Comments on: Good and bad financial innovation A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: Daniel Hess Sat, 29 Aug 2009 22:28:23 +0000 The flaws with CDSs are plain right in this blog entry.

Fact 1: AIG only ever sold, and never bought, credit protection.

Fact 2: AIG’s credit rating remained AAA until the bitter end.

Why was AIG able to do what they did for so long? Why hadn’t AIG lost its AAA long before? Because their CDS situation was incomprehensible, even to themselves.

Gaute, makes an excellent point about complexity. CDSs complexity comes from the fact that the probability of future defaults cannot possibly be known with any any reasonable precision.

Moreover the CDS market has demonstrated that it is a total joke. Last November, Berkshire’s five-year CDS spreads were at 475 BP.

The fact that there is a market and trading does not mean anything. Just look at AIG, FNM etc.

By: Gaute Fri, 28 Aug 2009 20:57:59 +0000 Good innovations result in products that are easy to regulate. Everything that is so complex that it is almost impossible to regulate and enforce will be abused. Complex rules on complex facts gives you complexity squared, which is the sure way to lawless territory.

By: Ginger Yellow Fri, 28 Aug 2009 15:03:17 +0000 “It was only after the credit market imploded that the negative-basis trade started becoming possible. ”

Huh? The boom years for negative basis trades, in Europe at least, were in 2005 and 2006.

By: Ken Fri, 28 Aug 2009 15:02:07 +0000 “AIG in general, and AIG Financial Products in particular, did a lot of things wrong. But that’s not the fault of the CDS market.”

Not in the sense that the market mechanisms were faulty, perhaps. But it indicates the market participants were not acting as they should, in order for that market to function properly. At some point, should not participants have asked how AIG was always selling and never buying?

By: Murray Fri, 28 Aug 2009 14:56:17 +0000 Felix, securitization did not absolve lenders from sensible underwriting. The lenders abrogated responsibility – and also ignored the very real risks that they still carried even after selling loans to securitizations, like being on the hook for buying early defaulting and fraudulent loans back, at par, from securitization pools. That’s what killed so many subprime lenders so early in the crisis.

Securitization was just the tool. And not the only one. Option ARMs, after all, were loans that were kept on banks’ balance sheet.

I’m not saying securitization didn’t play a role. But blaming a financing tool rather than the people using/abusing it is just silly.

By: 3 Fri, 28 Aug 2009 14:15:48 +0000 A couple of things to add:
1) We were doing negative-basis trades long before the credit market imploded. All you had to do was go to Ambac, MBIA, etc. and get them to ‘insure’ your AAA CDO for a few basis points.
2) Municipalities are the furthest things from sophisticated investors.

By: ab Fri, 28 Aug 2009 13:59:44 +0000 “In general, lending shouldn’t be easy to come by; and it should in principle always be just as easy to issue equity as it is to issue debt.”

I understand why you say this (especially in light of the excesses of the past decade), but I think it’s important to consider the full implications. Thinking about individuals instead of corporates, a world of tight credit means a world where the poor are increasingly shut out of economic opportunities. The more we restrict credit, the more we restrict real growth opportunities. And for those who no longer can get a mortgage, car loan, credit card, small business loan, etc., “issuing equity” is not going to be the answer (equity in an individual’s future earnings?).

Remember in all your ranting against borrowing that some debt can be a catalyst for real growth, and expanding access to credit is often a really positive economic development. And to the extent that investors understand SIMPLE securitization structures (e.g. credit card pass-throughs) and want to take that risk, it increases the availability of credit and lowers the cost. More often than not, that’s a socially beneficial activity.

By: Cezmi Dispinar Fri, 28 Aug 2009 12:36:08 +0000 There is another aspect in my opinion, Felix, regarding prevention from selling of harmful products to consumers. Banks nowadays are not looking for Bankers as employees, but for people who are able to sell every crap to consumers, cause they (the sellers) get paid for the total amount of the products they sell, not for consulting of the consumers, what is good, what is bad. I admit this has to do with the wrong remuneration in the finance sector. But it is not happening regardless of the so called „new products“ with alot alphas and betas in their labels which are overfloating the markets in the recent years.

By: David Fri, 28 Aug 2009 09:05:50 +0000 Insufficient financial education does lead directly to one of the major issues of the moment: levels of financial sector compensation. If they were better educated about the likelihood of a successful outcome (or rather the lack thereof), consumers and corporate representatives would not pay nearly so much for financial advice and products, and the institutions and hedge funds would not be able to make the margins to pay their staff so much.