More Jokes from Bigtime Capitalists

[GuyThiebaut]

I heard a very good description of UK bankers today on BBC Radio 4, an institution in the UK I'll have you know, which was - it's like a man who has been saved from drowning and at the greatest danger to the person saving him, the saved man then walks off without so much as a thank you or acknowledgment of having been saved.

Continuous effort - not strength or intelligence - is the key to unlocking our potential.(Winston Churchill)

[Oakman]

GuyThiebaut wrote:

an institution in the UK I'll have you know

So is Bedlam Hospital for the Insane. ;)

GuyThiebaut wrote:

a very good description of UK bankers today

I heard today that all of these banks here in the US who have been helping themselves to the taxpayer's money as greedily as they can get away with being are simultaneously running as much of their money into offshore banks in countries that don't tax corporations. Nothing illegal about that of course, but highly ironic.

Jon Smith & Wesson: The original point and click interface

[Lynn Marentette]

Jon, I posted your quotes on my "Economic Sounds and Sights" blog. I'm using the blog to collect information and content that I plan on incorporating into an interactive time-line project about the current economic crisis. Do you have a link that I could add to the post? Thanks! Lynn http://econsoundsandsights.blogspot.com http://interactivemultimediatechnology.blogspot.com

Seeking Sustainable Innovation

[73Zeppelin]

If you're doing a timeline, then you should note that on your blog you've left out any mention of the monolines. You should also look into mark-to-market accounting and what happens to the counterparty of an OTC contract when Bank A loses money on a trade (particularly in the case of a CDO).

modified on Monday, January 19, 2009 2:37 PM

[Lynn Marentette]

Hi. Thanks for your suggestions. I'm not an economist, so I know I've missed some key factors involved in the economic crisis. I started the blog when I realized that I was unfamiliar with the finanical terms tossed around on CNBC's Squawk Box. I started listening to the program in my car on my way to work, via XM radio, last March, and as the economy started to nose-dive, I decided to ramp up my knowledge. When I started the blog, I had no idea of the seriousness of the problem. I haven't mentioned everything on my blog, partly because of time limitations, and partly because I'm still learning. I welcome any links you might have regarding mark-to market accounting and the story behind the monolines. I'd like to follow what is happening to the quants who are now looking for jobs. I work in a public school district, so I know that there is a shortage of high school math teachers across the US.

Seeking Sustainable Innovation

[73Zeppelin]

"Monolines" is short for monoline insurer. These are the parties that insured the CDOs. If the bond-writer defaults, the monoline is responsible for paying the principle to the bond holder. In this way, risk is transferred from the bond holder to the monoline. In return, the bond holder pays a premium (the cost of insurance) to the monoline. Monoline insurers are typically not highly capitalized - that is their liabilities far outnumber their assets. As the crisis unfolded and people began defaulting on their mortgages, the monolines started suffering large losses as they were forced to pay out. Some got into negative equity. Eventually credit ratings agencies started downgrading their ratings (i.e. from AAA to lower) leading to further losses. This calls into question the accountability of ratings agencies - for example, should they be held accountable to those for who they provide the ratings? The other issue is that the OTC market can be highly illiquid - this means that, although the financial contracts are sound, it may be very difficult to find a counterparty to a trade. There's this famous story about Buffet trying to unload $400 million in swaps and it took him 4 years to do it. The problem with mark-to-market is that it results in the credit derivatives downward spiral. CDOs are not easy to value. There are some mathematical equations that can be used, but since most banks wanted end-of-day VaR reports on all positions they would just mark-to-market. This means that as asset values plunged banks were forced to mark down their book values resulting in further losses; one loss reinforced the other. That's the CDO downward spiral - decreased asset value, leading to decreased book value, leading to decreased asset value... This has the added disadvantage that future asset values cannot be calculated. The other remark I'll make about the accounting is that bundling mortgage debt up into CDOs also allows banks to take a liability off their books and turn it into an asset. This makes exposure difficult to calculate. So, it's not the exotic financial contracts per se that are at the root of the problem, rather it's the accounting methodology and lack of financial transparency and regulation (i.e. leverage, backing capital, etc...) that allowed most of these institutions to take these huge risks. However, it's much easier for the press to talk about obscure contracts and math than it is to talk about the real issues.

Lynn Marentette wrote:<

[Lynn Marentette]

Thanks for such an informative reply. Do you mind if I post some of this on my blog? If so, should I use your 73 zeppelin name as the source? Do you have a website or blog? I try to link my quotes to the source as much as I can. "...unless there is complete collapse of an institution, a 1 billion dollar loss on a trade is a 1 billion dollar gain for the trade counterparty. I don't think this gets enough attention in the press and it's an important issue. The financial crisis is not simply all firms everywhere losing money - there are people on the other side of the trade winning money." Who is the counter-party? You are right, no-one discusses this point. Lynn

Seeking Sustainable Innovation

[73Zeppelin]

Lynn Marentette wrote:

Thanks for such an informative reply. Do you mind if I post some of this on my blog? If so, should I use your 73 zeppelin name as the source? Do you have a website or blog? I try to link my quotes to the source as much as I can. "...unless there is complete collapse of an institution, a 1 billion dollar loss on a trade is a 1 billion dollar gain for the trade counterparty. I don't think this gets enough attention in the press and it's an important issue. The financial crisis is not simply all firms everywhere losing money - there are people on the other side of the trade winning money." Who is the counter-party? You are right, no-one discusses this point. Lynn

No problem. I would prefer to remain anonymous as the finance community is rather small. For that reason, and others, I don't keep a blog or website. What's important to understand is that the over-the-counter (OTC) market is a very different place than, say, the NYSE. While not completely accurate, for all intents and purposes, private investors (like you and I) don't have access to the OTC (we do in some sense, but I don't recommend individuals trade on the OTC - very risky). Consequently, the OTC is dominated by institutions like investment banks. An OTC contract is a contract traded between counterparties in the OTC market - these contracts are highly specialized, traded in low volume and highly illiquid (due to their specialized nature). If, say, JP Morgan wanted to trade a credit default swap with, say, Lehman Bros., then this contract would be negotiated between these two parties, on the OTC and in the absence of the usual regulation that you get on the futures and stock markets (standarized contracts, good delivery, etc...). Specifically, the terms of the contract are mutually agreed upon by the two counterparties rather than mediated a third party or controlled/regulated by an exchange. Now, if JP Morgan bets wrong on the trade, then the counterparty (Lehman) receives the profit. To use numbers: let's say that JP Morgan loses 1 billion on a credit default swap position - then Lehman pockets a billion dollar gain. The derivatives contract saved Lehman from losing a billion dollars and, hence, the positive social impact of derivatives. Of late, the media seems to report only the losing side of the transaction, not mentioning the windfall that goes to the counterparty. The reports are therefore highly biased. That is not to say

[Lynn Marentette]

Thanks. I took an info visualization class last year and saved/bookmarked everything. There probably is a good infographic on-line that explains derivatives in a way most people could understand. (I just haven't found it yet.) In my timeline, it would be interesting to show how the unregulated OTC trading practices impacted our economy over time. By the way, do you know much about "Quantitative Behavioral Finance"? I took an "AI for Games" class, and some of the concepts we learned from our textbook - "Artificial Intelligence, A Modern Approach" - look like they are used in quantitative finance in some way. -Lynn

Seeking Sustainable Innovation

[73Zeppelin]

Lynn Marentette wrote:

I took an info visualization class last year and saved/bookmarked everything. There probably is a good infographic on-line that explains derivatives in a way most people could understand. (I just haven't found it yet.)

Hmmm. It depends. Derivatives are simply contracts derived from other assets. So options are usually "derived" from stocks. There are a large number of derivative contracts, all with different payoff schemes and written on different underlyings. The simplest are what they call the "plain vanilla" types - usually European call options. The complexity goes up from there.

Lynn Marentette wrote:

In my timeline, it would be interesting to show how the unregulated OTC trading practices impacted our economy over time.

Yes, that could be an interesting project.

Lynn Marentette wrote:

By the way, do you know much about "Quantitative Behavioral Finance"?

I know about it. I wasn't active in that field myself - I did asset pricing (futures, options, etc...) mostly mathematical and computer pricing. I can answer questions if you have any.

Lynn Marentette wrote:

I took an "AI for Games" class, and some of the concepts we learned from our textbook - "Artificial Intelligence, A Modern Approach" - look like they are used in quantitative finance in some way.

Could be - I'd have to know which concepts you are referring to. Neural networks are used, for example. Modern finance is quite mathematically complex. I think one of the problems is that regulation didn't, or couldn't, keep up with the pace of innovation in financial products.