Janet Tavakoli Sounds The Alarm (Again)


Of course nobody will be listening….

In an earlier post, I wrote that Congress should act immediately to abolish credit default swaps on the United States, because these derivatives will foment distortions in global currencies and gold. Credit defaults swaps on the United States currently settle in euros, but there is talk of creating new contracts calling for settlement in gold. Congress should immediately ban all credit derivatives on the United States, since the opportunities for mischief making outweigh the hedging value.

In my opinion Congress should ban any and all securities for trading by any regulated entity (such as banks, hedge funds, mutual funds and similar) that are not exchange-traded.  Not clearinghouse-listed, exchange traded.


Because it is my considered opinion that such instruments as CDOs and custom, bespoke CDS have as one of their key elements to their marketability obfuscation of who holds what risk, why they hold the risk, and under what terms they will need to pay.

How much mayhem could “creative” minds generate in the credit default swap markets, the currency markets, and the gold market? Quite a bit, since customized credit default swaps can be embedded in all manner of financial investments, and they can be written to offload unexpected risks on naïve investors.

The Dodd-Frank “financial reform” bill doesn’t address customized over-the-counter credit default swaps, and the bill doesn’t do anything at all to reign in speculation in the currency markets or the commodities markets.

That “omission” was intentional.  The simple fact of the matter is that these highly-customized contracts are extremely profitable for the banks and other large financial institutions.  But the basic laws of business balance prohibit these artifices from being profitable unless someone is able to hide their true characteristics. 

The clear and obvious fact is that nobody works for free.  Therefore, the more-complex a security is, and the more hands it touches, the worse the deal for the customer.  There is no way around this.  The only way you can have these deals be “better” for the customer is if someone gets rooked or the customer is wrong about what he thinks the “better deal” constitutes. 

You always have a right to take a less-advantageous deal for yourself, but nobody does of their own free will.  The only time this sort of thing ever happens is if someone is deceived.  That is, they take a risk they didn’t know they had, or they’re convinced to lend someone money at terms that look attractive but that’s only true because the risk they believe they’re accepting is different – and less – than the risk they actually accept.

This is what made loans like OptionARMs, the custom Abacus CDOs and similar instruments possible.  Were the customers to understand what they were buying they would have never bought.  Customers were mollified by worthless “ratings”, the pronouncements of various actors such as lending officers and other alleged “professionals” and in some cases outright fraud such as the cases where a consumer had his or her income changed by a lending officer to pass some computer-driven ratio.

One can argue that these acts should be prosecuted, and I both have and will continue to.  But looking forward rather than in the rear-view mirror the only way to stop this is to bar the creation and trading of these instruments.  If whatever we trade is forced onto an exchange then there is no chain risk and there is no hiding of the sausage.  With exchange trading everyone can see the best bid and offer, we know what open interest is, and there is never a question as to the mark on that instrument – it’s right there, “in your face” every trading day.

Janet talks about Central Bankers having a “bubble deflator”, and that the financial industry has once again found a way to play without adult supervision.  She’s right in her analysis of the implications, but the better option is to not allow instruments to be offered that are intentionally-complex for the purpose of deceiving people in the first place.

The Market-Ticker