president's first year - will make it hard to pass any new spending programmes."

    ..this is a really bad time for an election. so it's a good thing that the us gives the incumbent a few months handover period to focus on what is best for the country (never thought i would say that about gwb)

    xtrouble @ 69 - i really like your idea. certainly worth a discussion. but in the current environment the treasury has to go for a tried and tested route, which is the debt consolidation bank.

    i am getting fed up with all of the posts on this blog that confuse "banks" with "bankers". everyone agrees that bankers should be punished. however you do not achieve this by punishing banks. banks = ordinary people's money. please get this into your heads. when a bank fails (and especially when an entire banking system fails), ordinary people suffer. the bankers will lose their jobs in this crisis anyway, but they already have a big cushion of cash to land on. ordinary people do not.

  • Comment number 99.

    China will surely have something to say about the Toxic Bank - as the dollar inevitably tanks, sovereign wealth funds left holding dollars will be trashed and the wealth created by China and the oil economies vanish.

    What fascinates me is how the new reality (expensive or little credit for years to come) will translate into behaviour of our youngsters. Nothing in their experience will equip them for what's coming. They can always text their mates to see what to do. Buy shares in mobile phone companies!!!

    The "masters of the universe" have a lot to answer for - their arrogance will doubtless pass blame to everyone else for not "getting it" - but in the end we all pick up the tab while they enjoy their white yachts.

  • Comment number 100.

    The answer to this problem is relatively simple. The US and UK should launch a hostile takeover of the Caymans/Channel Islands and other tax havens into which the leaders of this city gold rush have squirreled trillions of dollars worth of their ill-gotten gains over the past 20 years.

    The amount of force required would be minimal, and it would be a better vote-winner than invading Iran.

    The bail-out stinks - people who borrowed way more than they could afford (out of greed) will get to keep what they bought without paying for it, while the people that operated the system that lent it to them escape with their commission-based wealth intact.

    I have no desire to see depositors lose their savings when banks fail, but would despise any bail-out that does not see the full burden of value loss fall on those who are responsible and benefited from the upside.


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