Little you know about the economy, nothing you know about socialism, because you have not done your homework. I am far from being a socialist, but I am a defender of free markets.
I agree on the banks. The banks were unregulated, so their balance sheets were all interlinked via dubious OTC trades - in particular credit default swaps and collateralized debt obligations. If these instruments had been regulated and traded via an exchange with an appropriate management of counterparty risk, easy would it have been to allow for bank failures. But interlinkage more than size created moral hazard, the failure managers were not punished but saved from failure.
The crucial point is that free markets do NOT work. You need a regulated market, which includes the careful design of a mechanism that allows for competion. This has nothing to do with socialism. You are preaching a soccer game without rules and without an arbiter. This means going back 1000 years in history and ignoring all the achievements that have been made since the renaissance.
The world is no longer a place for uneducated wannabee-John-Waynes like George Bush, who engage in criminal acts and thereby create harm to the reputation of the US in the world. Following this path just leads to extinction of species, destruction of natural resources and finally to distribution wars. The "tragedy of the commons" problem is more acute than ever.
Deregulation Created Moral Hazard and Allowed for Ignoring Counterparty Risk
Actually it was the deregulation, which started during the Reagon/Thatcher periods that allowed the banks to engage in all sorts of dubious contracts. This created an interlinkage preventing some of them from failure. Failure is only possible, if counterparty risk is controlled and partly mutualized. Counterparty risk is mmonitored in the regulated market place, but not in OTC business. In a regulated market you need to deposit a margin to cover the counterparty risk. Another point is transparency, which favors price discovery. A regulated market place allows for price discovery. The OTC segment of the market relies on price discovery in primary regulated markets.
OTC is a Way of Defecting in Terms of Game Theory
So OTC and dark pools are damaging the markets
- because they do not contribute to price discovery
- they do not allow for equal access to markets by all participants, but favor monopolies or oligopolies
- they do not manage counterparty risk in an appropriate way
In terms of game theory this behavior is called defection. Defection explains why a Nash equilibrium does not need to be Pareto efficient, or why markets fail. Defection is also the base for moral hazard.
What about reading some books on
-> game theory
-> mechanism design theory
-> non-linear dynamics
to get a better idea of what is going on?
Sorry for my outspokenness, but you have heavily insulted me (not personally but intellectually) by calling me a socialist.
McCarthy died in 1957, you don't want to start that all over?
Last edited by Fat Tails; June 20th, 2011 at 05:38 PM.
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Feudalism: You have two cows. The lord of the manor takes some of the milk. And all the cream.
Pure Socialism: You have two cows. The government takes them and puts them in a barn with everyone else's cows. You have to take care of all the cows. The government gives you as much milk as you need.
Socialism: You have two cows. The government takes one of your cows and gives it to your neighbor. You're both forced to join a cooperative where you have to teach your neighbor how to take care of his cow.
Bureaucratic Socialism: You have two cows. The government takes them and puts them in a barn with everyone else's cows. They are cared for by ex-chicken farmers. You have to take care of the chickens the government took from the chicken farmers. The government gives you as much milk and as many eggs as its regulations say you should need.
Fascism: You have two cows. The government takes both, hires you to take care of them, and sells you the milk.
Pure Communism: You have two cows. Your neighbors help you take care of them, and you all share the milk.
Russian Communism: You have two cows. You have to take care of them, but the government takes all the milk.
Communism: You have two cows. The government seizes both and provides you with milk. You wait in line for you share of the milk, but it's so long that the milk is sour by the time you get it.
Dictatorship: You have two cows. The government takes both and shoots you.
Militarism: You have two cows. The government takes both and drafts you.
Pure Democracy: You have two cows. Your neighbors decide who gets the milk.
Representative Democracy: You have two cows. Your neighbors pick someone to tell you who gets the milk.
American Democracy: The government promises to give you two cows if you vote for it. After the election, the president is impeached for speculating in cow futures. The press dubs the affair "Cowgate." The cows are set free.
Democracy, Democrat-style: You have two cows. Your neighbor has none. You feel guilty for being so successful. You vote politicians into office who tax your cows, which forces you to sell one to pay the tax. The politicians use the tax money to buy a cow for your neighbor. You feel good. Barbra Streisand sings for you.
Democracy, Republican-style: You have two cows. Your neighbor has none. You move to a better neighborhood.
Indian Democracy: You have two cows. You worship them.
British Democracy: You have two cows. You feed them sheep brains and they go mad. The government gives you compensation for your diseased cows, compensation for your lost income, and a grant not to use your fields for anything else. And tells the public not to worry.
Bureaucracy: You have two cows. At first the government regulates what you can feed them and when you can milk them. Then it pays you not to milk them. After that it takes both, shoots one, milks the other, and pours the milk down the drain. Then it requires you to fill out forms accounting for the missing cows.
Anarchy: You have two cows. Either you sell the milk at a fair price or your neighbors try to kill you and take the cows.
Capitalism: You have two cows. You lay one off, and force the other to produce the milk of four cows. You are surprised when she drops dead.
Singaporean Democracy: You have two cows. The government fines you for keeping two unlicensed farm animals in an apartment.
Hong Kong Capitalism (alias Enron Capitalism):
You have two cows.
You sell three of them to your publicly-listed company, using letters of credit opened by your brother-in-law at the bank, then execute an debt/equity swap with associated general offer so that you get all four cows back, with a tax deduction for keeping five cows.
The milk rights of six cows are transferred via a Panamanian intermediary to a Cayman Isands company secretly owned by the majority shareholder, who sells the rights to all seven cows' milk back to the listed company.
The annual report says that the company owns eight cows, with an option on one more.
Meanwhile, you kill the two cows because the Feng Shui is bad.
Environmentalism: You have two cows. The government bans you from milking or killing them.
Totalitarianism: You have two cows. The government takes them and denies they ever existed. Milk is banned.
Foreign Policy, American-Style: You have two cows. The government taxes them and uses the money to buy a cow for a poor farmer a country ruled by a dictator. The farmer has no hay to feed the cow and his religion forbids him from eating it. The cow dies. The man dies. The dictator confiscates the dead man's farm and sells it, using the money to purchase US military equipment. The President declares the program a success and announces closer ties with our new ally.
Bureaucracy, American-Style: You have two cows but you have to kill one of them because the government will only give you a license for one of them. The license requires you to sell all your milk to the government, which uses it to make cheese. The government pays lots of money to store the cheese in refrigerated warehouses. When the cheese spoils, the government distributes it to the poor. The poor get sick from the cheese, go to the emergency room, and are turned away because they have no health insurance. The President declares the program a success and reminds us that we have the finest health care system in the world.
American Corporation: You have two cows. You sell one to a subsidiary company and lease it back to yourself so you can declare it as a tax loss. Your bosses give you a huge bonus. You inject the cows with drugs and they produce four times the normal amount of milk. Your bosses give you a huge bonus. When the drugs cause one of the cows to drop dead you announce to the press that you have down-sized, reducing expenses by 50 percent. The company stock goes up and your bosses give you a huge bonus. You lay off all your workers and move your production facilities to Mexico. You get a huge bonus. You contribute some of your profit to the President's re-election campaign. The President announces tax cuts for corporations in order to stimulate the economy.
Japanese Corporation: You have two cows. You redesign them so they are one-tenth the size of an ordinary cow and produce twenty times the milk. You teach the cows to travel on unbelievably crowded trains. Your cows always get higher test scores than cows in the U.S. or Europe, but they drink a lot of sake.
German Corporation: You have two cows. You engineer them so they are all blond, drink lots of beer, give excellent milk, and run a hundred miles an hour. Unfortunately they also demand 13 weeks of vacation per year and are very expensive to repair.
Russian Corporation: You have two cows. You have some vodka. You count your cows and discover you really have five cows! You have more vodka. You count them again and discover you have 42 cows! You stop counting cows and have some more vodka. The Russian Mafia arrives and takes over all your cows. You have more vodka.
Italian Corporation: You have two cows but you can't find them. While searching for them you meet a beautiful woman, take her out to lunch and then make love to her. Life is good.
French Corporation: You have two cows. You go on strike because you want another cow, more vacation and shorter work weeks. The French government announces that it will never agree to your demands. You go to lunch and eat fabulous food and drink wonderful wine. While you are at lunch, the airline pilots and flight controllers join your strike, shutting down all air traffic. The truckers block all the roads and the dock workers block all the ports. By dinner time the French government announces it agrees with all your demands. Life is good.
Political Correctness: You are associated with (the concept of "ownership" is an outdated symbol of your decadent, warmongering, intolerant past) two differently-aged (but no less valuable to society) bovines of non-specified gender. They get married and adopt a calf.
Counterculturalism: Wow, dude, there's like . . . these two cows, man. You have got to have some of this milk.
Surrealism: You have two giraffes. The government requires you to take harmonica lessons.
I'm just a simple man trading a simple plan.
My daddy always said, "Every day above ground is a good day!"
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Regulation is what got us into this whole mess...not deregulation.
You see, in a FREE MARKET, greed counteracts greed. Stockholders and Employees do what's in the best interest of the company. Sometimes that means being greedy. Most of the time it means ensuring you stay competitive and survive another day amongs all the other companies.
Back before liberal socialists invaded Washington, if you wanted to buy a house, you needed good credit, good job with good work history, a downpayment. You were lucky to move into a 3 bedroom house with 2 baths and a garage and a fenced backyard that was 20 years old. This was your first (meager) home. After paying your mortgage for 15 straight years, you either sold the house and used the equity to move into your dream home, or you took out an equity loan and fixed up your older home into your dream home.
Along come the Democrats. They see that home ownership is a very common aspect of the path to prosperity. One of them gets a grand idea. Let's give loans to "underprivelaged" people so that they too can enjoy the American dream. Barney Frank and his cast of well meaning idiots craft and pass the "Community Reinvestment Act of 1977." This legislation basically tells the banks, they have to loan to "subprime" individuals under threat of credit restrictions from the Federal Government. This is what affectionately creates the original "subprime" market.
During the 1990's times were great and the government pushed for even more leniency through FHA sponsored loans (backed by Fannie and Freddie). Now you could not only own a home, you could do it with bad credit, little to no downpayment, finance the closing costs as part of the loan, sign an adjustable rate mortgage and move into a BRAND NEW, 4 bedroom 3.5 bath 3 car garage house with a pool. After all, John Q Public deserves the American dream.
The subprime market was the fuel which fed the fire. You can have all the spark in the world....you can have Greenspan dumping massive amounts of cash, you can have crooked mortgage brokers, you can even have evil scheming bankers who create all sorts of products and you can have ratings companies that look the other way.
Without fuel to burn the spark is useless. The massive amounts of free money from Greenspan is the other component that if removed, would have probably prevented the entire thing (or at least greatly muted it). If you REMOVE the subprime market....then there's no victims. No influx of demand to overstimulate construction which spiked supply, no idiots to default on the homes they couldn't afford.
Like most catastrophes, it was a confluence of factors that all played a part, but the main two were the creation of the subprime market and massive amounts of free money. All the CDO's and default swaps and adjustable rate mortgages and mountains of sheetrock are useless without them.
So, in closing, it's when the government messes with an already healthy system (albeit with good intentions) that unintended, unanticipated consequences always ocurr.
You have no answer to market failures, limits of self-regulation, mechanism design. You are repeating your religion, without having studied the subject. Could you please reply, how you want to cope with a prisoner's dilemma situation, the tragedy of the commons and moral hazard, which is a consequence of defection in free markets.
I absolutely agree with you. I am aware of Bill Clinton's National Homeownership Strategy. In 1997 purchase of non-GSE subprime mortgaged securities was up to $ 60 billion from $ 10 billion in 1991. This certainly was one of the foundations for the later problems that Fannie Mae and Freddy Mac ran into, before they had to be rescued with taxpayer's money.
However, this is not market regulation. It is interventionism. The soccer association is not supposed to select the players or run their own teams, they shall only set up the rules. The arbitre is not supposed to play and make a goal, but his role is to supervise the players. When the state directly or indirectly subsidizes any venture, this will mostly go wrong, if it can be done by private investors. But on the other side there are sectors, where the private sector cannot provide for an optimal solution. Again these are the cases where the Nash equilibrium will not lead to Pareto optimality. The best example in the US is education. Public education in the US is an expensive disaster.
Greenspan was put into office by a Republican president, but he cannot be blamed alone, as the Greenspan Put suggests. Abundant money also was the consequence of ever growing US trade deficitis. The money - useless abroad - was recycled into the US and significantly contributed to the disaster.
Agree. Abundant money was the trigger, obscure over-the-counter (we are back to the subject) instruments like CDOs and CDS acted as a catalyst. Actually the delayed the bursting of the bubble. Without CDS and CDO a medium sized bubble might have exploded in 2005, with the help of these obfuscators, the full dimension of the problem remained hidden until 2007.
OTC business is harmful due to lack of transparency and complications it brings along for managing counterparty risk. An open and transparent market for CDS and CDOs - both types of instruments being regulated - would not have avoided the bubble, but some of its consequences.
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Did you write that yourself or was it from another source? Brilliant stuff
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Thanks for debunking
Thanks FT for taking on the shallow, mendacious and unbelievable bankster apologist arguments presented earlier.
Professor William K. Black among others makes a compelling case regarding who should be going to jail.
The list of those to whom credit is due must would have to include Ronald Reagan (not guilty by reason of senility?), William Simon, Milton Freidman, Alan Greenspan, Phil Gramm, Bob Rubin, Larry Summers, and the four Bushes: George HW, Bill, George W, and Barack.
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