Open Thread

Our regular featured content-

• On This Day In History March 9 by TheMomCat
• Punting the Pundits by TheMomCat

And these featured articles-

• Greece Succeeds In Averting Another Crisis by: TheMomCat
• Eric Holder promotes Obama administration’s assassination policy by: joe shikspack
• Mirror Mirror by: ek hornbeck

Write more and often.  This is an Open Thread

by Herman Cain and Stephen Colbert.

Unintended irony from the NYT

By Glenn Greenwald, Salon

Thursday, Mar 8, 2012 10:47 AM Eastern Standard Time

It’s simply shocking to find a country which would allow its political class to be dominated by those who “have profited from the crony capitalism that has come to define its economic order” and who “nearly brought down” its banking system. What must it be like to live in such a country? But even more bewildering still is that the Afghans simply refuse to prosecute their high-levels financial criminals, even though the U.S. is providing advice and oversight! Maybe it’s unsurprising to see a country treat its powerful criminals with impunity, but not when they have the United States of America providing guidance and wise counsel. What could possibly explain this? Are they simply ignoring the important lessons we’re teaching and the shining example we’ve set?

Maybe he should just throw them in the dryer for a few minutes.

Open Thread

Crossposted from The Stars Hollow Gazette

Credit Default Swaps (CDS) Are Insurance Products, Not Tradeable Assets

Author: Barry Ritholtz, EconoMonitor

March 2nd, 2012

The CFMA radically deregulated derivatives. The law changed the Commodity Exchange Act of 1936 (CEA) to exempt derivatives transactions from regulations as either “futures” (under the CEA) or “securities” under federal securities laws. Further, the CFMA specifically exempted Credit Defaults Swaps and other derivative products from regulation by any State Insurance Board or Regulators.

This rule change exempting CDS from insurance oversight led to a very specific economic behavioral change: Companies that wrote insurance had to explicitly reserve for expected losses and eventual payout in a conservative manner. Companies that wrote Credit Defaults Swaps did not.

Hence, AIG was able to underwrite over THREE TRILLION DOLLARS worth of derivatives, reserving precisely zero dollars agianst potential claims. This was enormously lucrative, except for that whole crashing & burning into insolvency thingie.

How Greece’s default could kill the sovereign CDS market

By Felix Salmon, Reuters

February 29, 2012

The way that CDS auctions are meant to work is that once a borrower defaults on its debt, that defaulted debt continues to be traded in the market, and its value then determines the amount that credit default swaps need to pay out. But in this case, Greece’s defaulted debt might well not continue to be traded in the market. In which case, when traders need to find a cheapest-to-deliver bond to bid on in the CDS auction, they’re going to have to use one of the new bonds, rather than one of the old ones.

…

In other words, Greece’s CDS really aren’t protecting holders of Greek bonds at all – or if they do, it’s more a matter of luck than of law. When they get paid out on their CDS holdings, people owning protection against a Greek default won’t get paid according to how much money they lost on their old bonds. Instead, they’ll get paid according to the nominal price of the new bonds.

What this means is that the CDS architecture is broken, and can’t cope with collective action clauses. And as a result, according to the hedge fund manager who tipped me off to the whole problem, “this Greece CDS imbroglio might be the final blow for sovereign CDS as a product.”

Greece Readies Record Debt Swap With 60% Commitments

By Maria Petrakis and Fabio Benedetti-Valentini, Bloomberg News

Mar 8, 2012 6:59 AM ET

While Greece would prefer a voluntary deal, the government has said it will use collective action clauses to force holders of Greek-law bonds into the swap if the so-called private sector involvement falls short and it gets sufficient approval from investors to change the bonds’ terms.

“I think that the markets are aware of the risk that a majority for voluntary restructuring is not available, and so I think the surprise won’t be too big if tonight when they realize the collective action clauses will have to be applied,” Bofinger said.

…

“I do fully expect to be part of the collective action clause,” Patrick Armstrong, managing partner at Armstrong Investment Managers in London, said yesterday in a Bloomberg Television interview. He won’t voluntarily join in the swap because of the “minuscule” chance his bond maturing March 20 will be redeemed at face value.

Compelling holdouts to take part will likely trigger insurance contracts on the debt known as credit default swaps.

“I can’t see any scenario where people are forced to participate against their will and they aren’t triggered,” Armstrong said.

How all CDS are at risk of not paying out

By Felix Salmon, Reuters

March 5, 2012

At heart, the problem is what happens when an issuer swaps out all of its bonds for some new bonds. There’s no reason at all why the new bonds should trade at a massive discount to par – indeed, issuers often like it when their new bonds trade at or near 100 cents on the dollar. But if the CDS auction happens after the bond exchange, and if all of the old bonds are exchanged, then holders of the new bonds are forced to tender new bonds into the exchange, even if they’re trading at 100 cents on the dollar. Which means that holders of old bonds could suffer a huge haircut in the value of their bonds, but still get no payout from their CDS.

This has been an issue in the past. When Anglo Irish Bank restructured its bonds, it amended the old bonds to include a call option which allowed the bank to buy back every €1,000 of bonds for €0.01. That was an effective way of wiping out the value of the old bonds – but it also risked serious damage to the CDS market, since in a CDS auction, the value of a bond is calculated as the price of the bond considered as a percentage of the outstanding principal – and the outstanding principal is considered to be not the face value of the bond but rather the amount of the call option. If Anglo Irish had done the exchange quickly, before a CDS auction was possible, then bondholders would have had to tender bonds with a call option at €0.01 – which would mean that they couldn’t claim any payout on their CDS at all.

In the end, Anglo Irish took pity on the CDS holders, and staggered its restructuring so that there was enough time for ISDA to conduct an auction before the bonds got changed out of all recognition. But hoping that the issuer will act in a friendly manner is not exactly an optimum strategy – especially since, by definition, the issuer will be in the process of going bust.

…

This doesn’t just seem unsatisfactory at first blush; it is unsatisfactory. And there is no second blush. Essentially, CDS holders are reduced to hoping that the issuer will be nice, and structure the exchange in such a way as to let them get paid out. But there’s no particular reason why the issuer should do that, especially seeing as how the CDS holders were the people who were effectively shorting the issuer as it tumbled into bankruptcy.

…

If you own protection on a credit, then, you’re very much in a world of caveat emptor. You can trade in and out of CDS and make a good living; these things are, first and foremost, trading vehicles. That’s why they’re more liquid than bonds. But if you have a strategy which involves actually getting paid out on your CDS in the event of default, then you should definitely worry that the payout might not happen, even if the event of default is clear and declared. What’s more, there’s really no good way to hedge that risk.

Crossposted from The Stars Hollow Gazette

G-8 summit to be held at Camp David, not Chicago

By Christi Parsons Tribune reporter, Chicago Tribune

5:42 p.m. CST, March 5, 2012

Camp David will more closely approximate the remote settings in which the G8 leaders prefer to gather. Summits in large cities typically see clamorous protests, while those in the countryside are calmer and more sedate.

…

Chicago police estimated that 2,000 to 10,000 demonstrators were expected to show up for the overlapping G-8 and NATO summits.  At least two major demonstrations were already planned for downtown during the summit, and organizers said they wanted to send crowds of marchers down Michigan Avenue in the middle of the day.

…

The mayor had also sought tough changes in ordinances governing public demonstrations. But in the face of criticism from aldermen and civil rights groups, he was forced to scale them back.

(h/t Atrios)

I have even less interest in this edition of the Insane Clown Posse than most (if that were possible).  I’ll have neither the time nor inclination to join you.  If you insist on playing along with Mitt there’s a place to scribble below.

You may well ask what those fancy +3s are.  Those are delegates chosen outside the normal selection process and will not be decided tonight.

Crossposted from The Stars Hollow Gazette

In two previous posts I’ve collected some of letsgetitdone’s reactions to Dylan Matthews’ Washington Post article on Modern Monetary Theory and the responses of other authors-

• Everything we thought we knew is wrong!
• Wrong Again!

In this final installment is some of his extensive treatment of Dean Baker’s critiques.

In his first reaction to Dean Baker, letsgetitdone outlines 7 areas of specific differences between Keynesian Deficit Doves and MMT and their policy implications-

1. Government deficit spending for recovery.
2. Government fiscal policy over the business cycle.
3. Long Term Deficit Reduction Planning.
4. Long Term Deficit Reduction Projections.
5. Funding Government spending.
6. Social Security Solvency.
7. Proposed progressive reform programs.

The end for MMT is achieving public purpose including full employment with price stability as one aspect of it. Since the MMT view is that fiscal policy is much more useful for doing this than monetary policy MMT focuses on how fiscal policy should be set.

Its general view is that alternative budgetary plans have to be assessed from the viewpoint of their anticipated outcomes, without regard to deficits or surpluses as outcomes valued in themselves. Of course, full employment is positively valued and unemployment negatively valued, but a whole range of valued outcomes is relevant for such assessments. Those are the ends, and fiscal policy is the means. Monetary policy and trade policy are also means, but are not nearly as important as fiscal policy in their effective short-term impact.

Baker wrote a second article which letsgetitdone also felt largely ignored the critical differences between MMT and Deficit Dove Keynesianism and this time responded with a 3 part piece-

In the first part he discusses these issues-

Like MMT Says: Monetary Policy Would Be Ineffective

I won’t go into the details here, but the bottom line seems to be that he thinks the Fed could add $20 Billion to aggregate demand mostly through mortgage refinancing arrangements.

My own bottom line is that what he outlines might work, but only proves the MMT point that monetary policy can do very little to help solve our present economic problems. We have about a 28 million person U6 employment problem, which could take as much as $1.2 Trillion in carefully formulated deficit spending. So, adding $20 Billion in aggregate demand to the economy makes very little contribution compared to the scale of the problem. It’s the proverbial drop in the bucket and justifies the lack of emphasis MMT places on this channel.

Expanding US Exports at the Expense of Decreasing Real Wealth?

The MMT argument is that as long as other nations are willing to send us more real wealth in return for dollars, than we send them, then that is a net benefit for American consumers. Certainly, our willingness to accommodate their desire to exchange exports for dollars has caused real damage to US industries, and the erosion of skills and capabilities among workers and has also cost the jobs of Americans.

…

In other words, the big negatives that are related to our positive current account balance with the rest of the world (colloquially known as our trade deficit) are costs that we don’t have to bear, according to MMT, to get the benefits of imports. We could employ Americans fully, our people could be developing new skills and experiences, our wealth in facilities and social conditions we all share could be vastly increased, if the Government used its capability to help us fulfill the opportunities the current account balances give us to turn to other things that badly need doing, rather than making televisions, toys, clothes, and all the other things we no longer make. MMT says that the Government’s deficit will equal private sector savings plus the current account balance. So, if both are high that makes room for large Government deficits, and, in fact, actually demands them, since if we try to reduce them the end result will be less real wealth coming from imports and less nominal wealth accumulated from savings.

letsgetitdone continues in the second part–

Expanding US Exports at the Expense of Decreasing Real Wealth? (continued)

(W)hy do economists like Dean and Paul Krugman insist on relying on far-fetched scenarios to try to argue against simple truths that may apply today? The current account balance will probably be around 4-5% of GDP this year. As the economy recovers it will probably rise to 6% of GDP again, which represents a very real benefit to the United States. But there’s no reason to expect that this growth would continue indefinitely or ever reach 50% of GDP. Why should it? What are the dynamics that would drive things this way, and make other nations value the dollar so much, that they will keep their own populations barefoot?

…

Dean then continues with other arguments about re-balancing trade and its effects which are largely correct. But his remarks on the devaluation strategy not being “a beggar thy neighbor” strategy are only correct if we assume that such a strategy would not lead to negative compositional effects at the higher level of the international economic system.

If US attempts to devalue were followed by other nations responding in kind, then a race-to-the-bottom could result which would harm workers in all the major nations of the world. In this context MMT would probably say, don’t devalue. Instead use fiscal policy to fully employ all of your working people, and then let other nations devalue your currency as they please. There will be far less danger of a race to the bottom in this scenario, since your attempt to employ all of your own people to domestic tasks producing valued outcomes, can hardly be viewed as an attack on the desires of other nations to continue to export to you.

Is Work Sharing a Separate Channel for Raising Aggregate Demand?

I find myself in complete agreement with the proposals in the past few paragraphs and the arguments for the benefits of work sharing. I have only one problem with it, and that is why Dean classifies this proposal as a separate channel from the Government deficit spending channel?

From my point of view, making the standard work week 35 hours and mandating the kinds of fringe benefits they have in Europe and compensating workers directly with Government subsidies for the reduction of 5 hours of work per week they receive, is definitely using the Government channel to raise aggregate demand, since the increased demand comes from the Government subsidy assumed by the proposal. It’s not a proposal the economists developing MMT have put forward. But I’ve put forward a similar proposal, and I see nothing in it that is in conflict with MMT.

In the third part letsgetitdone concludes with a discussion of Dean Baker’s contention that MMT relies “exclusively” on the fiscal channel-

Pitfalls of the Fiscal Policy Channel

MMT doesn’t advocate wasteful spending, or digging holes for the sake of the activity, or spending money on projects and programs that will waste real resources or people’s lives. There is a risk that any spending, private or public, will be wasteful or involve an excess of real costs over real benefits. But that’s no excuse for avoiding private sector spending, so why should it be one for avoiding public sector spending when that’s called for?

The events of the last ten years show that both Federal spending on Wars, and private spending on financial adventures can be disastrous, but it was wasteful investments on fantasy sand castles that crashed much of the world economy; not deficit spending in the United States intended to achieve public purpose. In fact, that kind of spending has been starved for the past 35 years at least. And right now, there is no record of wasteful public spending that remotely compares with the record of wasteful private spending over that same period.

…

MMT, itself, it favors spending that can be justified based on projections of its real benefits and costs, not projections of its nominal benefits and costs to a Federal Government that can never have any solvency problem. MMT is against crony capitalism, and for prosecutions of banksters and fraudsters. MMT proposals in the health care area would not only improve health care outcomes and reduce private sector expenditures on health care but would also produce millions of new jobs in the health care sector, while putting the health insurance barons out of business. MMT stimulus proposals for ending the recession, include Revenue Sharing grants to States on a per person basis, so that States could re-hire staff laid off in response to the recession’s impact on tax revenues. It’s very doubtful that hiring back Police, Firefighters, Teachers, and other State Civil Servants would be viewed as wasteful to most people.

Dean’s Conclusion and Mine

(M)y view is that Washington in its current state doesn’t care about logical inconsistency, or rationality, or arithmetic. At this point it is a closed “village” of opinion. As Dean implies, points of view that have no currency in the village don’t get discussed, or ridiculed when they are. The question however, is how does a closed system like this change, since it is fairly closed to changes in viewpoint that may be necessary to use to solve its problems?

I think the answer to that question is raw failure that destroys confidence in the governing world view which is neoliberalism. The highly visible failure of neoliberalism in 2008 wasn’t capitalized on by this Administration. It was loyal to the neoliberal point of vew and followed the prescriptions of neoliberals for fixing the problems it created.

However, the failures of neoliberalism continue. We see the disaster in Europe now taking shape, we see the extreme discontent among so many in American society, including most importantly the young who cannot see any acceptable future. The stresses grow with each passing year of injustice and maintenance of levels of real unemployment that haven’t been seen in this country since the 1930s.

…

The worst of the anger is yet to sweep this country. When it does, when the banking system falls either in Europe or here, when the big banks are taken into resolution and the serious investigations start under a new Attorney General, the changing of the guard in Washington will come; and the old regime, along with their neoliberal paradigm, will be swept away. And it is then that MMT will be accepted in Congress and the Executive Branch sufficiently, so that its policies will get a chance. If those policies succeed, then neoiberalism will be gone, hopefully for good.

This week’s episodes originally aired April 22, 2005.