“I’m so bored. I hate my life.” - Britney Spears

Das Langweilige ist interessant geworden, weil das Interessante angefangen hat langweilig zu werden. – Thomas Mann

"Never for money/always for love" - The Talking Heads

Wednesday, November 26, 2008

Financial Cryptozoology

Because History is a poet, the idea of resurrected the financial sector of 2007 is rubbing elbows, in the press, with the idea that scientists are now able to genetically recreate the Wooly Mammoth. And there is a certain resonance between the big American banks and the Mammoths:

Preserved frozen remains of woolly mammoths have been found in the northern parts of Siberia. This is a rare occurrence, essentially requiring the animal to have been buried rapidly in liquid or semi-solids such as silt, mud and icy water which then froze.

This may have occurred in a number of ways. Mammoths may have been trapped in bogs or quicksands and either died of starvation or exposure, or drowning if they sank under the surface. They may have fallen through frozen ice into small ponds or potholes, entombing them. Many are certainly known to have been killed in rivers, perhaps through being swept away by river floods; in one location, by the Berelekh River in Yakutia in Siberia, more than 9,000 bones from at least 156 individual mammoths have been found in a single spot, apparently having been swept there by the current.

To date, thirty-nine preserved bodies have been found, but only four of them are complete. In most cases the flesh shows signs of decay before its freezing and later desiccation. Stories abound about frozen mammoth corpses that were still edible once defrosted, but the original sources (e.g. William R. Farrand's article in Science 133 [March 17, 1961]:729-735) indicate that the corpses were in fact terribly decayed, and the stench so unbearable that only the dogs accompanying the finders showed any interest in the flesh.”

Buried rapidly in liquid or semi-solids – a few changes and that would fit for Bear Stearns. You do remember Bear, don’t you? Used to be a bank.

Well, since this weekend the U.S. committed to Citi with a sorta startling generosity – equal to two years of the Iraq war, which is a pretty good party for a weekend even for Uncle Sam, you must admit – it is interesting to read about what the financial sector was up to, so that, when we clone our new species of mammoth bank, we aren’t surprised by its behavior in the wild.

So I went to this site , via Felix Salmon. This is how Alan Kohler describes them:

“Here’s how it works: a bank will set up a shelf company in Cayman Islands or somewhere with $2 of capital and shareholders other than the bank itself. They are usually charities that could use a little cash, and when some nice banker in a suit shows up and offers them money to sign some documents, they do.

That allows the so-called special purpose vehicle (SPV) to have “deniability”, as in “it’s nothing to do with us” – an idea the banks would have picked up from the Godfather movies.

The bank then creates a CDS between itself and the SPV. Usually credit default swaps reference a single third party, but for the purpose of the synthetic CDOs, they reference at least 100 companies.

The CDS contracts between the SPV can be $US500 million to $US1 billion, or sometimes more. They have a variety of twists and turns, but it usually goes something like this: if seven of the 100 reference entities default, the SPV has to pay the bank a third of the money; if eight default, it’s two-thirds; and if nine default, the whole amount is repayable.

For this, the bank agrees to pay the SPV 1 or 2 per cent per annum of the contracted sum.

Finally the SPV is taken along to Moody’s, Standard and Poor’s and Fitch’s and the ratings agencies sprinkle AAA magic dust upon it, and transform it from a pumpkin into a splendid coach.”

Kohler points out that the tipping point is coming, since the reference entities were a list of things like, oh, General Motors, Lehman Bank, etc. Now it might seem that’s no big deal, these 2 dollar SIVs will just collapse – but the genius of the system was to send salesmen around to get investors to put money into those clonish entitites. Oh, the joy! Pension funds. City governments looking for an exciting yield. Mutual funds. The whole wondrous world. And so they grew and grew, like mighty mammoths. Now, if they collapse, the banks will be all saved! By sucking enormous amounts of money from the rest of the system. Or, as Kohler puts it:
“It is a truly great irony that the world’s banks could end up being saved not by governments, but by the synthetic CDO time bomb that they set ticking with their own questionable practices during the credit boom.”

I have to give the establishment a lot of credit. They successfully made the guys on assembly lines making GM cars and trucks villains in the classic mode of that type dear to Reagan, the leaching, fraudulent, probably black welfare mother. One of Reagan’s most popular creations. Meanwhile, admitting the poor leadership of the banks, and the fact that they didn’t understand the risks they were running, they have, shall we say, omitted the sausage making part of the sausage – what were the instruments of that risk all about? You can see that innovations like this are the vehicle that allowed the ownership society to take greater risks – and don’t we all love risks? You might not be able to see that it did any social good at all. But then, if you are looking for social good, you haven’t been reading your Rand. So you definitely don’t understand D.C.

The O. Henry part of this little fairy tale is that, fucking over the auto industry might just be the trigger for the CDS cascade. whosoever diggeth a pit/shall fall in it...

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