One thing is for certain, the global financial system is an extremely complex and tightly coupled system that is in the throes of non-linear feedback loops that threaten to rend it limb from limb. Small and slow inputs, like the bailout bill ($700 billion) or the ad hoc actions of the Federal Reserve (already $1.8 trillion and climbing), from the government control system are not even in the ballpark of what's necessary to mitigate the system's excesses and return it to normal operation.
One solution: Nuke entire parts of the system. In short, destroy the system's network connectivity. For example, credit default swaps ensure that failure will spread through internetworked contracts. Nuke CDS derivatives ($60 trillion or so) by making them illegal. Destroy parts of the network in order to save the remainder -- firewalls and firebreaks.
It'll happen, but too late. As you've talked about in other posts, this thing is moving too fast, with too many drivers and too much information flow for the bureaucrats and bankers that supposedly "run" the system. By the time they get around to nuking things like the CDS market, the devastation will already be done.
Posted by: Flagg | October 03, 2008 at 04:10 PM
In 1933 - they triaged the banking system - C banks were wound up. B banks were merged into A Banks and A banks were the survivors.
Swaps and derivatives have been the killer as has been leverage. This comnbination - took the market from mediating the needs of the economy and its capital to simply "playing" with money. All the reward was in playing.
So I agree with you John - pull back on the leverage and not only make swaps illegal but only allow those who play by the rules to have access to the window or FDIC insurance.
Cut out the cancer of the Casino
Posted by: Rob Paterson | October 04, 2008 at 08:35 PM
John & Rob
Other than angry, connected and bankrupt elite insiders ( perhaps a good thing in terms of salutory effects) what would be the strategic spillover costs of nuking this class of derivatives ?
Posted by: zenpundit | October 06, 2008 at 04:08 PM
Hi "Zen"
They break the link between the natural flows of savings and the need for real investment. They have since 1984 become ends in themselves.
They started as conveniences - we used them to make a shift between fixed and floating - A has fixed B has floating rate money - we can exchange the mechanism.
But then they became this vast pool that dwarfs the ability of any regulator or any capital base - Beyond trillions - THIS is what hangs over us all.
They are not essential and drive too much leverage. The system needs to shrink to what can be accomplished by agency and not leverage. It is the leverage that has done us all in.
Posted by: Rob Paterson | October 07, 2008 at 06:22 AM
Yes, John, nuke the CDS market.
And maybe all banks that sell / buy them in amounts greater than their other lending.
When 500 000 folk lose their construction jobs because of overbuilding, it's obvious and 'ok'. The CDS financial market overbuilding is even worse -- so more than 500 000 overpaid bankers will need new jobs. What they were doing before was no more valuable than building a $300 McMansion that nobody buys for more than $150k. Except the real built stuff has some value -- a CDS w/ a bankrupt counterparty is 0.
(Not here for a while)
Posted by: Tom Grey | December 03, 2008 at 12:24 PM