CaptainJJack

Dinallo Has Common Sense Solutions on CDS and Regulatory Issues

The Credit Default Swap is not an insurance contract. There is no way to pool the risk.

It is a risk transfer product, just like a futures contract or an interest rate swap contract.

The issue is "contagion" , and it is why you do not see insurance contracts written on investment risk, generally. The environment that creates a problem for one creates the problem in many.

The correct way to regulate these is in an exchange, like other investment derivatives. They should be subject to the standard rules on market manipulation and clearing, in cash, everyday, at market.

There is no need for an insurable interest anymore than there is a need for an insurable interest in an interest rate swap or a grain futures contract.

Finally, I could not agree more that the repeal of Glass Steagall was the single biggest cause of this crisis. The Fed and the FDIC were formed in recognition that commercial banks were historically not regionally diversified, and often when a town or region went down, so did the banks.

However, the Fed requires that these banks hold much greater capital, with leverage at roughly 10 times, and the FDIC requires that the commercial banks fund the losses. Given the margins in this business, these banks achieve high ROEs even with the low leverage.

The Fed And FDIC were never designed to backstop an investment bank. The investment banks primary strategy is to borrow money and trade, and there is almost no way they can survive long term without 30+ leverage, the margins are far to thin.

As long as the one type of bank can own the other, we will see bad outcomes.

Picking Goldman's Brain for Long / Short Strategies

What I can never seem to get from Goldman or anybody else is the extent to which the REITs are obligated with their mortgages. I cannot find it directly addressed in any of the prospectuses I read, either.

If a REIT owns a property, and it fails to make the mortgage payments and goes into foreclosure, is the REIT obligated beyond turning over the keys to the building? If the answer is yes, then REITs are still horrible.

However, if the answer is "no" (and I believe the answer is no based on no more than my own sense that if the answer were yes, it would be called out in the prospectuses and by the analysts directly), then REITs could turn out very well since the losses on a given property are limited to the equity value, the current valuations already reflect a large portion of the equity write-offs.

And, the buildings are still around, but now are selling at lower valuations. Anybody who lived through the 1990 cycle saw buildings changing owners over and over until the prices paid were justified by the building operating cash flow.

So, the question is, are they like stock holders whose losses are limited to the equity in the building, or are they like private developers who often use the equity of one building as a guarantee of performance for another building?

Was the AIG Bailout a Goldman Bailout by Proxy?

I had also heard that some very big beneficiaries were European Banks, and I wonder if International Central Bank relations did not have a very important influence.

All I remember was that after Freddie and Fannie collapsed, things started to come apart very, very fast. In the banks, the standing orders were to collect from all the other banks before paying out any money. In other words, make sure you got paid, first, before releasing any money.

Obviously, this led to things seizing up, and LIBOR spreads blew out.

From what I remember, the Bear Stearns came apart, then the GSEs, then the AIG bailout, and the final straw was Lehman, where they simply ran out of money and/or viable buyers.

That is when TARP was born, and although the initial rational, buying toxic assets, was poorly reasoned and driven by ideology more than anything else, the driving force was that they needed more funding.

I love these 20/20 hindsight criticisms of this and TARP. With the benefit of 20/20 hindsight, I could have been a billionaire.

From where I sit, Ben Bernanke and Hank Paulson should get the Freedom Medal for saving the world from a financial collapse.

High Frequency Trading: We Fear What We Do Not Understand

I appreciate this article, but there is one area that bothers me.

The underlying assumption is that markets are rational and that there is an equilibrium price, even in the short run. I you believe this, then all that program trading does is get you to the price you would have gotten to anyway, just faster.

But I do not believe this is true in the short run. The market "votes" in the short run and "weighs" in the long run.

In the short run, the stock may not stabilize around an equilibrium and I think it is possible to pound a stock, especially a financial stock that essentially trades on the amount of trust people have in the institution, into oblivion.

The issue is not so much front running as stock price manipulation by piling on

Obama's Donut Economics

You can add tax policy to the list of ineffective job creation ideas.

The tax cuts under Bush helped low wage workers buy more Chinese goods at WalMart and high wage workers buy more BMWs from Germany.

You factor out the purchases financed by home equity loans, and the US GDP did not grow at all under Bush lower taxes.

Obama's tax cuts are no better and are about as effective as the tax cuts last year. What people didn't save, they bought from China.

Who Will Profit from Mark to Market Changes?

I agree with falanke. Mark to market will not go away, but there will be clarification on how to value assets when there is no market.

I suspect this WILL provide a lot of relief, but it will be no panacea, and where an MBS has been traded, that price will be reflected in setting the value as I understand the way FASB is going.

The biggest mistake FASB made was moving the "market value" of the assets from a footnote to the balance sheet.

I believe this was in response to what I call "efficient market Nazis" who believed that the markets would ignore fluctuations in the asset values in setting the price of the firm (i.e.the stock price). Further, they believed (and still believe) anything other than today's market value for an asset is delusional.

While this may be great in theory, it ignores the reality that there are short to medium term trading strategies that take advantage of market mis-pricing through fear and greed, emotions that overrule efficient market rational thought, and if the firm is vulnerable enough, they can destroy the firm.

Although I do not follow the International Accounting Standards, a possible way out of this mess is to adopt a new set of recognized standards that had the benefit of seeing how our FASB mess unfolded.

America's Banks: Are They Really Insolvent?

Even though there are a lot of comments here, I feel compelled to add my own solution:

I think the banks should be required to mark to market each quarter, BUT it should be in a footnote and not part of the actual balance sheet. This IS a distinction with a difference because the capital adequacy ratios and the ability to lend should be based on the balance sheet and not the footnote numbers.

The numbers that go on the balance sheet should reflect the ECONOMIC reality as the bank knows it at the end of each quarter, and that speaks to the question of WHEN and how much cash flow the bank is truly expecting from the asset.

If the bank expects that it will only receive 50% of the cashflow from the asset that it had been expecting to receive, it should market the asset down to 50% and put THAT amount on its balance sheet.

Yes, this IS mark to model, and yes, it is subject to manipulation, but that is why the true market value is in the footnote. The bank could play some games, here, but in the end, the analyst, and regulator, can see both numbers.

In other words, it should be based on the bank's expected cash flow.

I believe you will see that the "stress testing" outlined by Geithner is designed to effectively move from market to market to expected cash flow as the basis for evaluating the bank's creditworthiness and solidity.

I guess Geithner feels he cannot avoid mark to market balance sheets, so he is doing the next best thing to what I am suggesting.

Finally, I predict that Geithner will wait until the stress test is pretty far along before starting the auction market, but that needs to be set up to get the true market values to keep everybody honest, and it will.

On Buffett-Back Riding

I have owned BRK for years, and while I did not follow Buffet into GE and GS, I would have done the deals, and I still think they will work.

What I look for is high ROE with low P/E's; i.e. good stocks at cheap prices.

I believe the ROE is the single biggest test of competitive advantage, and if the ROE is consistently high for long periods of time, there is a reason for it. I think GE and GS would fit that bill today, as would GE.

However, there are three things that are SIGNIFICANTLY different from the eras where Buffet made great picks:

1. The credit system is not functioning, and even strong companies can get killed if they cannot get financing. This is a system that may be permanently damaged, and it threatens GE, GS, WFC, USB, and AMEX.

2. The crisis is global, and it is occurring across all asset classes. It is the most serious crisis in my lifetime, and it will last for as long as it takes to get in the financial system leverage down.

3. The role of government has gone from a passive, referee to an active investor with objectives that include a lot more than getting a good return.

We are in uncharted waters, and Buffet is basically making the bet that things will work out. He has the staying power to make that bet work, but it is certainly not without significant risk.