derivatives

Obama and Geithner - Back to the Future on Corporate Tax Breaks and Derivative Deregulation

Michael Collins
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Speculation reigns supreme in your nation's capital. Who is next in line after the bin Laden operation? The bipartisan coalition directing the war on terror forgot one important fact about the security of the United States of America. It doesn't matter who they kill overseas, the assault on almost all citizens continues unabated at home. No one is doing anything to stop it. Only the financial and political elite remain immune. (Image-WikiCommons)

According to the National Bureau of Economic Research, the national economic collapse (aka recession) ended June 2009. That's news to the 55% of the public that believe we're in either a recession or depression (April 2011).

Picking Over the Financial Reform Corpse

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Matt Taibbi has written an autopsy report on the lack of real financial reform and how it happened. In Wall Street's Big Win, Taibbi first sums up what happened in the last decade:

The huge profits that Wall Street earned in the past decade were driven in large part by a single, far-reaching scheme, one in which bankers, home lenders and other players exploited loopholes in the system to magically transform subprime home borrowers into AAA investments, sell them off to unsuspecting pension funds and foreign trade unions and other suckers, then multiply their score by leveraging their phony-baloney deals over and over. It was pure ­financial alchemy – turning ­manure into gold, then spinning it Rumpelstiltskin-style into vast profits using complex, mostly unregulated new instruments that almost no one outside of a few experts in the field really understood. With the government borrowing mountains of Chinese and Saudi cash to fight two crazy wars, and the domestic manufacturing base mostly vanished overseas, this massive fraud for all intents and purposes was the American economy in the 2000s; we were a nation subsisting on an elaborate check-­bouncing scheme.

Many of us contend the dot con bust, 9/11 fueled, offshore outsourcing 2001 recession never really recovered. It was masked by the glorified ponzi scheme described above.

An Update on Financial Reform Legislative Shenanigans

Update: The bill passed, 59-39. Next stop will be the conference committee, where a manager's amendment along with other modifications are possible.

Update: Republicans blocked the Merkley-Levin amendment. The amendment which would have stopped proprietary trading with taxpayers, account holders money. Nasdaq News:

Two of the most anxiously awaited amendments to the U.S. Senate's financial-overhaul bill will not get votes after Republicans maneuvered to kill a controversial plan to sharply curb a lucrative Wall Street trading business.

As the endgame on the bill drew close, Republican leaders convinced U.S. Sen. Sam Brownback (R., Kan.) to withdraw his hot-button amendment that would have excluded auto dealers from oversight by the new consumer watchdog created by the bill.

Brownback's move effectively squashed a second, contentious amendment that had been attached, for strategic reason, to the Brownback amendment. The second amendment--hotly opposed by Wall Street--would have banned most banks from using their own capital to make market bets, so-called proprietary trading.

Derivatives, derivatives, derivatives!

Over and over again, we discover, upon some obscure audit or forensic accounting report being published, derivatives were the real culprit behind some bank/credit union/country failing.

Now we have Greece considering suing U.S. banks over credit default swaps on their sovereign debt and other derivatives.

Greece is considering taking legal action against U.S. investment banks that might have contributed to the country’s debt crisis, Prime Minister George Papandreou said.

“I wouldn’t rule out that this may be a recourse,” Papandreou said.

While this interview is making headlines buzz, to read the details of why Greece would consider suing U.S. banks click here and here

What a surprise, having a vehicle that pays out hansomely if a nation defaults on their debt might create some shady dealings. Bloomberg:

European Central Bank President Jean-Claude Trichet said May 6 that he was concerned about speculation in bond markets using credit default swaps. “By first buying the CDS and then trying to affect market sentiment by going short on the underlying bond, investors can make large profits,” he said.

Rethinking the Political Economy

One of the most misused and abused terms in language today is "free market".
The definition of a free market is business governed by supply and demand, and not restrained by government regulation or subsidy.
This definition is often used in conjunction with environmental regulation and minimum wage laws, but almost never with trade between firms and corporations. Which is the problem, because without government protections this "free market" wouldn't exist.

What's Happening with Financial Reform Legislation?

As what happens in our Congress, things change, get confusing and obscured. Last we left off on Financial reform, we noted the Dodd bill was a Dud and things have degenerated into political circus.

Now, Senator Lincoln has introduced a new bill which will be voted on in the The Senate agriculture committee. The current guesses are it will be voted out of committee and onto the Senate floor by April 26th. Here is the actual bill text and here is her press release:

The Wall Street Transparency and Accountability Act of 2010

Senate Committee on Agriculture, Nutrition, and Forestry, Chairman Blanche Lincoln

 

Chris Dodd's wife and derivatives trading - "all in the family"


It’s all in the family! Senator Chris Dodd writes a financial reform bill but forgets to regulate derivatives, “financial weapons of mass destruction.” Then we find out that his wife works for the owners of two exchanges that will very likely benefit from Dodd's “reform” legislation.

 

They make the rules. They take the money, all of it, and leave us with debt. And they tell us it’s all legal.

Here’s the story.

Pricing a CDO - Not only Bad Math, Bad Computation too

A working paper, Computational complexity and informational asymmetry in financial products, Sanjeev Arora, Boaz Barak, Markus Brunnermeier, Rong Ge. sheds some light on the complex mathematical models upon which credit default obligations and other derivatives are based.

What Arora et al. prove is not only are many derivative mathematical models impossible to compute, never mind in real time, because they require more computing power than the world possesses, the missing information to run a mathematical model is a very good place to cheat with.

To understand what CDOs, derivatives are, see this post, complete with video tutorials. For some background on the mathematics behind derivatives, read We Want the Formula and this one on some of the probability functions.

Onto the paper. Firstly this quote:

One of our main results suggests that it may be computationally intractable to price derivatives even when buyers know almost all of the relevant information, and furthermore this is true even in very simple models of asset yields.

Derivatives, Remember Them? Obama's Legislative Proposal

A legislative proposal for derivatives regulation has been release from the Obama administration. The actual bill is IMPROVEMENTS TO REGULATION OF
OVER-THE-COUNTER DERIVATIVES MARKETS
(large pdf). Here is he U.S. Treasury overview of the bill in a press release.

First, what kills me is the Treasury calls OTC and CDSes financial innovation. I don't think mathematical fiction is a new science frankly. It's so strange to me that no one is looking to regulate these instruments themselves.

Ok, what's in the bill (or what is not in it)?

The Wall Street Journal:

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