Here it comes again folks….. and it’s our fault for allowing it.
Guarantees provided by U.S. lenders on government, bank and corporate debt in those countries rose 10 percent from the previous quarter to $567 billion, according to the most recent data from the Bank for International Settlements. Those guarantees refer to credit-default swaps written on bonds.
That would be ok if it was known that the seller could pay because they had laid actual capital against that position. That’s “One Dollar of Capital” and while it can lead to a nasty loss it can’t cause systemic risk because you can only bet what you have. If you want to bet more you have to either sell bonds, sell common stock or retain earnings (first), so your position is always covered.
But that’s not what we allow. We allow banks to simply claim they can cover it because “someone else” took the other side of the position — who is not required to prove they can clear the trade if it goes the wrong way.
Counterparty failure is another risk for banks selling insurance on the debt of the five counties. When a swap is triggered by default, a bank could find that a client who sold the protection can’t pay. The firm still has to make good on its promise to pay whoever bought protection.
And again, the problem is that there is no enforcement of a requirement that all underwater positions that are open be backed by actual capital and be proved as “good” on a daily basis.
This isn’t impossible to do by any stretch of the imagination. Computers are really good at counting things and keeping track of such stuff. We just refuse to force that at a regulatory level and the reason is simple: If you force people to gamble with only capital they actually have, instead of counterfeiting it through various “sleight of hand” games, then the so-called “profits” that have been “earned” by these institutions collapse inward.
The real problem with these games is that the so-called “profits” are in fact a skimming — or if you prefer looting — operation and come at the expense of everyone else in the economy. That includes you, by the way, especially when these “bets” go bad and you get tapped to cover it. The worst part of it is that it’s not just the explicit bailouts like TARP — it’s also the incessant skim that comes from fees on everything you do, directly and indirectly, whether the ~2% you pay on every credit or debit card transaction (yes, you the consumer pay it although you don’t see it) to the much higher prices you pay for everyday goods and services as the firms you deal with are effectively forced into the game to “hedge” the risk of pricing moves on commodities that the banks create with their proprietary trading!
We will never have sound banking — or a sound financial system — until we put a stop to this. There is nothing wrong with speculation, but that speculation must be undertaken only with your own capital. These are the rules that everyday people have to live with in their lives — I, and every other “retail” trader, must post actual capital against all of our positions and we’re marked at the largest time frame on a nightly basis — and sometimes more-often.
One Dollar of Capital is the only answer folks.