Bummer

A federal judge has stayed the Minnesota law banning predictions markets.

This is temporary, so Minnesoto might still prevail, but the injunction is disappointing.

The bookies Kalshi and Polymarket, along with the Trump DoJ claimed that these were swaps, not betting.

It's not a surprise that Trump is a big supporter of this sort of gambling.  He and his family are deep into the so-called "Prediction Markets",  Also, there is compelling evidence that members of his administration are using the markets to insider trade.

Corruption is as corruption does.

As I have noted for well over a decade, swaps are basically just betting, not insurance, which should have been banned via a legal framework dating back to the Marine Insurance Act of 1746, which prevented people from doing the equivalent of getting paid for burning down their neighbors house.

A federal judge on Monday blocked a Minnesota state law that would ban prediction markets days before it was set to go into effect, siding with a federal financial regulator and two companies that had sued to stop it.

In May, Minnesota became the first state to pass a law making it a felony for most prediction markets to locally operate and advertise. The Commodity Futures Trading Commission, a federal agency that oversees prediction markets, and the markets Kalshi and Polymarket sued, arguing that the platforms can be regulated only at the federal level.

On Monday, Judge Kate M. Menendez of the U.S. District Court for the District of Minnesota granted a preliminary injunction to halt the law from going into effect on Saturday, finding that the companies faced a threat of irreparable harm. The law will remain on hold until a final ruling is made in the case.

………

The agency has faced criticism for making what appear to be favorable decisions for prediction markets with ties to the Trump family. Donald Trump Jr. advises Kalshi and Polymarket, and he backs Polymarket financially.

President Trump has posted on Truth Social that the agency, not states, must have “exclusive authority” over prediction markets.

 

About Someone Banned This Crap

Minnesota has just passed a law banning prediction markets. (Utah seems likely to follow

About f%$#ing time.  This is a profoundly wasteful, corrupt, and unproductive activity.

Of course, because it is a corrupt activity, and one of Trump's sons is on the payroll of the two largest players in the space, Polymarket and Kalshi, so the Trump administration promptly sued to prevent the law from going into effect.

The Trump administration yesterday sued Minnesota in an attempt to block the first state law that prohibits prediction markets.

While other states imposed restrictions on prediction markets, Minnesota banned them outright in a law signed by Gov. Tim Walz on Monday. The US Commodity Futures Trading Commission announced a lawsuit against the state, saying that Minnesota’s “new legislation represents the most aggressive move by a state to shut down CFTC-regulated markets and undermine the federal regulatory regime set up by Congress more than 50 years ago.”

………

The Minnesota law makes it a felony to create, operate, or advertise a prediction market. The CFTC asked the court for preliminary and permanent injunctions to prohibit Minnesota from enforcing the law, which is scheduled to take effect on August 1. The case was filed in US District Court for the District of Minnesota.

………

The Minnesota law defines a prediction market as “a system that allows consumers to place a wager on the future outcome of a specified event that is not determined or affected by the performance of the parties to the contract.” The law’s specified events include but are not limited to sports games, wars, mass shootings, acts of terrorism, elections, court cases, deaths or assassinations, weather conditions, and pop culture events such as awards or release dates.

That last bit sounds an awful lot like the Marine Insurance Act of 1746, which was an unalloyed good.

Shut them down. 

The General Case of Saroff's Rule

Let me remind you of what I call  Saroff's Rule, "If a financial transaction is complex enough to require that a news organization use a cartoon to explain it, its purpose is to deceive."

Well, a recent paper by economists from MIT, ASU, and UCSD shows that complexity more generally appears to have deception as its primary purpose:

Economist George Akerlof has spent much of his celebrated career thinking about how trickery and deceit affect markets. His most famous insight, which won him the 2001 Nobel Prize in economics, is that when buyers and sellers have different information, lack of trust can cause markets to break down. In those models, no one actually ends up getting tricked -- everyone is perfectly rational, so even the possibility of getting cheated causes them to stay prudently out of the market. But in his book “Phishing for Phools,” written with fellow Nobelist Robert Shiller, Akerlof goes one step further. Much of the actual, real-world economy, he says, involves trickery and deception.

………

A recent paper by economists Andra Ghent, Walter Torous and Rossen Valkanov may shed some light on the question. Ghent and her co-authors look at mortgage-backed securities, which figured prominently in the crisis. They try to measure how complex various products were, using measures like the number of pages in the prospectus, the number of tranches in the security and the number of different types of collateral.

That allowed the researchers to see whether more complex products fared better or worse in the years before the crisis. Using Bloomberg data, they look at private-label, mortgage-backed securities issued between 1999 and 2007. They then look forward in time, to see which products defaulted and which ones experienced more foreclosures in the mortgage pools that they used as collateral.

It turns out that complexity was a bad sign. More complex deals experienced higher default rates and more foreclosures on their collateral. So if you were an MBS buyer from 1999 to 2007, the rational thing to do would have been to demand a higher interest rate on a more complex security.

Except that didn’t happen. Ghent et al. found that complexity had no correlation with the yields on MBS. That means that although more complex products were riskier on average, buyers didn’t recognize that fact. The authors also carefully exclude the possibility that complex deals commanded higher prices because they were specially tailored to individual buyers’ needs -- in fact, most products contained the same types of collateral, but the complex ones were just of lower quality.

………

Interestingly, Ghent and her coauthors find that credit-ratings companies tended to give higher grades to more complex products. That implied the credit raters were willing to trust issuers when figuring out what was actually in the products got too hard. Maybe it’s human nature to trust our counterparties more when things get too complicated. Or maybe the ratings companies’ well-known bad incentives took over when complexity and opacity made their misbehavior harder to observe.

I will go a step further than the economists do (45 page PDF), the words "fraud" "corruption" and "crime do not occur in the paper, and suggest that this complexity is present because of a deliberate and specific intent to deceive investors, and that the credit rating agencies were willfully blind to this because it made the money.

To paraphrase Paul Volker, no useful innovations have come from banks since the introduction of the automatic teller machine.

Reinstate the principle you can only buy insurance on things when you have a direct interest in their continued existence.

It's a principle that was made law by the Marine Insurance Act of 1746, and worked until people decided that things like naked credit default swaps were an essential innovation.

Reinstate that.

Put derivatives at the back of the bankruptcy queue, not the front.

Put a Tobin tax on financial transactions.

Shut it down.

Shut it all down.

Why Ignoring the Marine Insurance Act of 1746 is a Bad Idea, Part MCMXXVII

For those who don't remember, the Marine Insurance Act of 1746 required, "Anyone seeking to collect on an insurance contract to have an interest in the continued existence of the insured property." (Link)

Basically, it means that you cannot purchase insurance on your neighbors home, and collect when you burn it down.

The act was passed because around that time, there was a war between Britain and France, and some people were purchasing insurance on ships, and then send the itinerary and manifest to accomplices in France, who would relay this information to the French navy, who would seize the ship, and the insurance fraudster and his accomplish would divide the spoils.

In 1999, it was decided that the form of insurance known as a Credit Default Swap wasn't insurance, because, well ……… because.

As a result, we have seen an explosion in speculators who insure things, and then blow them up.

Well it now appears that the Vulture funds who pushed Argentina into default may have engaged in this strategy:

So for Elliott an unseemly legal victory may not mean cold cash. Fear of default and/or eagerness to please Argentina may prompt some in the financial community to buy them out at a good price, but a sure thing that is not. Whatever American courts say, for all the reasons above, Argentina will probably not settle. Those bonds bought cheap (according to sources, Elliott spent close to $50 million purchasing about $220 million of old Argentinian bonds in 2008) may have looked to an informed observer beforehand quite unlikely to produce a decent return.

So why bother with an exorbitant legal fight? Well, the CDS route would be one reason. The likelihood of CDS triggering (failure to pay on foreign exchange bonds) would have appeared as very high precisely for all the reasons that make the likelihood of a settlement so low.

This scenario may have seemed plausible, at least more so than expecting Argentina to pay holdouts in full or something close to it. Elliott may have known payment is a long shot, but being a bondholder at least lets it try for a legal solution that could lead to default. That pari passu had been breached would have been a no brainer, for “all” you needed was to show that the country had legally subordinated you versus other creditors, and Argentina did that in 2005 by passing the so-called Lock Law prohibiting itself from making good on the holdouts (this was a key argument to have the courts declare a breach of pari passu; apparently, this kind of explicit de jure discrimination-subordination of creditors is very unusual).

Obtaining ratable payment as a remedy is unusual, though not unprecedented, but may have seemed like good odds in this case given the specific wording of the pari passu clause in question (which seemed to call for equal payments and not just equal rank) and the uniquely uncooperative character of the debtor; from reading the courts´ statements, one can sense that discomfort with the country´s attitude forced the judges´ hands towards a solution that in any other case may have seemed too harsh. Argentina´s behavior presented a unique opportunity to persuade a court to impose ratable payments; discipline for an unruly country.

With hindsight, Argentina was the perfect collaborator to have the CDS trigger: the Lock Law, tirades against holdouts, and contempt for court rulings on the way to its final refusal to settle guarantee that a failure to pay event materialised. For all the Kirchner government rage against speculators, in what would be a delicious paradox, it may have made the vultures rich by triggering the CDS.

This is actually a higher percentage strategy than getting 100¢ on the dollar from Argentina.

They make money, and in the process, they inflict enormous pain on the people of Argentina, and does damage to the US as a venue for sovereign debt.

I'm with Paul Volker when he said only the worthwhile innovation of this generation was the ATM.

Jon Stewart and Samantha Bee Take Down the Financial Press

On a number of occasions, I have noted that it has been illegal to take out insurance on something in which one does not have an interest in its continued existence.

So, it's illegal to take out a policy on your neighbor's house, because otherwise, you would have an interested in burning it down.

This problem was first addressed, in the UK at least in the by the Marine Insurance Act of 1746.

The proximate cause was people who would buy insurance on a merchant ship, and then leak the manifests and schedules to the French, who were at war with the British at the time, and they would collect the insurance payouts.

It has been the law for longer then there has been the United States.

Only in the late 1990s, they decided that it did not apply to credit default swaps, and so the ripe-for-abuse "naked" CDS was born.

Well, the Daily Show found a story on Bloomberg about how the private equity firm Blackstone Group purchased a naked CDS on a 3^rd party loan to the Spanish gaming company Codere.

Blackstone then made a loan to Codere that was conditional to their making their making a payment late on the aforementioned 3^rd party loan, which was a "credit event" which netted the investment firm a $15,000,000.00 payout.

What I do not understand how this isn't insurance fraud, except, of course, a CDS isn't insurance, except, of course, that it is.

But besides the Bloomberg article there has been crickets from the financial press, which Jon Stewart and Samantha Bee discussed last night.



Brutal

Amity Shlaes is a F%$#ing Moron, Part LVMXXVII

Here latest brain fart is the suggestion that the federal government place levies on the states, and to allow them to collect the taxes, because the Articles of Confederation were such a good idea.

I'm not being metaphorical here.  She literally extolls the virtues of the articles of confederation:

.There will be objections, of course. The first is that states’ collecting the money isn’t our tradition. It is, actually. Under the Articles of Confederation, the states, not individuals, owed payments to the federal government. The modern income tax, where citizens pay the federal government, came into being only a century ago. 

Which is not the same thing as saying that the federal government hasn't had taxing authority for the past 223 years, though she is implying that the failed and rejected Articles of Incorporation is part of the American tradition of governance.

The Magna Carta, and the Marine Insurance Act of 1746 have more to do with the heritage and traditions of the United States than does the Articles of Confederation.

Just remember that she spent decade as a "senior fellow in economic history at the Council on Foreign Relations," as well as being an adjunct (temp) prof at NYU's Stern School of Business, despite making sh%$ up in her so called histories, and despite the fact that she her degree in is in English.

So if a representative from either of the above institutions claims that the sky is blue, find independent verification.

Any organization that hires her has no credibility.

Another Example Why the Credit Default Swap is the Toxic Waste of the Financial World

On an article about how Greek government debt may take down the Euro, we find this little gem:

Lagarde’s demand for a larger haircut smacked into an onslaught of leaks from the bond-swap negotiations between the government and private sector bond holders. First, there were rumors that the banks had largely agreed on a deal. Then there were rumors that hedge funds that had acquired some of these bonds at a discount were refusing to go along with anything. They were betting that they could profit from a default because it would trigger CDS payouts. And if the majority agreed to the haircut, they would also profit because Greece would eventually redeem the bonds.

Now, there are rumors that the government wants to compel these hedge funds to join the bailout majority. Tool: retroactive “collective-action clauses”—if a majority of bondholders agrees to the deal, the recalcitrant minority could be forced to go along.

Of course, the question is how you can make money for this.

It comes down to the fact that there is something called the "naked" credit default swap.

The nickel tour is that a CDS is an insurance policy, you pay your premiums, and in the event of "something" happening, you get a payout for the "loss".

The reason that I put "loss" in scare quotes is because unlike most forms of insurance, there is no requirement to hold an interest in the continued existence of whatever you are insuring.

This has been case since 1746 (!) when Parliament passed the Marine Insurance Act.

Basically, if I purchase a CDS on something risky, like Greek sovereign debt, I have to pay a lot of money, but let's engage in a little mental exercise:

• Assume a billion dollars in a specific debt issue.
• Buy $1 million dollars in debt at a discount from someone who is scared, let's say it's 50¢ on the dollar. So you spend $500,000.
• You purchase a CDS on the whole issue, let's assume that it's a 30% payment, or $300 million.
• Refuse to accept a haircut, triggering a default, and a full payout on the CDS.
• So, you spent $300.5 million, and get a $1 billion payout.

This is vulture capitalism at it's worse.  You don't just wait for something to die, you figure a way to pluck out the eyes to hasten the demise.

This is a microcosm for everything that is wrong with "Anglo Saxon" hyper-capitalism.

Catch Phrases I

Round up the usual suspects

Control fraud occurs when a trusted person in a high responsible position in a company, corporation or state uses their powers to subvert the company and to engage in extensive fraud for personal gain.

Pass the Popcorn

We don't care, we don't have to ……… we're the phone company.

---

Richard Whitney (financier) - Wikipedia, the free encyclopedia the corrupt head of the NYSE, who went to jail, and had to find work on a farm when he got out.

The origins of the Evangelical political movement grew from racial bigotry, not abortion.

Dianne Feinstein^*
*Full disclosure, my great grandfather, Harry Goldman, and her grandfather, Sam Goldman were brothers, though we have never met, either in person or electronically.




 

Once again, I am compelled to make the repeat the wisest thing that I've read this century: (bush fuck up quote)

This article is far better than anything I could write, (alternate link) I learned some things:

In 1746, Parliament passed the Marine Insurance Act, requiring anyone seeking to collect on an insurance contract to have an interest in the continued existence of the insured property. Thus was born the insured-interest doctrine. The indemnity doctrine, which precludes a buyer from insuring property for more than it’s worth, soon followed. The point of these rules is to limit insurance contracts to trading existing risks and not to create new risks by giving buyers of insurance incentive to destroy property. The doctrines have been part of insurance law in both England and the United States (which in 1746 were colonies under English common law) ever since.

     
Bummer of a birth mark, InsertNameHere

^*The definition of Santorum is, "That frothy mixture of lube and fecal matter that is sometimes the byproduct of anal sex".

how do do indented multiline footnotes

^*how do do indented multiline footnotes
testing
testing testing testing testing testing testing testing tes

The classic rejoinder is the Yiddish, "Az der bubbe vot gehat baytzim vot zie geven mein zayde." (If my grandmother had balls she'd be my grandfather.)

Please note: once again, that I do not vet, nor do I endorse any ad that appears on my site, and I reserve the right to mock both the ads that appear on my site, as well as the advertisers.

Also, please note, this should be in no way construed as an inducement or a request for my reader(s) to click on any ad that they would not otherwise be inclined to investigate further. This would be a violation of the terms of service for Google™ Adsense<™.

The Swedish concept of Offentlighetsprincipen (openness)


At least, there is symmetry.
\

Russia to export Worlds Most Capable Surface to Air Missile my RCS computations

Matthew Yglesias on The Green Lantern Theory of Geopolitics (TPM Cafe)

The central tenet of conservatism is that, to quote (the composer, not the political theorist) Frank Wilhoit, "There must be in-groups whom the law protects but does not bind, alongside out-groups whom the law binds but does not protect."

Various character based gesture crap
╭∩╮( •̀_•́ )╭∩╮
凸( •̀_•́ )凸
We find the defendants incredibly guilty

 

Repeal SEC Rule 10b-18, adopted in 1982, which legalized stock buybacks. (Provided a "Safe Harbor")

Before that, it was presumed that stock buybacks were a form stock manipulation, so a company would have to justify such actions to regulators.

 

I Approve of this Filibuster Threat

Byron Dorgan, who has not only been a strong advocate for financial reform, but predicted 15 years ago the clusterf%$# that would occur from Robert Rubin's vision of finance, has proposed an amendment to the finance reform that would ban Naked (i.e. an insurance policy in which you bet on your neighbor's house burning down) Credit Default Swaps.

It appears now that the Senate leadership will not allow this amendment to be voted on, so the distinguished gentleman from North Dakota is threatening a filibuster:

In the Senate Democratic Caucus meeting today, Dorgan and other progressive senators pressed the leadership to allow their amendments to strengthen the bill to come to a vote. According to Dorgan, the leadership relented and said his amendment would be one of the ones to come to a vote.

But tonight, as Brian Beutler reports, when the list of amendments to be voted on was released, Dorgan's was not among them. A frustrated Dorgan approached Dodd and Majority Leader Harry Reid on the floor this evening and told them he would filibuster financial reform if his amendment doesn't get a vote. "I understand everybody thinks their amendment's important, but the question of the unbelievable speculation in credit default swaps that have no insurable interest -- if we can't vote on something like that, given what we've seen in recent years, then it's not really financial reform," Dorgan told us.

I keep quoting the same article, which notes that specuilative insurance was recognized as a very bad thing 3264 years ago:

In 1746, Parliament passed the Marine Insurance Act, requiring anyone seeking to collect on an insurance contract to have an interest in the continued existence of the insured property. Thus was born the insured-interest doctrine. The indemnity doctrine, which precludes a buyer from insuring property for more than it’s worth, soon followed. The point of these rules is to limit insurance contracts to trading existing risks and not to create new risks by giving buyers of insurance incentive to destroy property. The doctrines have been part of insurance law in both England and the United States (which in 1746 were colonies under English common law) ever since.

But the masters of the universe who nearly killed us all insist that they know better.

Well, they don't and they should not be listened to, because their interest is purely in their creating ways for them to make money, and if they crash the financial system every 20 years, well, they've got theirs.

The reason that Dorgan is not getting his vote is because the reform is so transparently the right thing to do: Just ask the average voter if their neighbor, the creepy one who seems to have strange visitors, should be able to take out insurance on that average voter's house, so that the creep gets paid when the voter's house gets burnt down mysteriously.

They won't allow the vote because the bankers do not want it, and because if it comes up for a vote, they will have to pass it, because it is so transparently the right thing to do.

It's enough to make me root for the "medicine for chickens" lady to beat Harry Reid in his reelection bid.

Not Enough Bullets

Transocean, the firm operating BP's oil rig that exploded and created a blowout that is threatening most of the US Gulf coast, will make $270m from the loss of the rig because it was insured for more than it was worth.

I thought that this has been illegal since the Marine Insurance Act of 1746.

From that Communist Rag The Financial Times

Wolfgang Münchau proposes an outright ban on naked credit default swaps: (CDS)

I generally do not like to propose bans. But I cannot understand why we are still allowing the trade in credit default swaps without ownership of the underlying securities. Especially in the eurozone, currently subject to a series of speculative attacks, a generalised ban on so-called naked CDSs should be a no-brainer.

Naked CDSs are the instrument of choice for those who take large bets against European governments, most recently in Greece. Ben Bernanke, the chairman of the Federal Reserve, said last week that the Fed was investigating “a number of questions relating to Goldman Sachs and other companies in their derivatives arrangements with Greece”. Using CDSs to destabilise a government was “counter-productive”, he said. Unfortunately, it is legal.

As I have noted for some time, the Credit Default Swap is insurance, and there is a very good reason that the British Parliament passed the Marine Insurance Act of 1746, which required, "anyone seeking to collect on an insurance contract to have an interest in the continued existence of the insured property," as well as, "precluding a buyer from insuring property for more than it’s worth."

This should not be SEC slap on the wrist stuff. This should be illegal unenforceable contracts, and you go to jail stuff.

Can We Please Start Arresting Bankers?

Seriously, the good folks at Citi are planning to start selling, "derivatives intended to pay out in the event of a financial crisis."

That's right, they are creating instruments that will allow people to bet against our financial system, and win if they, or their friends take it down:

Credit specialists at Citi are considering launching the first derivatives intended to pay out in the event of a financial crisis. The firm has drawn up plans for a tradable liquidity index, known as the CLX, on which products could be structured that allow buyers to hedge a spike in funding costs.

(emphasis mine)

Seriously, if our forfathers understood the need to prevent this sort of casino gambling masquerading as insurance when the parliament passed the Marine Insurance Act of 1746, no that's not an error, taking out insurance on something in which you have no interest in the continued existence of the insured property has been illegal for 264 years, because otherwise, people do things like take out insurance in their neighbor's house, and then burn it down.

These people are terrorists under the (admittedly lax) standards of the PATRIOT act and its successors, and they should be pursued as such, with all the jurisprudence that Dick Cheney wants for suspected al Qaeda members.

H/t Felix Salmon, who crystallizes the basic point rather clearly:

We learned in the crash of 1987 [and 2001, and 2008, me] that when financial markets start selling products which insure a portfolio against catastrophic loss, the very existence of those products can destabilize the market and make it more prone to crashing. And, of course, we learned that such insurance has a tendency not to get paid out on exactly when it’s most needed. But heaven forfend that the market should ever learn from its mistakes.

We need hand cuffs for dishonest and delusional bankers today, or we'll need pitchforks, torches, tar and feathers for all bankers tomorrow.

Why the Naked CDS Should Be Banned: Part McCMLXXVII

Yes, once again we have Goldman Sachs that great vampire squid wrapped around the face of humanity,^* using naked Credit Default Swaps, (CDS) which are basically insurance policies, with the crucial differenc being that you can insure your neighbor's home, and collect when you burn it down, something forbidden in other insurance products since 1746.

You see Goldman Sachs bought naked CDS, and then interfered in its reorganizing its debt so that it could collect:

International Brotherhood of Teamsters President James Hoffa said Goldman Sachs Group Inc. is creating derivatives trades that would profit from the bankruptcy of YRC Worldwide Inc., the trucking company trying to avert failure with a debt exchange.

The most profitable securities firm in Wall Street history “is actively soliciting bond trades for clients and underwriting credit-default swaps to benefit from a failed exchange and resulting bankruptcy,” Hoffa, the union leader, wrote in a letter dated yesterday to Goldman Sachs Chief Executive Officer Lloyd Blankfein.

YRC, the biggest U.S. trucker by sales, is extending the exchange offer deadline to Dec. 23, after investors holding 75 percent of its debt initially agreed to the exchange, below the 95 percent required by bank lenders. As of 5 p.m. in New York yesterday, participation fell to 57 percent, the Overland Park, Kansas-based company said in a statement. The company said it believes some bondholders have withdrawn because they want to tender their notes only on the expiration date.

The company has faced opposition to its plan to exchange $536.8 million of notes for equity from bondholders who also own derivatives that pay out in a default, according to people familiar with the matter. The Teamsters’ pressure comes as Goldman Sachs is under fire from other labor groups over its role in the subprime mortgage crisis.

This is precisely why the Marine Insurance Act of 1746 was passed, and why the writing of new naked CDS instruments should be banned, and existing naked CDS contracts should be rendered unenforceable.

There is a difference between making money off of someone else's misfortune, and making money by causing someone else's misfortune.

^*Alas, I cannot claim credit for this bon mot, it was coined by the great Matt Taibbi, in his article on the massive criminal conspiracy investment firm, The Great American Bubble Machine.

It's Called Lipstick on a Pig, and It is Illegal

McClatchy, just finished an investigation of some of Goldman Sachs' behavior, and the lede says it all:

In 2006 and 2007, Goldman Sachs Group peddled more than $40 billion in securities backed by at least 200,000 risky home mortgages, but never told the buyers it was secretly betting that a sharp drop in U.S. housing prices would send the value of those securities plummeting.

You know, being a bit more optimistic in public than being in private is a fuzzy line. This ain't it.

Later in the article, it is discussed how Goldman, and hedge fund operator John Paulson, bought billions in Credit Default Swaps (CDS) on mortgage backed bonds to profit on the collapse.

Note that Paulson is in a different boat from Goldman, because he didn't sell those bonds in the first place, but once again it shows how the lessons of the South Sea Bubble, which led to the Marine Insurance Act of 1746 have been forgotton and so it is no longer required that people who buy insurance, including swaps, must have a material interest in the underlying asset.

H/t Atrios.

One Very Big Plus to the Waxman-Markey Climate Bill

It appears that the legislation, which creates a Co₂ cap and trade regime, also bans naked credit default swaps, and could be construed as banning all credit default swaps:

Here's the key passage from Waxman-Markey, buried on page 1,070 of the 1,428-page bill introduced in the Senate on July 6:

"It shall be unlawful for any person to enter into a credit default swap unless the person:

1) owns a credit instrument which is insured by the credit default swap;

2) would experience financial loss if an event that is the subject of the credit default swap occurs with respect to the credit instrument; and

3) meets . . . minimum capital adequacy standards…"

Basically, a credit default swap is an insurance policy on a financial instrument, and a naked swap is an insurance on a policy in which one has no interest in its continued existence.

This section of the bill is clearly intended to ban naked swaps, but some people are arguing that the specific language of the bill actually bans all CDS, because the person selling the swap does not have own, "a credit instrument which is insured by the credit default swap," but by selling the insurance they are "entering into" the CDS.

My guess is that the courts will not view this as a ban on all CDS instruments, and if Waxman-Markey bans nakes swaps, this is enough to justify support the bill on its own, as weak as it is.

By background, in insurance, it's forbidden to, for example, take out insurance on things like your neighbor's home, and has been for some time:

In 1746, Parliament passed the Marine Insurance Act, requiring anyone seeking to collect on an insurance contract to have an interest in the continued existence of the insured property. Thus was born the insured-interest doctrine. The indemnity doctrine, which precludes a buyer from insuring property for more than it’s worth, soon followed. The point of these rules is to limit insurance contracts to trading existing risks and not to create new risks by giving buyers of insurance incentive to destroy property. The doctrines have been part of insurance law in both England and the United States (which in 1746 were colonies under English common law) ever since.

Unfortunately, in the Greenspan/Rubin/Summers America, it was decided that this 263 year old lesson could be ignored, and so we have trillions of dollars in casino bets masquerading as insurance, but isn't insurance, because then the contracts for naked swaps would be unenforceable as insurance policies.

H/t Kevin Drum

Banks Burnt on "Sure Fire" Credit Default Swaps

The Wall Street Journal has the story of how a bunch of the large investment banks got burned investing in "sure fire" credit default swaps. (paid subscription required)

You get a copy of the article here.



This kind of crap is why naked credit default swaps should be banned.

This ain't nothing but a bunco game, straight out of the Mel Brooks movie, and Broadway musical, The Producers.

Some quotes from the article, and my comments:

The trade, by Amherst Holdings of Austin, Texas, was particularly galling to the big banks because it turned what they believed was a sure-fire profit into a loss.

(all emphasis in quotes mine)

If the profit is "sure fire" it means that someone is engaging in deceptive activity.

Privately held Amherst says it acted in good faith trying to limit losses for clients, who had sold credit-default swaps on the securities. "We wouldn't jeopardize our business and reputation by entering into an opportunistic trade knowing what the outcome would be," said Amherst's chief executive, Sean Dobson.

This is a shot across the bow of the banks on the other side, since this is exactly what the big investment banks intended.

So far the latest dust-up has been all words, in part, bankers say, because they are wary of attracting more regulatory scrutiny at a time when lawmakers are planning major reforms in the largely unregulated derivatives markets, long lucrative for banks. While the banks' combined losses from the trade were in the tens of millions of dollars -- modest by recent standards -- they are the buzz of Wall Street as firms try to prevent a repeat of the episode.

Ban naked CDS contracts, and it will not repeat.

Traders can buy credit-default swaps on securities they don't own. At one point, at least $130 million of bets had been made on the performance of around $27 million in securities, according to a person familiar with the matter.

This is the part where credit default swaps, called a "naked" CDS in industry parlance, become a 3 card Monte game, and not insurance.

This kind of shit happens, and when things fall apart, you end up with AIG owing 40 or 50 times the value of the asset in insurance payouts.

This is why, 263 years ago, parliament passed the Marine Insurance Act of 1746, which required that anyone wanting an insurance payout demonstrate an interest in the continued existence of the property.

We have known for over 2½ centuries, since the South Sea Bubble, that this sort of insurance is dangerous and does nothing but create opportunities to game the system.

The frightening part here is that this scam is completely legal

Here is how it works:

1. Amherst Holdings sells credit default swaps on a bunch of bonds to J.P. Morgan Chase & Co.
   
2. Amherst Holdings sells credit default swaps on a bunch of bonds to Royal Amherst Holdings sells credit default swaps on a bunch of bonds to Bank of Scotland Group PLC
   
3. Amherst Holdings sells credit default swaps on a bunch of bonds to Goldman Sachs
   
4. Amherst Holdings sells credit default swaps on a bunch of bonds to UBS
   
5. Amherst Holdings sells credit default swaps on a bunch of Bank of America Corp.
   
6. Amherst Holdings sells credit default swaps on a bunch of bonds to a bunch of other banks
   
7. Premiums exceed the face value of the bonds by many times.
   
8. Amherst Holdings takes some of the premiums, and gives this to Aurora Loan Services with instructions to buy and retire the bonds.
   
9. The CDS contracts are now worthless, and Amherst Holdings has taken way more in premiums than it spent on the bonds.
   
10. Collect underpants.
    
11. Profit!

OK, it doesn't actually involve underpants, but still.

US Looking at New Regulations on Finance Industry

I find this hard to believe, coming as it does from Timothy "Regulatory Capture" Geithner, but we now have reports that the Treasury is looking at new regulations on bank executive compensation, with the appropriate squeals of protest from the pigs who get the pay and bonuses.

There is also a proposal to regulate derivative trading by requiring that most of them be traded on open and transparent markets, as opposed to the "black pools" in the shadow banking system.

Additionally they are looking to implement a reporting system on these trades based on the "Trace" system on bond prices, which halved the spreads between buy and sell prices that banks charged to purchasers by about ½.

Now, if they could only remember the lessons the Marine Insurance Act of 1746, and require that people who buy insurance, including swaps, must have a material interest in the underlying asset.

Unfortunately, Geithner, Summers, and Their Evil Minions^™ still have their heart set on making the Federal Reserve the "systemic risk regulator, which is bad for a number of reasons:

• The Fed has been captured by Wall Street.
• There is no accountability at all, with its members appointed to very long terms by Congress, or by the banks themselves.
• The organization is opaque and secretive.

My guess is that these proposals are going to be half measures designed to forestall real change, but I'm a pessimist realist.

Remember What I Said About the Marine Insurance Act of 1746?

If not, see here, but once again, we are seeing the effects of ignoring this 346 year old lesson, because investors have made bets on the failure of bonds that they do not hold through Credit Default Swaps (CDS), and in so doing, look likely to be driving otherwise solvent companies into bankruptcy:

Amusement-park operator Six Flags Inc. and automaker Ford Motor Co. may be pushed toward bankruptcy by bondholders trying to profit from credit-default swaps that protect against losses on their high-yield debt.

By employing a so-called negative-basis trade, investors could buy Six Flags bonds at 20.5 cents on the dollar and credit- default swaps at 71 cents. If the New York-based chain defaults, the creditors would receive the face value of the debt, minus costs. In a Feb. 27 note, Citigroup Inc.’s high-yield strategists put that profit at 6 percentage points, or $600,000 on a $10 million purchase.

....

It was recognized centuries ago that you should not be allowed to use insurance to do this, because it leads to fraud and panics, but the free market mousketeers decided that that was old thinking, and that they had no need for no stinking insurance regulations.

Regulating Credit Default Swaps

The head of the Agriculture committee, Collin Peterson (D-MN-07) is proposing that credit default swaps be treated like the insurance that they are. Here is money quote(PDF):

(h) LIMITATION ON ELIGIBILITY TO PURCHASE A CREDIT DEFAULT SWAP.—It shall be unlawful for any person to enter into a credit default swap unless the person would experience financial loss if an event that is the subject of the credit default swap occurs.
...
EFFECTIVE DATE.—The amendments made by this section shall be effective for credit default swaps (as defined in section 1a(34) of the Commodity Exchange Act) entered into after 90 days after the date of the enactment of this section.

Basically, what this is saying is that you can't buy insurance on something unless you actually benefit from it.

This was discovered a long time ago, specifically 263 years ago, when the British Parliament passed the Marine Insurance Act of 1746:

In 1746, Parliament passed the Marine Insurance Act, requiring anyone seeking to collect on an insurance contract to have an interest in the continued existence of the insured property. Thus was born the insured-interest doctrine. The indemnity doctrine, which precludes a buyer from insuring property for more than it’s worth, soon followed. The point of these rules is to limit insurance contracts to trading existing risks and not to create new risks by giving buyers of insurance incentive to destroy property. The doctrines have been part of insurance law in both England and the United States (which in 1746 were colonies under English common law) ever since.

Unfortunately, it appears that the distinguished gentleman from Minnesota only intends for this regulation to be temporary, but it's a good start.

It should be permanent though, there is a reason that this adopted so long ago.

Credit Default Swaps: A Primer

This article is far better than anything I could write, I learned some things.

BTW, of note is the fact that the CDS problem was addressed by regulation in 1746 by the Marine Insurance Act, so it's not like we haven't seen this problem before.