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Forum Post: Credit Default Swaps

Posted 2 years ago on March 20, 2012, 9:30 p.m. EST by mvjobless (370)
This content is user submitted and not an official statement

Finally, the CFTC implemented new regulations on derivatives, credit default swaps, etc. See article in the New York Times today.

46 Comments

46 Comments


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[-] 5 points by francismjenkins (3713) 2 years ago

There was a time (not long ago, early 90's) when most of these instruments were considered illegal gambling, I mean literally, derivatives were considered gambling ... and outlawed! Interestingly, the more we dig into this mess, the more find that change isn't so much the issue, but rather "reversing changes" that were made to our system by corrupt politicians (like Bill Clinton and George Bush).

[-] 1 points by mvjobless (370) 2 years ago

I know what you mean. I think that the powerful money behind the CDS market won't allow the return of Glass Steagall and these new regulations put out by the CFTC are meant to slow walk us back in that direction. But the question is, can it be done in time, that is, in time to stop the insane bankers from crashing the entire global economy. Time will tell.

[-] 2 points by francismjenkins (3713) 2 years ago

Well, impetus is building for restoring GS (I am hearing more and more democrats discussing the issue). I guess living in our world, it's amazing to think that this issue isn't front and center for everyone, but politicians must live in a cocoon :)

[-] -1 points by ibanker (-99) 2 years ago

Really? And could you provide some reference? I don't think so. But I can. Since 1970, futures on various commodities have been traded through the Chicago Board of Trade (CBT). And futures are a type of derivatives. I can list other examples too but suffice it to say you don't know anything about what you are taking. There is a saying "It is better to shut up and make people wonder if you are stupid rather than open your mouth and remove all doubts".

[-] 4 points by francismjenkins (3713) 2 years ago

"The classic example of this is the Commodities Futures Modernization Act of 2000. It basically decriminalized gambling on Wall Street by legalizing credit-default swaps, which were illegal for almost 100 years because they had previously destabilized the economy," Lindt said in an interview published by the university's news bureau. "Special-interest lobbyists slipped provisions into this act, eliminating the anti-gambling enforcement mechanisms in other statutes, which then allowed Wall Street financiers to gamble on these credit-default swaps. Congress has called this 'casino capitalism,' and rightly so. It's a major reason why we're in our current economic mess."

http://www.upi.com/Business_News/Consumer-Corner/2011/05/01/Consumer-Corner-Prof-says-you-cant-gamble-your-way-to-prosperity/UPI-97331304238600/

The CFMA continued an existing 1992 preemption of state laws that prevented any such law from treating eligible OTC derivatives transactions as gambling or otherwise illegal. It also extended that preemption to security-based derivatives that had previously been excluded from the CEA and its preemption of state law.[6]

http://en.wikipedia.org/wiki/Commodity_Futures_Modernization_Act_of_2000

It was the Futures Trading Practices Act of 1992 (FTPA), which first preempted state gambling laws, and then CFMA extended the law to cover more exotic instruments:

The FTPA also provided that such CFTC exemptions preempted any state law that would otherwise make such transactions illegal as gambling or otherwise. See Id.

More specifically, these instruments were prohibited under state gambling laws regulating bucket shops:

These so-called synthetic or naked credit default swaps are pure gambling. In the 19th century many American cities had what were known as bucket shops. A bucket shop had a New York Stock Exchange ticker and would post quotations as they came in. Rather than buy the stock, the customer bet on the tape—e.g., 20 shares of sugar at $100. The shop took a commission: If the stock went to $105, the shop paid; if it went down, the customer lost. Customers could also short a stock. Edwin Lefèvre’s 1923 classic Reminiscences of a Stock Operator vividly describes the turn-of-the century bucket shop. The shops were partially blamed for the Panic of 1907, and the states outlawed them shortly after that.

http://www.chroniclesmagazine.org/2009/06/03/bailing-out-the-bucket-shops/

Okay, there's your references. Oh and btw, you provided no references, just a bare assertion.

But, the story becomes even more convoluted.

During her tenure on the CFTC, Born lobbied Congress and the President to give the CFTC oversight of off-exchange markets for derivatives in addition to its role with respect to exchange-traded derivatives,[4] but her warnings were opposed by other regulators.[5] Born resigned as chairperson on June 1, 1999, shortly after Congress passed legislation prohibiting her agency from regulating derivatives.[6]

http://en.wikipedia.org/wiki/Brooksley_Born

The Clinton Administration pushed Born out of the CFTC, the last thing they needed was the headache of an honest regulator who actually worked on behalf of the public interest. But there's yet even more twists and turns in the sorted details of how we arrived in this place (particularly with respect to how Glass Steagall was overturned), but this should be enough for you to chew on for now.

Oh and btw, the CBT listed its first exchange traded futures contract in 1864, not the 1970's. Anyway, now I see what the real problem is, not only are you guys a gang of crooks, but you're incompetent crooks. I mean WTF, if you're gonna be a gangster, at least watch a few Godfather reruns and learn how it's done.

[-] 1 points by Nevada1 (4835) 2 years ago

Hi Francis, Thank you for post. Best Regards

[-] 0 points by ibanker (-99) 2 years ago

All that you have written here talks about CDS and not derivates in general. Your previous comment was that "derivatives were considered gambling" and my reply was on that. Context bro, context.

[-] 2 points by francismjenkins (3713) 2 years ago

Context? The context is the type of derivative instruments that have caused some of our problems, not futures contracts on commodities (which, as far as I know, has not caused any problems, and in fact serves a good function)? I'd even be willing to say, in theory, credit default swaps could serve a good function, assuming all parties understand the risk (and that's where the need for regulation comes in).

In the first instance, allowing traditionally conservative commercial banking to combine with traditionally high risk investment banking, is not a good mix. You create a situation where the incentives become dysfunctional, and indeed, conflicted. But secondly, there's a good reason why we don't see many problems with futures contracts on commodities, they're exchange traded and regulated by the CFTC.

The thing is we really don't need to imagine what a stable financial industry looks like, we only need to reach back to the sound practices of the not so distant past (or apply the legal structure we have in place in other areas, more broadly). Understanding why our financial system crashed is not rocket science, we have mountains of evidence to show us exactly what happened, and why. That the financial industry continually tries to obfuscate the issue is irrelevant (of course this is what they will try to do, because they perceive regulation as against their interests, and this cancerous idea has infected almost every corner of the financial industry).

[-] -2 points by ibanker (-99) 2 years ago

Forwards arent exchange traded and yet they are very useful and widely used. I dont see any reason for an exchange traded derivative being any more safer than a non exchange traded derivatives. In a OTC case too, both the parties can avail enough market info to make a sound decision. Besides OTC helps provide sufficient flexibility to both parties which exchange traded ones cant.

[-] 2 points by francismjenkins (3713) 2 years ago

Forwards are OTC, and if they're traded over the counter, they can easily be adapted to exchange trading. A regulator cannot understand risk if they lack adequate information regarding the transactions regulated parties are engaging in. The question we have to ask ourselves is whether the "additional flexibility" you mention is worth the risks this activity creates for the system?

I think the answer is clearly NO. Moreover, I'm not even convinced that exchange trading can't be modified in this case, to accommodate this flexibility (if in fact there's a valid need for it).

Just like we outlaw heroin, cocaine, and murder, society has the right to outlaw activities that create widespread harm. There is no right to engage in harmful activity, by mere caveat of framing it as business. Just like we don't allow companies to dump toxins in our ground water, we are perfectly justified in not allowing them to ruin our economy, creating widespread disruption and despair.

[-] 0 points by ibanker (-99) 2 years ago

Now you are getting into rhetoric by comparing derivatives with substance abuse. The sheer volume of derivates traded means that no exchange can ever keep up with the kind of derivatives we can create. Besides, I dont see how putting it on an exchange would make it any safer

[-] 1 points by francismjenkins (3713) 2 years ago

So the volume, in terms of number of transactions, would be more than the number of transactions of say trading activity in the NYSE? That's patently absurd.

[-] 0 points by ibanker (-99) 2 years ago

complexity combined with volume.

[-] 1 points by francismjenkins (3713) 2 years ago

Ahhh, in other words, NO (but let's toss in some obfuscation). Interesting trick, but it won't work here (lest you forget, some of us are also from New York) :)

[-] 0 points by ibanker (-99) 2 years ago

may seem obfuscation to you but look from where i stand and what i do, it appears reasonable

[-] 1 points by francismjenkins (3713) 2 years ago

Yet you've provided absolutely no reason why this claim shouldn't be viewed as absurd. I mean, to say the number of transactions involving credit default swaps comes even close to the number of shares traded on the NYSE, is a ridiculous claim. Moreover, you can't make a bare assertion like the number of transactions added to the complexity of the transactions makes the volume heavier than anything else we currently regulate, without a very good study, supported by a wealth of data, application of relevant mathematical models and computational tools, etc. When you make a "shooting from the hip" statement like that ... it's easy to see that you're full of shit.

I should say, I have a law degree, my undergrad was finance, and I have a decent background in science and mathematics. You're not talking to some kid who's majoring in arts and crafts, who spent his day doing bong hits\, so spare me the bullshit, or better stated, spare yourself the embarrassment.

[-] 0 points by ibanker (-99) 2 years ago

Exchange traded financial instruments are the most simplest there are - shares, options, futures, bonds, ETFs etc. Those are low in complexity and therefore it is easy for an exchange to deal with those, the volume notwithstanding. But structures derivatives products are complex and often tailor made to client requirement and therefore are not meant for everyone's needs.Also considering the sheer ingenuity of financial engineers, exchanges would never be able to value the products we will throw at them.

Take ETFs, there are already worries that the proliferation of ETFs would expose exchanges to huge systemic risks, and there are only some 2000 odd ETFs. Imagine what happens if we throw every conceivable structured product that we can make into the mix. it would be crazy.

So let me repeat, structured derivatives by definition are meant to address specific client needs while anything on an exchange addresses broader needs. They are incongruent. It would be like selling a Buggati Veyron on Walmart

FYI, I dont have a fin degree. I have a math degree.

[-] 0 points by francismjenkins (3713) 2 years ago

Fair enough, but you still don't have a study to quantify this (and you started out by making a specific statement regarding the capacity to regulate these instruments). Nevertheless, there is standardization in these agreements. For one thing, the ISDA contract is a standardized boiler plate agreement. There are enough commonalities in these agreements to allow for some sort of exchange mechanism. The goal would be to simply record transactions so they're transparent to regulators (so risk can be quantified). The nature of these contracts obviously implies that some modification to the concept of "exchange traded" would be necessary (these are negotiated agreements), but there's no rational economic reason for the lack of transparency (besides the fact that the industry naturally resists oversight).

Like I said, I'd like to see Glass Steagall restored (or I should say, the provision overturned by Gramm Leach), which itself solves part of the problem. However, we still need regulation of these instruments, because FDIC insured commercial banks will still need to hedge risk. But you can bet that if the industry continues to resist rational regulation, they will always be an election cycle away from getting hammered by regulation. Wall Street will forever have to pay protection money to Washington, and the price tag will continually rise over time (and bankers will become more unpopular over time). In other words, the long term dynamics are not in your industries favor.

Put it this way, I certainly wouldn't invest my money in a large bank. Maybe if I was an active day trader I might make a quick buy and sell, but as a long term investment, no way. I'd hate to have my livelihood invested in an industry that relies on authoritarian tactics by the state to sustain itself.

That is a dead end road. Remember in Godfather II, when Michael was discussing the Cuban rebels with Hyman Roth. Even though Michael was planning to kill Roth anyway, he made a memorable observation about those rebels. He noticed that rather than being arrested, one rebel pulled the pin on a grenade, killing himself along with many of the soldiers who were trying to arrest him. The moral of the story is devotion. When you have people ready to sleep on concrete, get beat up by cops (and police agencies who are dumb enough to get predictably baited in by their tactics), and do it over and over and over again, you're fucked (unless we become such a horrible totalitarian state, not even bankers will want to live in it). Eventually, the NYPD will probably make a really bad mistake (it's sort of a statistical inevitability), when that happens, things will likely get much worse for large banks.

[-] 1 points by mvjobless (370) 2 years ago

Sure, if you notice the date of this post and simply go to the NY Times archives; search CFTC, I'm sure you can find it if you are really interested. Not to mention just how much publicity credit default swaps has gotten throughout this financial crisis, especially "naked" credit default swaps, one would have to be an ignoramus not to have heard of this. Let's see, how many documentaries and articles have been written about this subject? About 600 hundred trillion, like the value of the credit default swap market.

[-] -1 points by ibanker (-99) 2 years ago

So you judge the usefulness or lack thereof of a financial instrument by the amount of publicity it received? Do you understand what CDS are and why they are used and what purpose they serve in risk management?

[-] 1 points by mvjobless (370) 2 years ago

Yes, I do. And do you know what "naked" credit default swaps are? Maybe you should stop trying to bury the legitimate swap market that is used to hedge in commodoties markets under the criminal CDS market being perpetrated by the big banks, in some effort to confuse people. Simon Johnson, Noriel Roubini, William Black, are all good sources I rely on.

[-] -3 points by DKAtoday (22325) from Coon Rapids, MN 2 years ago

Risk Management on WallStreet?

Oh . . . you mean the public's money. Yeah there is that.

Fortunate for you to have such a generous government.

Take all the risks you want. Who cares if you have a toxic meltdown here and there.

[-] -2 points by ibanker (-99) 2 years ago

how many financial crisis of this level did we have in the last 50 years? Barring the great depression and the japanese asset price bubble, not much really. A few hiccups, nothing major.

Stop the BS rhetoric. Take it to one of your OWS get together where ignorant people will clap at this.

[-] -3 points by DKAtoday (22325) from Coon Rapids, MN 2 years ago

I'm sorry are you still dizzy from the troll juggling today? Perhaps you should have volunteered for the troll toss or something less spiny anyway.

You trolls are such good sports and good sport.

Thanks for playing.

[-] 0 points by BullsAndBears (-36) 2 years ago

Classic ows move. Not intelligent enough to have a logical debate so you resort to name calling. Just cut your losses and admit you dont know what youre talking about.

[-] 3 points by TrevorMnemonic (5827) 2 years ago

"Who is the "brilliant" person that came and said "let's do credit default swaps?" ... Find him... Fire him!"

  • one of my favorite quotes during the bailouts.

Dear Tax Payer - http://www.youtube.com/watch?v=-o9BBNUBs1w

[-] 2 points by geo (2638) from Concord, NC 2 years ago

LOL.....Fire him??? They gave him a Noble Prize in Economic Sciences, 1997 for creating the formula to value derivatives.... a guy named Merton.

[-] -1 points by ibanker (-99) 2 years ago

It's less of a formula and more of a method. Then again, what would you know.

[-] 2 points by geo (2638) from Concord, NC 2 years ago

The method was coded. It was a mathematical model. What would I know? Four years with Cantor Fitzgerald, the bond traders, and four more years with Wachovia/Wells Fargo.

[-] -2 points by ibanker (-99) 2 years ago

As a trader? And yet you think derivatives are bad?

[-] 3 points by geo (2638) from Concord, NC 2 years ago

You think 'riskless capitalism' is good? The world of hedging shouldn't exist.

[-] -1 points by ibanker (-99) 2 years ago

Yes surely. companies should mitigate risks, thats common sense. Hedging helps companies to mitigate unforeseen risks and get some measure of certainty. Dude, I dont know what work you did for Cantor or Wachovia but anyone who does not understand the importance of hedging risks has serious issues.

[-] 2 points by geo (2638) from Concord, NC 2 years ago

Or they have learned to see the system for what it really is. Adam Smith would be appalled. Excuse me but I have to go to work now. Just agree to disagree.

[-] 1 points by mvjobless (370) 2 years ago

If my research is correct, JP Morgan invented these credit default swaps to use in house. The rest is history.

[-] 0 points by ibanker (-99) 2 years ago

I don't think it takes a particularly brilliant person to realize the value of CDS. It's a great way to mitigate risk and get protection. In many ways you can equate it to say a life insurance for an organization/project. But then all this that i am taking about is pure logic. And when did logic ever win over rhetoric. So keep spewing rhetoric.

[-] 1 points by TrevorMnemonic (5827) 2 years ago

I think you need to watch the full video. The quote goes deeper than that and is about the way they were used that created a massive problem.

Let's see what kind of person you are. True or False: The Financial Modernization Act of 1999 was great.

[-] -1 points by ibanker (-99) 2 years ago

Great? I wish I had the luxury of giving such binary opinions. Great or not great. Good or Evil. Remember, only a Sith deals in absolutes.

[-] 1 points by TrevorMnemonic (5827) 2 years ago

The correct answer is FALSE. It was a terrible piece of legislation.

[-] -1 points by ibanker (-99) 2 years ago

Again I dont deal in absolutes. Think whatever you want to.

[-] 1 points by TrevorMnemonic (5827) 2 years ago

I deal with algebra and facts. You should try them. They really open your eyes to truth.

[-] -1 points by ibanker (-99) 2 years ago

algebra... hmm heard about those stuff... but then i m sure u wud know those better than me considering i am only a undergrad in math (with a minor in CS) from a univ that only comes in the top 10 rankings each year and I work as a quant at a ibank. I sure am not as good as you with algebra but I will sure, as you insist, will try them. Thanks for the life changing suggestion

[-] 2 points by geo (2638) from Concord, NC 2 years ago

It's a smoke screen at best. Until banks are required to put their exposure due to derivatives on the balance sheets, there will be no real transparency.

[-] -1 points by ibanker (-99) 2 years ago

FYI they do

[-] 2 points by geo (2638) from Concord, NC 2 years ago

Thats why Wachovia put out their quarterly reports and then went belly up over the course of a weekend. No where was it mentioned in any of the reports that Wachovia was in the RED because of the bad paper they were holding... it wasn't on the books. Had the investors known of the billions of dollars of debt in CDO's/CDS's they were carrying they would have run for the hills.

[-] 0 points by Secretariat (33) 2 years ago

""NATO is staging "Massacre of Christians in Syria by Muslims", by bringing Al Qaida and other radical Islamists to Syria, in order to initiate a war, where they can nuke Iran, give a lesson to rising China, control Middle East oil resources, and allow some people to print as much money as they wish by using petrodollars, so they can control the society and the world through their wealth and power. This will also allow capitalism to continue by breaking the Eastern and the Socialist spirituality which is growing around the world and which is the biggest threat to capitalist ruling elite. ""

[-] 1 points by mvjobless (370) 2 years ago

Yes, I have found different sources that say the CIA is all over Syria and setting up what is happening there now. I don't doubt the possibility of the scenario you laid out above however I wonder if they can really pull that off given the catastrophe that is our domestic front. It feels more and more like a race between good and evil

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