The trouble is that by the time its obvious from the markets that people have made mistakes, it’s really too late to do anything other than pick up the pieces.

dmg555: Immediate pricing has volatility disadvantages, but I suggest it is the lesser of two evils and better than hidden pricing which leads to huge sudden shocks to the system. If we knew how to release tectonic plates slowly we wouldn’t have major earthquakes.

The trouble with the idea that pushing derivatives onto exchanges would fix the problems is that most of the derivatives that caused problems were quite liquid and freely traded on the market. There were (and are) indexes for CDS’s, for example.

It’s not volatility that’s the problem. It’s panic selling which can destroy a market. It’s just not true that people will buy if the price is low enough. Once fear sets in, people won’t buy at any price, and it takes a massive intervention to stabilize things.

dmg555: If these contracts are pushed onto exchanges, easily traded, valued, and transparent, capitalism can sort out the winners from the losers.

Nope. Doesn’t work. Imagine someone selling cars. People are a bit reluctant to buy, so the car company gives a guarantee. The cars are sold, and they are no longer liabilities to the company. The car company calculates the amount that it well lose via guarantees, and some time passes. Then it turns out that the cars are defective and are falling apart left and right, and that the car company has to make good on their guarantees. Suddenly an “off-book” liability goes “on-book.”

Having a liquid market for cars doesn’t help, because once the bad news is reflected in the price of the car, it’s too late.

“Let’s face it, banks want as little price discovery as possible because it leads to more generous pricing opportunities. Especially if a hedger or speculator wants to put on a non-standard position, banks stand to make the lion’s share of their profits relative to facilitating large numbers of exchange-traded instruments with razor-thin margins.”

like this was a big reason why bond trading, or the pricing of credit risk, has migrated to CDS… information arbitrage/assymmetries indeed cheers!

dmg555

Articles and info on Yves Smith’s site (around Jsn-Mar) suggested that the very smart minds on the trading floor at Sachs did what everyone else did in 06/07, but the powers that be in the firm decided to take positions elsewhere that reversed those trades and went further in the opposite direction, hence the sacks (sorry, bad pun) of money they made.

As for rich crooks, ooh, that reeked a little of calvinistic brimstone, then again, in some principalities of the world, they are valued citizens…

Anyway, the problem I think is cultural. The U.S. has always followed the maxim “You can’t argue with success.” The U.K., which had been sceptical for most of the 20th century, followed the Americans since Thatcher.

Basically, when someone makes a lot of money, the reaction the Anglo-Saxon world today is that it is deserved and therefore the earner has some special knowledge or ability. So who in their right mind can question such an ethereal being? In fact, the correct reaction to someone making a lot of money is, Who is this crook?

I agree with you that markets can sometimes overreact but the world needs derivative contracts, and Bears Stearn’s fall is an example of why financial systems can not be trusted to individual human egos. Human beings, no matter what their accomplished level within a corporate financial system are reluctant by nature to admit they have made a mistake. Market volatility will eventually bring in a buyer of last resort. Even Jim Roger’s would buy US dollars at a 50% discount to where they are now.

If we allow derivative contracts currently worth 383 trillion dollars, to sit hidden away on any number of company balance sheets, the next time we have a serious mismatch between real and assumed values, the Fed’s 910 Billion dollar balance sheet may not be large enough to become the buyer of last resort. Immediate pricing has volatility disadvantages, but I suggest it is the lesser of two evils and better than hidden pricing which leads to huge sudden shocks to the system. If we knew how to release tectonic plates slowly we wouldn’t have major earthquakes. If these contracts are pushed onto exchanges, easily traded, valued, and transparent, capitalism can sort out the winners from the losers. In our past episode, Goldman Sacks was the winner and Bear Stearns was the loser. My guess is that someone at Goldman didn’t trust the rating agencies, did their own homework and tested the market in early 2007.

Lack of transparency is also called privacy. I wouldn’t put my money in a bank that released all of the details of my financial transactions to the world.

In any case, I really don’t think that more data would have prevented the mess. All the data in the world is useless if people aren’t going to ask the right questions. Subprime borrower obviously is not going to be able to pay his loan, who gets hit? Bank is making record earnings, where exactly is this money coming from?

If people weren’t willing to think about things that were happening right in front of them, then having more numbers would not have alerted them to problems. And even if someone had concluded in 2004, that banks had too many off-book liabilities, now what?

The problem is that mark to market can be very destabilizing. Something goes down, this causes all of the derivative values to go down, which forces banks to sell their derivatives, which causes derivative values to go down, which forces banks to sell their derivatives, and away we go…..

I’d actually go into the direction of reducing the speed at which things happen. The thing about markets is that things can happen very quickly, and if things happen too quickly to have a meeting to do something about it, this could be very bad.

That’s very scary. because pretty much everyone in the trenches knew that there was going to be a problem two or three years ago. All you really had to do to see the problem was to ask the question “what happens if housing prices go down?”

bsetser: off balance exposure via SIVs might have helped alert people to the problem

I don’t think so. If you told someone three years ago that banks had a huge off-balance exposure to SIV’s, the response might have been “what is an SIV?” Also, figuring out what to do is difficult, because people did these structures precisely because they were unregulated. Also, my sense is that if you crack down on SIV’s, the bubble would have moved elsewhere since the basic problem is that people were making money off of rising housing prices, which couldn’t rise forever.

some bop data is collected as a byproduct of tax data (think of the US data on reinvested earnings of us MNCs), and my sense is that the city operates as an offshore center (i.e. no taxes) for foreign funds. the treasury’s TIC and survey data don’t originate from tax data though and the UK presumably could produce similar data if it wanted to.