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I think the difference between equity speculation and bond speculation is important. Debt bubbles are much more catastrophic than equity bubbles.

by karzeem 17y ago

mattmaroon 17y ago
Right, the problem wasn't as much the home loans as all of the side-wagering. Nobody really knows the exact extent, but the credit default swaps are believed to be one to two orders of magnitude more money than the CDOs they were based on. Lehman and AIG in particular were destroyed by them.
- yummyfajitas 17y ago
  Lehman was not destroyed by swaps. They just took a large position in subprime loans and held many of the riskier tranches. This is exactly what the article advocates forcing commercial banks to do. Of course, the article doesn't make any distinctions that either matt or karzeem make, such as debt vs equity or CDO vs CDS.
  - mattmaroon 17y ago
    Actually you're right, they had $150b in CDOs against which over $400b in CDS were written. Still illustrates the point handily.
    - yummyfajitas 17y ago
      While there might have been $400b in CDS written against their CDOs, many of those CDS had mutually exclusive triggers, or were used to hedge against each other. For example, say I make a $200 bet with you that a coin comes up heads, and a $200 bet with pg thatit comes up tails. I've made $400 in bets, but I have only $200 in liabilities. Or I might buy a long position in apple, thinking it will go up. Then I think Steve Jobs might die, so I buy a short position. I now hold twice as many contracts, but my liability is completely covered. $400b in CDS is a meaningless number until we know how much of it was a liability.
- karzeem 17y ago
  I don't really know how to get around the problem of people placing bets with money they possess probabilistically. Clearly, if enough people are doing it, and enough of them make the same bad, massive bet, we all get screwed. But at the same, everyone in finance — even the most vanilla, small-town, we-just-take-deposits-and-make-safe-loans banks — works with money that has some nonzero chance of shrinking. The difference is that some correctly account for their worst-case scenario and others don't. Not sure where I'm going with that except to wonder whether there's some system that allows for speculation (i.e. opportunities to make money by making the right bet where someone else made the wrong one) while not tolerating a nonzero chance of a 2008-style meltdown.
- anamax 17y ago
  > Right, the problem wasn't as much the home loans as all of the side-wagering. Not so fast. US banks were basically required to own Fannie and Freddie stock plus if they didn't make "enough" loans to people who realistically couldn't pay them back, they got dinged by regulators. (Wells Fargo was getting hammered over this.) The stock holding is what pushed many of them into technical insolvency when Fannie and Freddie cratered. Combine that with regulators pushing mortgage-backed securities and you've covered the bulk of the problem. Throw in some govt officials who decided to pay off Goldman et al with taxpayer money instead of letting them rely on the "insurance" and collateral that they'd arranged, and the rest is a minor blip.

I think the difference between equity speculation and bond speculation is important. Debt bubbles are much more catastrophic than equity bubbles.

by karzeem 17y ago

I think the difference between equity speculation and bond speculation is important. Debt bubbles are much more catastrophic than equity bubbles.

mattmaroon 17y ago

Right, the problem wasn't as much the home loans as all of the side-wagering. Nobody really knows the exact extent, but the credit default swaps are believed to be one to two orders of magnitude more money than the CDOs they were based on. Lehman and AIG in particular were destroyed by them.

yummyfajitas 17y ago
Lehman was not destroyed by swaps. They just took a large position in subprime loans and held many of the riskier tranches. This is exactly what the article advocates forcing commercial banks to do. Of course, the article doesn't make any distinctions that either matt or karzeem make, such as debt vs equity or CDO vs CDS.
- mattmaroon 17y ago
  Actually you're right, they had $150b in CDOs against which over $400b in CDS were written. Still illustrates the point handily.
  - yummyfajitas 17y ago
    While there might have been $400b in CDS written against their CDOs, many of those CDS had mutually exclusive triggers, or were used to hedge against each other. For example, say I make a $200 bet with you that a coin comes up heads, and a $200 bet with pg thatit comes up tails. I've made $400 in bets, but I have only $200 in liabilities. Or I might buy a long position in apple, thinking it will go up. Then I think Steve Jobs might die, so I buy a short position. I now hold twice as many contracts, but my liability is completely covered. $400b in CDS is a meaningless number until we know how much of it was a liability.
karzeem 17y ago
I don't really know how to get around the problem of people placing bets with money they possess probabilistically. Clearly, if enough people are doing it, and enough of them make the same bad, massive bet, we all get screwed. But at the same, everyone in finance — even the most vanilla, small-town, we-just-take-deposits-and-make-safe-loans banks — works with money that has some nonzero chance of shrinking. The difference is that some correctly account for their worst-case scenario and others don't. Not sure where I'm going with that except to wonder whether there's some system that allows for speculation (i.e. opportunities to make money by making the right bet where someone else made the wrong one) while not tolerating a nonzero chance of a 2008-style meltdown.
anamax 17y ago
> Right, the problem wasn't as much the home loans as all of the side-wagering. Not so fast. US banks were basically required to own Fannie and Freddie stock plus if they didn't make "enough" loans to people who realistically couldn't pay them back, they got dinged by regulators. (Wells Fargo was getting hammered over this.) The stock holding is what pushed many of them into technical insolvency when Fannie and Freddie cratered. Combine that with regulators pushing mortgage-backed securities and you've covered the bulk of the problem. Throw in some govt officials who decided to pay off Goldman et al with taxpayer money instead of letting them rely on the "insurance" and collateral that they'd arranged, and the rest is a minor blip.