Credit default swaps should only be allowed with an offsetting credit exposure

Michael Moore could not seem to pinpoint exactly what is wrong with a Credit default swap. Here are some pointers

1. A naked credit default swap (without an underlying exposure )creates the incentive to bankrupt companies.

Say we have a hypothetical strong company B that has issued very little debt. Maybe one five year bond. The stock is doing middlin to ok depending on the state of the overall market. However, it may still have short-term borrowings and lines of credit to finance its day to day activities.Say another smart master of the universe broker-dealer, lets say G, buys credit protection from dumb insurance company A. G has no real credit exposure to B. However, it has a clear incentive to buy a credit default swap (these are cheap relative to the Notional. The premiium is an accrual and does not have to be paid right away. It has to be paid over the life of the swap). G has every incentive to short the stock of B and create an artifical credit panic for B. If the market is shaky, the fundamentals of the company do not matter. Banks will pull the credit lines of Company B and push it into a liquidity crisis. G will get away with the equivalent of collecting protection money. If dumb insurance company A does not post collateral, its friends in the Federal government will post margin. Depends on how big and dumb is A (or just corrupt).

2. A CDS exchange will not solve the above problem.

3. A CDS should be allowed only for the legitimate creditors of the company to buy protection against any outstanding exposure. A naked CDS is evil. It should be banned atleast till the CDS market is symmetrical and very liquid.

4. A CDS should require upfront payment. If they quote a 1000% CDS spread, the guy buying a CDS should put up a 1000%. This will quickly cap all CDS rates to a 100% of the exposure. The 1000% default spread is a bogus number and should not be allowed as an indicative price.

So there. Can someone please forward to Obama, Barney Frank, Michael Moore and the other CDS-haters ?

Equity compensation is the root of all Corporate evil

What Obama and Barney Frank need to focus on is the nefarious practice of Bankers being compensated through restricted stock or stock options. The basic premise of equity compensation is that Manager interests are aligned with shareholder interests through this practice. This theory is flawed for the following reasons

1. The actual cash value of payments in shares are never recognised in the Financials of the company. Share payments are recognised as part of the capital account and not in the operational earnings, as a cost.

2. The amount paid is not a fixed expense amount. Instead, it is a share of the company.

3. You cannot give away the farm to align a managers interest with the owner. To provide an analogy, if I pay my housekeeper, a share in my property so as he does not damage my property, eventually he will own my house and I will be the housekeeper.This is the same concept.

Are we there yet ?

It is time to buy. But not yet. We must wait for the market to hit the bottom. Till then we need to bide our time and drink to it. Bottoms up!

Capitalism has run out of capital. Ich machst nixt Das Kapital! (no it is not really German I just made something up from my Rosetta stone).

However note the profoundity of the statement - Capitalism has indeed run out of Capital! We need a new system. We need communism from China to provide us Capital. What happened to all our capital? Did someone madoff with it ?

We probably spent all our capital on Christmas gifts that nobody wants. We need to figure out a way to grow more capital. Capital does not grow on trees. It needs to be harnessed and managed so that it grows into more capital.

So it is not really a liquidity problem. We just need more money. Stop burning cash and conserve. Only way to build capital is by not wasting it.

Who gets a piece of the 700 billion ?

Now that the Senate has passed this huge payout of taxpayer money, how does the loot get divvied up ?

Obviously, since this is US taxpayer money, it should go only to US banks. Foreign banks should not be bailed out, so they can be let out of this equation.

Obviously, market gurus like Goldman, that had absolutely no CDO exposure cannot suddenly come up with "troubled" assets to sell. So they are out. Paulson would not bail out his former Bank - that would look so very suspicious!

So that leaves just Citigroup and Bank o fAmerica, maybe some other smaller players. These guys have already written down billions, so they might actually start reporting profits on the sale of these positions.

The curious part of this drama is how did they come up with the 700 Billion number. Did anybody ask for the calculations behind this number ?

Also, the point of the entire crisis was that nobody could put a good price on these assets. How is the Treasury planning to come up wih a price ? Conversely, if the Treasury knew the price of these assets, it could just tell the market these magical prices. Why do they need 700 billion to backup the prices ?

The correct way to do this was to de-securitize these assets and ban securitization. This package is going to simply get us out of this crisis and defer the crisis for another decade.


Securitization is the same as printing money. This flood will cause inflation and a further dollar collapse. It needs to be curtailed right away.

Why go after the Oil companies ?

Higher oil prices have all the politicians eyeing the profits of oil companies. I am happy with the oil companies making some profits. That will encourage more capital to be invested in these companies, which is what we all want. We need to invest in Oil to solve our energy problems.

But oil prices are not being driven by the oil companies. Prices are being driven up by speculators, mostly global hedge funds. These guys do not invest their profits in the oil industry. They use leverage to drive up the prices of what are essential commodities for the rest of the world, and then disappear with their ill gotten gains. So all you agitated people, go after the hedge funds, not the oil companies. There lies the real villain of the piece.