Derivative Dribble

HIGHLY RECOMMENDED: Washington Post takes us inside AIG-FP (“If they give back the money, then they will walk. And they will walk into the arms of AIG’s counterparties.”)

My latest for The Atlantic

HIGHLY RECOMMENDED: This Blog

Tuesday March 17, 2009

Fortune does a good job getting the facts straight about CDS

Friday March 13, 2009

Berkshire downgraded by Fitch

Thursday March 12, 2009

Gates back on top as crisis wipes out other billionaires

Monday March 9, 2009

Hilarious

Friday March 6, 2009

Alpha Ville on the ocean of looming corporate defaults

Thursday March 5. 2009

Citi drops below $1

My latest for the Atlantic

Wednesday March 4, 2009

FDIC might go insolvent

Tuesday March 3, 2009

Derivatives market remains profitable business for J.P. Morgan

Very interesting data on the multiplier effect from the CBO

Tuesday February 24, 2009

My latest article for the Atlantic

Monday February 23, 2009

FT on the prospect of a depression in Spain

Rick Santelli rouses traders over Obama’s housing plan

Sunday February 22, 2009

Citi in talks with U.S. Government over common equity stake

Thursday February 19, 2009

Must read: Buiter rips apart Obama’s housing plan

Saturday February 14, 2009

Collective decision making in animals and humans

Thursday February 12, 2009

New York edges closer to expanding rent control

Wednesday February 11, 2009

Rep. Kanjorski tells us how close to the edge we were

Treasury’s 6 and a half page plan to save the world

Tuesday February 10, 2009

Great article by the FT’s John Authers on the prospects of an equity bounce-back

Friday February 5, 2009

U.S. cuts almost 600,000 jobs

Wednesday February 4, 2009

My latest article for the Atlantic Business Channel

Tuesday February 3, 2009

E.U. pushes CDS exchange

Monday February 2, 2009

For my fellow music lovers: Classic Arts Showcase on YouTube

Consumers turn to thrift

Unemployment hits China

S&P says 200 defaults expected

Thursday January 30, 2009

Crash like this expected only once over next 34,000 years

Contraction bad, but better than expected

Wednesday January 28, 2009

John Authors on the perception of a bargain

Capacity drops in France and Italy

World growth worst in 60 years

Tuesday January 27, 2009

Japanese CDS spreads widen

The original Carlo Ponzi

Madoff Jr. gets busted in $400 million Ponzi scheme

Great article from Atlantic’s new business section

Monday January 26, 2009

Iceland’s government tumbles under pressure

Unemployment rate looms over banking sector

Redemptions slam hedge funds

Wednesday January 23, 2009

Obama thinks stimulus package could be ready mid February

Muni derivatives under investigation

Cocoa prices on the move

Very interesting John Authers video on the prospect of a slow down in China

Pope goes digital

U.K. officially in a recession

Wednesday January 22, 2009

Google beats the heard

N.Y. Times provides some perspective on the severity of the crisis

U.S. accuses China of currency manipulation

Tuesday January 21, 2009

Bank market capitalization, then and now

John Authers article and video on the second wave of banking turmoil

Black Rock’s profits plummet

Monday January 20, 2009

Obama sworn in

Reality might be a hologram

Banking crisis part II?

Thursday January 15, 2009

Volatility back on the rise

California to go insolvent in weeks

Big numbers for foreclosures in 2008

The wealthy slammed by the down turn

Testosterone and income

Roubini predicts more gloom

Bank stocks plummet

Mortgage rates hit record low

Wednesday January 14, 2009

Credit markets show signs of life despite rest of world

Martin Wolf takes on Obama’s stimulus package

CDS market predicts bleak future for sovereigns

Greece downgraded

Retail takes a nose dive

Banks need bigger TARP

Tuesday January 13, 2009

Citi gets closer to break up

Still no Russian gas flowing into E.U.

Pension funds hammered, seek Federal money

Release of TARP funds faces stiff opposition

U.S. imports plummet

Bernanke says fiscal measures not enough

Monday January 12, 2009

John Authers takes a look at sovereign default and the Euro

Proprietary trading winding down

Banks suspected in facilitating purchase of weapons for Iran

Barney Frank proposes drastic changes to TARP and Hope For Homeowners Act (a summary of the bill and the actual text can be found here)

A look at China

Sovereign downgrades looming

Friday January 9, 2009

Cash flowing back to emerging markets

No exit

Obama puts pressure on Congress over stimulus package

Congress points fingers at Treasury over TARP

Thursday January 8, 2009

Citi supports bankruptcy law reform

Very interesting article on government bonds

Dismal retail figures

Wednesday January 7, 2009

Gas supply to Europe cut

BofA finally sells stake in Chinese Bank

Rough month for employment

A closer look at Larry Summers

German bond auction fails: bad sign for sovereigns

Tuesday January 6, 2009

Pending home sales drop to record lows

Oil picks up steam

Monday January 5, 2009

Dim lights ahead

A bit of unexpected historical perspective on the credit crisis

Wednesday December 31, 2008

John Authers constructs a timeline of the disasters of 2008

Steepest drop ever for commodities

Muni market dries up as states face looming budget gaps

A brief history of numbers

Paulson says U.S. lacked tools to handle crisis

Tuesday December 30, 2008

Good series of video interviews of Roubini

All about numbers

U.S. home prices plummet 18%

Automakers consider change to supply model to prevent supply-side failures

The economics of climate change

Monday December 29, 2008

Retail bankruptcies and store closings on the rise

Corporate profits likely to continue losing streak

Conventional media outlets seek partnership with internet big wigs

John Authers sees gloomy future for equities

High hopes and big numbers

Tuesday December 23, 2008

U. Chicago points fingers at the bailout

Interactive applet rating financial big wigs

Monday December 22, 2008

Pound sinks to record low against basket of currencies

Toyota predicts first loss ever

Oil continues to slide despite OPEC cuts

Friday December 19, 2008

Mortgage interest rates drop

China blocks sale of assets

Sarkozy forces lending

Early Christmas for automakers

Thursday December 18, 2008

Gather ye rosebuds while ye may

Mining sector calls for unprecedented cut backs

Obama taps new SEC chief

Wednesday December 17, 2008

Tis dangerous on the high seas!

Deflation hits E.U.

Thrifty Texan to buy up banks

Public perception dims

More monoline madness

Tuesday December 16, 2008

Up to your ears

Free money!

Monday December 15, 2008

The long arm of Madoff

Derivative Dribble spots economic news faster than the MSM

Friday December 12, 2008

Bifurcation of the debt markets

Goldman predicts slow recovery for oil

California gets downgraded

The story of 2008

The ever entertaining Jim Rogers

India gets roped into the slow down

Senate puts the brakes on the Big 3

Thursday December 11, 2008

When fiat fails

It was a very bad year

This time the floor is falling

Wednesday December 10, 2008

The beginning of a market for toxic instruments?

Deflationary pressure in China?

Costly advice

John Authers looks back

Tuesday December 9, 2008

The title speaks for itself

Russia walks the sovereign plank: debt downgraded

OTC commodities central clearing house ready for launch

Corporate default rates set to rise

Monday December 8, 2008

BREAKING NEWS: Federal legislation proposed to regulate OTC Market

The invisible hand and the sovereign strangle

Video game nerds prove recession proof

Friday December 5, 2008

Economics at ground level

More truly awful news, this time it’s California

Distraction from all the bad news

Thursday December 4, 2008

Black Friday yields red November for retail

China Investment Corp won’t invest in U.S. financial institutions

$25 Oil

Wednesday December 3, 2008

CDS Index hits record level

Some rather awful news

Great explanation of Money Markets

Real yield on Treasuries dip into negative territory

Tuesday December 2, 2008

Bigger than the bail out

The ever increasing interest in CDS

Paulson v. Paulson

Monday December 1, 2008

BRIC nations to offer consumption through downturn

U.S. officially in recession

The Swiss financial throne under siege

Wednesday November 26, 2008

Banker’s Compensation

The space near zero

Shift from OTC to exchanges gains more momentum

Ship while you can

Tuesday November 25, 2008

The science of petty crime

New lending facility for instruments backed by consumer debt

Monday Novemer 24, 2008

Treasury pony’s up huge money

Buffett discloses info on Berkshire’s portfolio of financial weapons of mass destruction

More historical data on declines

Daily Liquidation

Citi gets early Christmas present and Paulson works another weekend

Friday November 21, 2008

Goldman predicts bleak outlook for U.S. Economy

One way ticket to safety

Thursday November 20, 2008

Slightly cooler heads in Iceland after IMF/Nordic bailout

The CDS Market becomes the new economic indicator

I’ve seen more and more of this type of analysis. The CDS market is becoming more and more relevant as an economic indicator. Keep up the good work Alpha Ville!

Inventories Swell Kudos to Naked Capitalism!

Following the money supply

Wednesday November 19, 2008

More monoline downgrades

CDS markets predict bleak future

CDS clearing house seems likely

Tuesday November 18, 2008

Detroit gets coals for Christmas

Fun with economic data

Japan wins economic beauty contest

Historical perspective on volatility

CIA Factbook v2

Monday November 17, 2008

Highly recommended: Interviews with Jim Rogers

The dangers of subjective valuation

Good article, even though I disagree

New York City real estate falls from grace

Greetings from Earth!

Citibank throws garage sale

Japan in technical recession

Friday November 14, 2008

FDIC to insure home mortgages

Eurozone in technical recession

Pensioners driven to theft

Thursday November 13, 2008

More complex than a synthetic CDO

Derivative Dribble considers asking Fed for money

Germany in technical recession

Greenwich points to Wall Street

Would be CDS regulator vindicated (?)

Paulson pulls the TARP from under the market

Pounded

In The Shadows Of Geometry

Comment »

Frontline Special On Financial Regulation

In Uncategorized on October 20, 2009 at 8:20 am

All,

PBS will be airing an episode of Frontline focused on financial regulation tonight (Tuesday, October 20, 2009 ) at 9 PM (ET) for those of you in NYC, but check local listings as airing times may differ in your location. I’m told that derivatives will be a featured topic. We’ll see what they say… While the title of the episode, “The Warning,” suggests that I will probably not agree with many of the arguments they put forth, Frontline is generally a very high quality program and I encourage all of you to watch it. I will be watching as well.

***UPDATE*** If you missed the program you can watch it online here. I was honestly quite disappointed with the program. It presented very complex issues in a terribly one-sided manner, utilized a very corny plot of a thwarted would be hero and of course referred to the OTC derivatives market as a $500 trillion “complex and arcane” industry. Clearly they don’t read this blog.

I understand it’s T.V., and you can’t get into that much detail, but there was absolutely no discussion of what derivatives are used for, no discussion of how widely used they are, and they seemed to suggest that OTC derivatives were at the heart of this crisis, which is a dubious claim at best. In any case, watch the video. If anything, it’s a valuable insight into how poorly understood the industry is, even among intelligent people. When you’re done watching the video, take a look at this article for a bit more context and color on the OTC derivatives market.

Regards,

Charles

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Asset Bubbles and Economic Activity

In Uncategorized on October 11, 2009 at 1:05 pm

Also published on the Atlantic Monthly’s Business Channel.

The internet economic debate du jour is summed up nicely by economist Paul Krugman as follows here:

why [doesn't] a housing boom — which requires shifting resources into housing — … produce the same kind of unemployment as a housing bust that shifts resources out of housing.

And here:

why … isn’t [ there ] mass unemployment when bubbles are growing as well as shrinking — why didn’t we need high unemployment elsewhere to get those people into the nail-pounding-in-Nevada business?

His point is, on balance, both booms and busts involve the reallocation of resources, yet only busts seem to produce mass unemployment. While Krugman and Arnold Kling* are wrapped up in a debate about how the question influences our understanding of government stimulus, I’d like to simply offer up an answer.

For any fixed amount of capital available for investment, an increase in the amount of capital allocated to one area implies that the amount of capital allocated to some other area must have decreased. In short, capital allocation with a fixed amount of capital is a zero sum game. The same is true of society’s capital. If the pie doesn’t grow, but stays fixed, and society shifts more of its capital into one area of economic activity, it necessarily implies that we have taken capital away from some other activity.

Asset bubbles, however, are, according to my theory of the world, able to temporarily increase the amount of capital society has available for investment because of the effect that asset bubbles have on the market’s expectation of incurring losses on investments tied to the bubble-asset. Some of the capital that society has available for investment is held back by the market in cash or cash-like investments, such as short term Treasuries, in order to cover potential losses that might arise from investments. Some entities, such as banks and insurers, are subject to regulations that dictate how much capital must be set aside to cover these potential losses. Other entities are free to estimate the amount of capital that needs to be held back in order to cover these losses. So, if we took a snap shot of all of society’s capital available for investment at a given point in time, some portion of that would be withheld as a loss reserve in cash or cash like investments. That means some portion of the capital available for investment isn’t really being allocated to “investments,” but being withheld to cover potential losses on bona fide investments.

Asset bubbles create value out of thin air. Price trends develop that deviate sharply from historical norms, and eventually a new, albeit temporary, norm is established. As a result, asset bubbles make the bubble-asset look like a much better investment than it will eventually turn out to be in the long term. As such, asset bubbles create capital available for investment out of thin air because they cause the market to underestimate the amount of capital that has to be set aside to cover potential losses arising from investments tied to the bubble-asset. This means that the effective pie, the portion that actually gets invested in non-cash assets, can be temporarily expanded, removing the zero sum accounting restriction, simply because less of society’s resources are used to cover losses.

When homes across the U.S. all started increasing in value more or less in tandem, home owners felt, and in fact were, richer than they were the day before. They could access the newly found equity in their home to purchase other goods, or double-down and purchase yet another home. As this process escalates and apparent price trends develop, banks feel more confident in making loans tied to housing and begin to compete for those loans. Mortgage lending, which was traditionally considered a “safe” lending business, got even more “safe” since the value of the collateral would surely continue to increase over the life of the loan. So even if the borrower lost his job or his legs, he could always sell the house to cover the loan: there will surely be plenty of equity between the face value of the loan and the price of the home upon sale. And so as lenders’ expectations of an upward trend in price becomes more entrenched, lenders become willing to lend greater amounts of money tied to real estate and can do so without subtracting from other lending activities by simply reserving less capital for losses on their real estate lending.

So what happens when bubbles pop? Once losses exceed expectations, the market is forced to reallocate its capital to cover those losses or face insolvency. If the price of the bubble-asset drops far enough, this could force fire sales outside the bubble-asset market as firms scramble to cover their liabilities. Once this happens, economic actors have less access to capital than they did before the bubble got started, leading to a sharp contraction in economic activity and concomitant upticks in unemployment.

One thing that still puzzles me is why bubbles pop when the bubble-asset isn’t usually expected to produce a cash flow. For example, capital invested in internet companies (e.g., internet stocks) should at some point generate the return that everyone was expecting. When internet startups don’t generate positive cash flows, those returns fail to materialize en mass, and that’s a clear signal to the market that its expectations were off. And so the bubble pops. But what sort of return were people expecting from housing? What was the signal that caused the bubble to pop? Clearly, defaults on bonds backed by real estate were the signal to the capital markets, but what caused the price plateau in the underlying housing market that got the defaults rolling? Was it that credit was extended to the maximum extent possible, and so no further appreciation was possible? Or was the cause psychological, a sort of vertigo price point at which both lenders and borrowers lose their nerve?

*Arnold Kling has proposed an alternate explanation involving the timing of bubbles, arguing that bubbles are gradual while busts are sudden, and that’s the cause. While shocks to expectations are generally bad for markets, I think that this explanation is intellectually unsatisfying because (i) it doesn’t explain why busts are sudden and (ii) it tacitly assumes that sudden changes create unemployment, which is probably true, but is merely descriptive and not explanatory.

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Charles Davì

Derivative Dribble

Truly Derivative Dribble

Frontline Special On Financial Regulation

Asset Bubbles and Economic Activity

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