a fat panda

Weakening Derivatives' Super-Priority

Derivatives have many different forms. The ones that I am most acquainted with would be that of senior uncollateralized bank debt. These aren't options at all, nor should they be treated like options. They aren't equity, and should get a preference over equity in a BK.

At no time should deriviatives come behind equity. This would incent managers to write riskier deals by insulating them from the consequences of their stupidity.


On Dec 18 10:55 AM Graham and Dodd Investor wrote:

> Derivatives should not receive priority because it is not "original"
> paper. The normal priority is debt first, then equity, then options,
> including derivatives. As it should be.

How to Fix the Fed - A Lesson from AIG

Separately, the Fed is broken, and minor patches aren't the answer.

The Fed is fundamentally broken when it puts the equity interests of banks above those of Americans. When it refuses to apply haircuts on taxpayer welfare, it is putting the equity interests of bankers above average taxpayers. That is bad. When you drive interest rates to zero, the Fed is putting the equity interests of banks above the interests of Americans living on a fixed income. That is outrageous.

The next time you hear about 20 billion in bonuses going to GS, don't think about Lloyd and his gaggle of welfare mommies. Think of the 80 year-old who gave-up basic needs like a telephone and coffee because the interest on her savings was cut by 90%. Then you can say you think that the Fed is savable. I know her, and I can't.

How to Fix the Fed - A Lesson from AIG

"Fed officials in New York tried meekly to get a better deal, but the trading partners argued that they'd be violating a fiduciary obligation to their own shareholders if they voluntarily gave up cash they were due. That's valid."

It isn't valid. It is absurd. The debt that they were owed is only as good as the counter-party risk that they accepted when they entered the contracts with AIG. If I made a loan to a dead-beat, would it be equally valid that taxpayer should pay me? AIG is not an FDIC insured company. These people took risks, and now want the taxpayer to take the consequence.

The Lehman Bankruptcy: Should All Big Banks in Trouble Fail?

"The same mechanism utilized to enable JP Morgan's absorption of Bear could have been used to enable Barclays to acquire Lehman without a Chapter 11 filing. "

I completely agree with you that the way Lehman failed was almost a worst case, but oddly enough you manage to pick the one resolution that would have been worse.

The 'mechanism' you are talking about is free risk. The taxpayer gave JPM cheap capital and asset guarantees to make that deal go through. It gave investors in and with Lehman the false belief that their investments would be made whole if Lehman failed. If anything, the mechanism that you praise is probably responsible more than anything for the failure at Lehman. If we had let Bear go at its true value, Lehman and others would have been much more willing to raise capital in the equity market. By why do that when people will take the name Lehman as a counterparty risk when they think it is really the taxpayer.

Buffett said, Investment without risk is like Christianity without hell.

The Lehman Bankruptcy: Should All Big Banks in Trouble Fail?

"Paulson was very clear that he could not stomach another bailout, on the heels of Freddie (FRE), Fannie (FNM) and Bear. He was very specific that Wall Street would have to learn a "moral hazard" lesson."

Paulson could stomach a bailout of AIG on the same day. It also could stomach giving assistance to BAC in the Merrill deal. So he could stomach 'bail-out'. How can you seriously hold the belief that Paulson wanted someone to learn any lesson. What lesson can be learned from propping-up the equity of Merrill and let the debt of Lehman go to 9 cents.

More AIG Controversy: Maiden Lane III

Milton Friedman noted that there are four ways to spend money, ranging from spending your money on yourself to spending someone else's money on someone else. He looked at the impact on quality and quantity of consumption. Here is a fifth, you are spending someone else's money on friends and family. The results shouldn't surprse anyone. "The argument for the NY Fed is that the banks had legal contracts that entitled them to the money. "

If you are going to talk about contracts, you can't talk about 2 lines within the contract ignoring the rest of it. The banks were owed money, yes, but these legal contracts carried counter-party risk. So the banks were owed money based on AIGs ability to pay. So the Fed's real argument should be the banks wanted money that didn't exist so we took it from the people who save in dollars.

CDS Regulation: Just One Simple Rule

Kid, Here is my primary concern with CDSs which aren't tied to an insurable asset. They are betting on failure. We are tying up a considerable amount of capital in this market, which that isn't terrible different than a horse race where people are betting on who will finish last. Is that a race you would watch?

In the same way these things are terrible for the economy when you consider the trapped capital and what it could be doing. Consider that hedge fund which borrows a dollar to fund a CDS is responsible for a dollar lost to the economy to promote a bet on failure. We then see the hedge fund do its best to destroy the company in which it has a bet. All told the economy would be better off if the dollar went to open a bar in a brothel.

CDS Regulation: Just One Simple Rule

"Now, here's why it's fallacious logic to apply this reasoning to CDS. If I buy CDS on a company without owning any of the underlying debt, I cannot effect the health of the company."

Rumor has it that you can affect the ability of the company to raise capital. Lowering the ability a company to raise capital in the equity markets does effect the health of the company.

I saw Ackman get on CNBC with a proposal to save the GSEs in which the equity holder would have been completely screwed. The stock opened 25% down. Here it is on SeekingAlpha.

seekingalpha.com/artic...

If the likes have Ackman had to hold the underlying securities to make money on this kind of activity, he wouldn't be so quick to destroy the underlying business.

Understanding the AIG Decision

"With hindsight, it now seems that companies like Goldman Sachs have turned out to be the biggest winners, .... But that wasn’t particularly foreseeable."

The tax payer dumped money into a company that said it was on the verge of bankrupcty. If you can't see that the winners are going to be the people to whom AIG owed money, you are really ought to consider another career. It isn't like you have to have a skill in reading tarot cards to see that coming.

Discretion and Financial Regulation: Always Doing the Wrong Thing

The bigger problem is that the regulator can't attract talent the way the entity to be regulated can. There is more money in working than regulating. This is a tortoise and hare kind of race. The hare is creating new products faster than the tortoise can digest the impact of the products.

How much of the top-talent coming out of college says, "I want to be a bank regulator". That almost sounds like a Monty Python song. It takes years of failure to make someone want to work for the government.

Bankrupt Deadbeat Banks Stiff Taxpayers

Patrick, I think you have understated the problem. If it were only TARP money. There is the TAF, which is also known as cash for trash. There is issuing debt backed by the FDIC, and expanding the FDIC backing of financial accounts. There is the Fed single handedly creating a market for MBS assets. The Fed has created a prefect scenario for bankers to make money by driving shortterm interest rates into the ground. If it were just the TARP money, your ire would be well placed.

We are preserving these people because Washington actually thinks that they know the way back to sensible banking as though they left a trail of breadcrumbs as they happily stumbled into the financial wild.

What Did the Ratings Agencies Know About AIG?

"And what, if anything, did the rating agencies do to warn financial regulators of the global crisis that might ensue, if AIG’s debt ratings were suddenly slashed."

What if anything could anyone have said that would have made our relagulators listen. Here is what Buffett said, and they didn't listen :

".. the macro picture is dangerous and getting more so. Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers, who in addition trade extensively with one other. The troubles of one could quickly infect the others. On top of that, these dealers are owed huge amounts by non-dealer counterparties. Some of these counterparties, as I’ve mentioned, are linked in ways that could cause them to contemporaneously run into a problem because of a single event (such as the implosion of the telecom industry or the precipitous decline in the value of merchant power projects). Linkage, when it suddenly surfaces, can trigger serious systemic problems."

What the blazes are you going to say to someone (Bernanke) who said "(the subprime fallout) will not affect the economy overall.'' in July of 2007 or someone (Paulson) who said in July of 2008 "it's a safe banking system, a sound banking system. Our regulators are on top of it. This is a very manageable situation." At that point, you realize that nothing said to the government would have changed a dollar of the loss.

The Lehman Debacle: Too Much Power to Too Few People

Your article is spot-on.

Capitalism needs stablity and predictibility to keep risk low. The biggest problem with the bail-outs was that they were on such unequal terms. Merrill equity holders were helped out, while the debt holders of Lehman were given nothing. That tells investors that the government is going to pick the winners and losers.

The Five Worst Bailouts

While you might be right about adding the GSEs to this list, GS was given a gift by the tax payer in the form of TARP money. Berkshire Hathaway, which put money into GS, got 10% preferred shares, instead of 5%. Plus Berkshire Hathaway will receive warrants to buy $5 billion in common stock at a strike price of $115 a share, which are exercisable at any time in a five-year period.


On Sep 07 03:24 AM Sean J. Ryan wrote:

> Agreed on AIG; I have yet to hear any actual evidence supporting
> the thesis that its failure would have caused a cascade of failures.
> In asserting that it must be so, the bailout advocates sound like
> medieval ship captains who pointed to the edges of the map and said
> "There be dragons."
>
> But I quarrel with the idea that GS or BAC were really bailouts,
> properly construed.
>
> GS didn't need the capital, and had just demostrated the ability
> to raise private capital (from none other than Buffett) just a month
> before Paulson forced them to take TARP funds.
>
> BAC was never at risk of failure, what the government really bailed
> them out from was the dilution shareholders would have absorbed had
> they been forced to raise capital in the markets.
>
> I'd substitute Fannie and Freddie for GS and BAC on the list of most
> outrageous bailouts.

The Five Worst Bailouts

I would argue that one of the top 5 worst bailouts should be Long-Term Capital. In some sense it set the expectations on Wall Street that you could do business with the AIG Financial Products group and you would be bailed-out of their stupidity.

I am not sure why the financial products group should have become a ward of the state. It could be set-up as a stand alone company, and its claimants could have dissolved the company themselves. The government probably would have had to add some money to the pot, but at least we would have been spared the whole "GS wasn't bailed-out". It would have been very clear how much money was transferred from the taxpayer to the shareholders of GS.