On Monday, Devilstower went through some of the ins and outs of the Goldman Sachs / Paulson / Magnetar deals, including discussion of that latest of Wall Street "innovations" to have nearly brought down the world economy. You know, the one that might or might not represent criminal fraud…Now we start to dig for the details. There will be a prospectus on each of these CDOs, and it’s very likely that numerically these babies are going to be correct. What it’s going to come down to is the language of the prospectus and the discussions (verbal and email) that were held with clients.
Complicating things is that the "synthetic" CDOs at the heart of the Goldman / Paulson end of this deal where not regular CDOs built by bundling together loans. Complicated as those are, these were a couple of steps removed. These synthetic CDOs were composed from bundles made up of swaps, in this case the pay-out side of default swaps on other CDOs. […]
What looks to make all this possible is a drastic undervaluing of the cost of default swaps which in turn was made possible by an over-valuing of the intelligence and moral judgment of the people involved in the market. In short, there was an intrinsic expectation that people won’t purposely buy crap, because most people didn’t think it through to the "how to leave another guy holding the bag" stage. Which is exactly the weakness that Magnetar and other hedge funds spotted after spending months studying the market and talking to the people who sold these instruments.Ah, "synthetic" CDOs. Wonderful. Something to note here is that we are multiple levels removed, at this point, from any of the these products having any market rationale other than purely as gambling among various investment firms. If all of the "financial innovations" we’re discussing here were banned tomorrow, it would make not a damn bit of difference to any firm in the nation making physical products or selling non-financial services.Instead, we’re talking about multiple layers of increasingly-crazy financial instruments that exist for no other reason than to give the financial industry more things to bet on. And at some point you have to ask yourself, given how preposterously huge the financial sector has gotten when compared to the rest of the economy, just how much of our economy should exist solely as bets among a small set of massive financial firms. It doesn’t help businesses raise capital. It doesn’t get widgets delivered more effectively. It doesn’t even do the one thing these products were purported to be invented for in the first place – reduce financial risk. [One could even argue that it sucks capital out of more productive business uses, since everyone on Wall Street is apparently so enamored with investing capital in fake industries that it has become harder and harder to find firms willing to invest it in real ones.]
Instead, the recent "innovations" of Goldman Sachs, AIG and the rest of Wall Street were in crafting an absurd shadow economy in which actual, concrete industry, products, debts or work is only used as the barest of theoretical foundations upon which to build layer upon layer of completely imaginary crap. This is apparently the highest and best use of economics, and was all was invented in order to provide new, abstract "investment opportunities" in things that have little other substantive reason to exist. None of it has purpose except as a way for one broker/company to invent something to sell to another broker/company, under the assumption that the broker/company who invented it will, by virtue of knowing a little more about the "thing" than whoever else buys it, will be able to gamble more knowledgeably about the outcome than anyone else.
Imagine what would have happened if we really did privatize social security, and as a result had dumped that whole massive pile of money into the financial markets – money that had never before been available to them. Well, there’s no actual business use for any of that money – there’s only so much credit that can be sucked up, as we’ve been seeing – so the only place that money can go is into speculation, in the form of either inflating stock prices or, more likely, going into inventing still more pools of abstract money based on other people’s abstract money based on a third set of abstract money. And everybody gets a new pair of dice to roll.
That’s what’s perhaps most annoying about all of this. Granted, I am no financial wunderkind collecting millions of dollars in bonuses as reward for figuring out how to sucker punch investors in the next office down, but I have yet to see it explained in any credible way why we need to have massive, hyper-leveraged gambling taking place on products that represent nothing. A perfectly serious question, then: if we banned the whole notion of CDOs tomorrow – just completely gutted that entire precept of the market, chopped off the whole limb – what would suffer?
Imagine what would have happened if we really did privatize social security, and as a result had dumped that whole massive pile of money into the financial markets – money that had never before been available to them. Well, there’s no actual business use for any of that money – there’s only so much credit that can be sucked up, as we’ve been seeing – so the only place that money can go is into speculation, in the form of either inflating stock prices or, more likely, going into inventing still more pools of abstract money based on other people’s abstract money based on a third set of abstract money. And everybody gets a new pair of dice to roll.
“We don’t need to regulate the derivatives. We need to outlaw them. Derivatives are to investments as pornography is to human relationships.. .”
Damn, that’s a good analogy!