Does anyone have $55 trillion to spare?
I think you need to understand credit default swaps, and why they matter. Will Hutton in The Observer spells out in words even I can understand what lies at "the dark heart of the global financial system" ...
... in particular, credit default swaps, the mechanisms routinely used to insure banks against losses on risky investments. This is a market more than twice the size of the combined GDP of the US, Japan and the EU ...
This market in credit derivatives has grown explosively over the last decade largely in response to the $10 trillion market in securitised assets - the packaging up of income from a huge variety of sources (office rents, port charges, mortgage payments, sport stadiums) and its subsequent sale as a 'security' to be traded between banks.
Plainly, these securities are risky, so the markets invented a system of insurance. A buyer of a securitised bond can purchase what is in effect an insurance contract that will protect him or her against default - a credit default swap (CDS). But unlike the comprehensive insurance contract on your car which you have with one insurance company, these credit default contracts can be freely bought and sold ...
Their purpose was a market solution to make securitisation less risky; in fact, they make it more risky, as we are now witnessing. The collapse of Lehman Brothers - the refusal to bail it out has had cataclysmic consequences - means that it can no longer honour $110bn of bonds, nor $440bn of CDSs it had written. On Friday, the dud contracts were auctioned, with buyers paying a paltry eight cents for every dollar. Put another way, there is now a $414bn hole which somebody holding these contracts has to honour. And if your head is spinning now, add the three bust Icelandic banks. They can no longer honour more than $50bn of bonds, nor a mind-boggling $200bn of CDSs.
The implications are global. The UK government might have frozen Icelandic assets in Britain to get some compensation for the losses, but we are only part of the story. Austrian, Danish and Finnish banks all hold near valueless Icelandic bonds on which they will have bought CDSs from heaven knows whom - Deutsche Bank? A two-bit hedge fund in Dubai? Lehman Brothers? Kaupthing? Shareholders in Barclays and RBS are rightly concerned; the two banks hold a stunning $2.4 trillion of CDSs each - more than the UK's GDP.
We don't know their exposure to Iceland and Lehman Brothers, but with such enormous credit derivative books it would be amazing if there were none. While every bank tries to pass the toxic parcel on to somebody else, the system has to find the money. So will compensation for the near valueless contracts and thus now uninsured debt ultimately be made - and by whom? And because nobody knows - not the regulators, banks or governments - who owns the swaps and whether they are credit-worthy, nobody can answer the question. Maybe holders of insurance policies will get the cash due to them, but will that weaken somebody else? The result - panic.
And here's his conclusion:
For 30 years, greedy, callow, ignorant financiers, supported by no less callow politicians from all the political parties, have proclaimed the wonders of financial innovation and how proud we all should be of the City of London. The price tag for their behaviour is an economic calamity. We should never have bought such snake oil. The consolation in these dark times is that we never will again.
© MMIX~RS~q~RS~~RS~z~RS~28~RS~)
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"The price tag for their behaviour is an economic calamity. We should never have bought such snake oil. The consolation in these dark times is that we never will again."
Hahahaha. What makes him so sure anyone will ever have the chance? In a way it's like saying you'll never run blinfolded over a cliff again. Anyway, it's clear nobody learned anything from the great depression. They forgot how it happened and so removed the restrictions to prevent it from happening again. There's no reason to believe that in a few generations they won't make exactly the same stupid mistake again once this is forgotten.
One analyst on CNN said there are 600 trillion dollars in derivitives in the world. Now it is clear why there is a credit crunch, everyone who has any money left is clinging to it for dear life while they can. How funny to watch CNBC and hear the sigh of relief on Friday afternoon when the DOW only dropped about 130 points at the closing bell. What if it starts down again tomorrow morning. As I write this, markets in Asia are opening. We'll know soon how they are trending.
To me two things are clear. If governments want to avoid a long deep recession, they will have to print lots of money and impose enormous inflation. This is the only way I see this debt being written off in any reasonable time. This is sure to cause major social dislocations and upset the entire existing applecart of the world's economies. Many hopes will be dashed.
The second thing is that the only way government can assure that business will get the credit they need is to create mechanisms to bypass the banks and other lending institutions if necessary and offer credit directly in effect competing with the banks. If the banks go bust, that will be the price they paid for their own foolishness. I think events will continue to move quickly now. Unless drastic steps are taken soon, the economies of the major industrial nations will begin shutting down one by one. The US is on the verge. Where is that 700 billion Congress promised the US market? It's been a whole week already. Time to act is running out quickly. Many businesses operate on month to month, week to week, even day to day cash flows. They are very vulnerable to a credit freeze up.
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#1 MarcusAureliusII
As much as it pains me to agree with your analysis (up to paragraph 3 above) I cannot agree with your solution of 'printing money'.
Printing money is carrying on doing what caused the problem in the first place - creating artificial or fake money by the banks. (By the securitising of poor quality loans and pretending that by doing so they mysteriously became good quality securities, and further constructing a huge pyramid of quasi insurance swaps on top of these.)
Printing money is the Weimar republic / Zimbabwe solution, and it fails.
I do not believe there is a simple or quick solution, but the wholesale printing of money is unwise. Some limited printing of money is inevitable to stabilise the banking system but after that prudent banking must return.
Perhaps you (MAII) think that we can or should continue with NINJA and Liar Loans? If so please justify your view.
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I don't have 55 trillion to hand at the moment so I have drawn it on my Icelandic account. The cheque's in the post.
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All I want is for Gordon Brown to be honest. His Press Conference and later Canary Wharf speeches were equally disgraceful. Brown has been in charge of the money supply for well over 10 years now.
If the RBS chairman can cash in so can Brown. The PM should offer his immediate resignation.
An election should be called now and a judicial review into banking and bankers... we are sleepwalking into oblivion... to bring the message home we should immediately cull the Olympics, ban all bank advertising/ marketing/ sponsorship reducing it to tombstome ads.
Clawing back the banking largesse from the wider financial services sector.
Shorting, Put/Call options should be outlawed, classed and regulated as gambling as should Fund managers loaning any financial instruments or shares in their portfolio.
All self certification mortgage applications should be vetted again any not 100% honest should not benefit from the bail-out and both the submitting broker and lending house fined 10 times the value of any commission and arrangerment fee paid.
It won't happen, politicians leaving office usually end up with one bank group or another but its fun to speculate
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The problem with the conclusion is that unfortunately as long as there are snake oil sellers there will be snake oil buyers.
If in years to come the Government decide to sell their Bank shares back to the public do you think the strap line for the sale could be. "If you see Fred, tell him"?
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Thanks. I now know what a CDR is.
Four years ago a Branch Manager for HSBC told me his Bank was looking for borrowers, not savers. Being thick, I couldn't work out how he could lend out money without depositors. Now I know why I was struggling !!
I trawled the High Street to find a safe home for £100000 18 months ago. HSBC gave me 20 minutes but didn't even bother to put its recommendations in writing. Alliance and Leicester also gave me 20 minutes I asked the Advisor to put his advice in writng as it had been rather a lot for me to absorb in such a short time. He wrote it on the back of an envelope as we walked to the door!
The female advisor from Nationwide put her advice in writing, sending me full details within3 days.
I fully realise no-one cares about money more than its depositor. But do the Banks realise this. How DARE they take such risks!!
Haven't much sympathy for individuals saving with icelandic banks. These accounts are online, and the 'net' has been warning about the risks all year.
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"Does anyone have $55 trillion to spare?"
Well I might be able to help you out if you've got change for a $100 trillion bill :-)
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BTW, I'm not taking any small denominations. I don't want briefcases full of one, two, five, and ten billion dollar bills. I don't even want my wallet cluttered up with 50 and 100 billion dollar bills either. No denominations less than one trillion dollars accepted. I like to travel "light."
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A few evenings ago, someone gave one of the TV news show announcers a Zimbabwean one billion dollar bill. He said it was worth 32 cents in real money. By that measure, 55 trillion dollars is worth $17,600. By the time the inflation resulting from the bailouts take full effect, that's all our 55 trillion will be worth too.
http://www.aol.com.au/news/story/Zimbabweans-battle-money-shortages-as-collectors-buy-hundred-billion-dollar-notes-on-eBay/756291/index.html
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Once again the thin line between sharp, canny business practice and outright criminality has been breached. (The line is so thin now that it can only be seen by an electron microscope.) There's plenty of blame to go round. We ought to bear in mind that the old notion of fiduciary responsibility belongs to all of us: high fliers and High Street investors alike. If the regulators were too reticent to reign in the derivitatives/collateralized debt markets, we should have held Brown's feet to the fire as Chancellor and stopped worshiping at the Temple of Greenspan.
Now there's Hell to pay and we've been handed the bill. What a surprise! Will the City bankers end up in the dock? I think not. Two generations hence this debacle, too will be forgotten.
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