[FoRK] The Looter's War on Selfishness

Stephen D. Williams sdw at lig.net
Wed Mar 25 23:39:29 PDT 2009

J. Andrew Rogers wrote:
> On Mar 23, 2009, at 4:15 PM, Stephen D. Williams wrote:
>> Clearly, I meant that banking and investment have, in the area of CDS 
>> and similar instruments, been effectively unregulated.
> The CDS instruments were largely unregulated (as such things go), but 
> no one credible seems to be saying that this was the cause of any 
> problems. In fact, most of the suggestions for useful regulation seem 
> to revolve around establishing a more standardized, central 
> clearinghouse for CDS transactions. The problem is not credit default 
> swaps per se, or any lack of regulation of such instruments, but the 
> fact that so many of them were tied to fraudulent Fannie and Freddie 
> mortgage debt instruments.
Really? "No one credible seems to be saying that..."?
It seems like I just posted this link:
"He conveniently forgot to mention that AIG had spent more than a decade 
systematically scheming to evade U.S. and international regulators, or 
that one of the causes of its "pneumonia" was making colossal, 
world-sinking $500 billion bets with money it didn't have, in a toxic 
and completely unregulated derivatives market.

Nor did anyone mention that when AIG finally got up from its seat at the 
Wall Street casino, broke and busted in the afterdawn light, it owed 
money all over town — and that a huge chunk of your taxpayer dollars in 
this particular bailout scam will be going to pay off the other high 
rollers at its table. Or that this was a casino unique among all 
casinos, one where middle-class taxpayers cover the bets of billionaires."

"Alan Greenspan has stated that the current global credit crisis cannot 
be blamed on mortgages being issued to households with poor credit, but 
rather on the securitization of such mortgages.[83]"
"Then President George W. Bush stated in September 2008: "Once this 
crisis is resolved, there will be time to update our financial 
regulatory structures. Our 21st century global economy remains regulated 
largely by outdated 20th century laws."[98] The Securities and Exchange 
Commission (SEC) has conceded that self-regulation of investment banks 
contributed to the crisis.[99][100]"
"Economist Joseph Stiglitz summarized how credit default swaps 
contributed to the systemic meltdown: "With this complicated 
intertwining of bets of great magnitude, no one could be sure of the 
financial position of anyone else-or even of one's own position. Not 
surprisingly, the credit markets froze."[148]"
"In a June 2008 speech, U.S. Treasury Secretary Timothy Geithner, then 
President and CEO of the NY Federal Reserve Bank, placed significant 
blame for the freezing of credit markets on a "run" on the entities in 
the "parallel" banking system, also called the shadow banking system. 
These entities became critical to the credit markets underpinning the 
financial system, but were not subject to the same regulatory controls."
"Nobel laureate Paul Krugman described the run on the shadow banking 
system as the "core of what happened" to cause the crisis. "As the 
shadow banking system expanded to rival or even surpass conventional 
banking in importance, politicians and government officials should have 
realized that they were re-creating the kind of financial vulnerability 
that made the Great Depression possible--and they should have responded 
by extending regulations and the financial safety net to cover these new 
institutions. Influential figures should have proclaimed a simple rule: 
anything that does what a bank does, anything that has to be rescued in 
crises the way banks are, should be regulated like a bank." He referred 
to this lack of controls as "malign neglect."[153]"

A cursory examination finds (and note that they found your Moral Hazard):
" As Forbes reported last September:

A big part of the reason was most likely that AIG's financial products 
unit, run by Cassano since 1988, was a veritable money machine, pouring 
$6 billion of riches into AIG's coffers from 1988 until 2005.... 
According to The Times, compensation ranged from $423 million to $616 
million for Cassano's group. That would be about 20% of the unit's 
revenue, meaning Cassano was being paid like a hedge fund manager.

This understanding of AIG's incentives may have been what prompted 
Federal Reserve Chair Ben Bernanke to sound off last week:

if there's a single episode in this entire 18 months that has made me 
more angry, I can't think of one, than AIG.... AIG exploited a huge gap 
in the regulatory system.... There was no oversight of the Financial 
Products division. This was a hedge fund, basically, that was attached 
to a large and stable insurance company, made huge numbers of 
irresponsible bets-- took huge losses. There was no regulatory oversight 
because there was a gap in the system.

So let's grant that Cassano and his cohorts may have had ample incentive 
to sell the product. But who would buy? Though he may not have been 
thinking of AIG and its counterparties in particular, Bernanke aptly 
described one potential answer in his remarks today on financial reform 
to address systemic risk:

In a crisis, the authorities have strong incentives to prevent the 
failure of a large, highly interconnected financial firm, because of the 
risks such a failure would pose to the financial system and the broader 
economy. However, the belief of market participants that a particular 
firm is considered too big to fail has many undesirable effects. For 
instance, it reduces market discipline and encourages excessive 
risk-taking by the firm."

"At testimony underway right now on Capitol Hill before Rep. Henry 
Waxman's (D-Calif.) House Oversight committee, Eric Dinallo, the 
superintendent of the New York State Insurance Dept., said AIG's 
troubles came when the insurance giant "got well away from its core 
competency of insurance."

Dinallo said AIG got too far into the credit-default swap market, or 
CDS. The CDS is a complex financial instrument in the bond market in 
which a bondholder hedges his or her bet against the bond failing by 
asking a third-party to insure it.

That's a legitimate and easy-to-regulate process, Dinallo said. The 
problem is that it accounts for only 10 percent of the CDS market.

The other 90 percent, Dinallo said, is what's known as a "naked" CDS, 
which is similar to naked shorting of a stock. And it's entirely 

Hey, Spitzer. This article one the first one above point out that we 
should be paying attention to who the counterparties are that are 
getting the money.
"And who were AIG's trading partners? No shock here: Goldman, Bank of 
America, Merrill Lynch, UBS, JPMorgan Chase, Morgan Stanley, Deutsche 
Bank, Barclays, and on it goes. So now we know for sure what we already 
surmised: The AIG bailout has been a way to hide an enormous second 
round of cash to the same group that had received TARP money already."

> Speaking of the devil, I just saw this journal abstract:
> "Guilty by Association? Regulating Credit Default Swaps"
> http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1368026
>> The fact is that AIG, because it had acquired a little thrift a few 
>> years ago, was able to end up regulated by an agency with a single 
>> person doing relevant oversight. That hardly sounds like too much 
>> regulation.
> This is specious reasoning dripping with non sequitur. How do you 
> think regulation normally works?
Normally, a regulator audits and monitors the entity that it is charged 
with regulating to obtain proof that regulations are being followed. 
Then they provide feedback for gaps and alarms to Congress et al when 
problems are likely or even present. None of that happened. "Specious 
... dripping with non sequitur"? Yah. Sure.
> Furthermore, few people seem to be making the claim that AIG was 
> engaged wholesale violation of regulations, so I am not sure why this 
> point even matters. To the extent that the problem was regulatory, it 
> is because the *regulations* were bad and the financial institutions 
> operated according to those regulatory rules, with regulators showing 
> no particular interest in investigating the obvious weaknesses in the 
> existing rules even when pointed out by those being regulated.
It is part the job of regulators to signal when they are unable to 
accomplish the goals of the regulations they do have.
>> I _want_ boom-bust cycles for technology, and to some extent 
>> cultural, rebirth and creative turnover. Reverse economy of scale is 
>> great when it allows just-in-time viability of new, better ideas. It 
>> is when there is land grab or pyramid or monopoly or some other 
>> sickness in the market that I get uncomfortable. Those are not 
>> healthy, even if they naturally occur.
> This is not an internally consistent argument, and one man's "creative 
> turnover" is another man's "sickness in the market". If you were 
> stricter about how you were analyzing this, you would realize that 
> what you really want is for Maxwell's Demon to violate the 2nd Law of 
> Thermodynamics, which falls under the broader umbrella of "wishful 
> thinking".

Perhaps I'm not being clear enough in identifying the "sickness" vs. 
"creative turnover". I don't think it is too hard to identify either of 
them. Or perhaps you don't believe that monopoly, pyramid schemes, or 
unrestricted land grabs are bad.
>> These seem to happen more often with haphazard deregulation than over 
>> regulation, however I can see it both ways. Transportation (shipping 
>> particularly), telephone, and cell service were all over regulated 
>> for far too long, for instance. Those are not healthy, even if they 
>> naturally occur. Sometimes it seems that perverse incentives abound, 
>> caused by more than poor regulation.
> You have to take the good with the bad. The decreased transaction 
> latency and massively increased flow of information and technology is 
> accelerating many of the "good" things, but it is also increasing the 
> sensitivity of the markets to differences in information latency and 
> distribution. Those are inherently inseparable consequences for all 
> practical purposes.

I don't care about markets being sensitive, as long as they are 
sensitive in constructive ways.
> There is no model of reality that allows a "just so" organization of 
> an economy that is all rainbows and ponies. Denial of the real 
> tradeoffs does not make them go away even though this is the full-time 
> job of Congress it seems.

The housing bubble was an obvious sickness. The gas bubble was another. 
It is likely that we can do better. It might not be likely that we can 
figure out how.

> Cheers,
> J. Andrew Rogers

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