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Janet Tavakoli

Janet Tavakoli

Posted: March 8, 2010 09:20 AM

Washington Must Ban U.S. Credit Derivatives as Traders Demand Gold (Part One)

What's Your Reaction:

Congress should act immediately to abolish credit default swaps on the United States, because these derivatives will foment distortions in global currencies and gold. Failure to act now will only mean the U.S. will be forced to act after these "financial weapons of mass destruction" levy heavy casualties. These obligations now settle in euros, but the end game is to settle them in gold. This is so ripe for speculative manipulation that you might as well cover the U.S. map with a bull's-eye.

Credit default swaps are not insurance. If you buy fire insurance on your home, you must own the house. If you buy credit protection on the United States, however, you do not need to own U.S. Treasury bonds. If your protection gains value after you buy it -- not because the U.S. defaults, but because of market mood changes -- you can resell that protection and make a profit.

Lower credit risk means a lower price for protection. Zero implies zero risk. The higher the basis points, the higher the implied risk. When U.S. credit default swaps were first introduced, the price of protection was around two basis points. According to Bloomberg, the price for five-year protection was around 38 basis points (per annum) on Friday. But the price in the over-the-counter market -- where this stuff actually trades -- was almost double or around 75 basis points.

Since most traders in U.S. credit default swaps don't think the U.S. will default any time soon, why are they trading U.S. credit default swaps? They are speculating on price movements the way a day trader buys and sells stocks to speculate on stock price movements.

Volume in U.S. credit default swaps is relatively small, but it can explode rapidly, just as volume expanded rapidly for credit default swaps on mortgage debt in 2006 and 2007.

Speculators Want U.S. CDS Payoffs in Gold

Remember AIG? When prices moved against AIG on its credit default swap contracts, AIG owed cash (collateral) to its trading partners. AIG paid billions of dollars and owed billions more when U.S. taxpayers bailed it out in September 2008.

U.S. credit default swaps currently trade in euros. After all, if the U.S. defaults, who will want payment in devalued U.S. dollars? The euro recently weakened relative to the dollar, and market participants are calling for contracts that require payment in gold. If they get their way, speculators on the winning side of a price move will demand collateral paid in gold.

The market can create an unlimited number of these contracts very rapidly. The U.S. wouldn't have to ever default to trigger a major disruption in the gold market. Spreads (or prices) on the credit default swaps could simply move based on "news," and demand for gold would soar.

If this speculation drives up the price of gold, and the available gold supply becomes limited, are you willing to post your children as collateral? I am pushing the point so that we put a stop to this before it is too late.

Global Disaster in the Making

More than a year has passed since former Treasury Secretary Henry Paulson went to Congress in September 2008 to plead for special powers and TARP money to bail out U.S. financial institutions. Yet there has been no meaningful financial reform.*

The European Union has its own challenges. German Chancellor Angela Merkel recently called for limits on credit derivatives on Greece, since the European Union is concerned about misuse of credit derivatives for speculation. Chancellor Merkel did not go far enough.

World leaders shouldn't merely ask for limits on sovereign credit derivatives. They should demand a ban on all sovereign credit default swaps.

See also: "Washington Must Ban U.S. Credit Derivatives: Games and Gold" (Part 2)


*This video explains how cheap money, wide-spread bad (often predatory) lending, phony securities, credit derivatives, and Wall Street banks' massive over-borrowing led to our current financial crisis. Yet there is still no meaningful reform. Explanation of credit derivatives begins at 8:00.


 
 
 
 
 
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01:11 AM on 04/30/2010
"If your protection gains value after you buy it -- not because the U.S. defaults, but because of market mood changes -- you can resell that protection and make a profit."

many people still don't understand this. Market makers and participants are betting on VOLATILITY. They love it. They make money on transactions. The US people must understand this! They want us on a roller coaster while they go long on Pfizer (xanax)
12:18 AM on 03/13/2010
Any country which allows credit default swaps should be summarily kicked out of the world bank and denied all international credit.
02:10 PM on 03/10/2010
GOLD, GOLD and more GOLD.... It is a depressing view, but I'd trust gold and silver more than the assets in bank's financial books..... GOT GOLD!
12:42 PM on 03/10/2010
Hiding in a Wall street canyon, a place where the past will always bury the future, the banker waits.

Banks too big to fail, morph into banks too big to govern, and we wonder why, as we huddle around our desktop campfires waiting for the next OPEC stimulation package to knock us off our collective log(in).

Monopoly control over legal tender has a long, mean spirited, history. A system that places malignant cells of usury along side the enlightened idea of democracy, is just plain, poor design.

Democracy tries to give all a level playing field. With time, usury by its’ nature, must dominate or die. It uses the algebraic concept of exponential growth to accomplish this domination; it now encompasses the entire planet. Coincidentally this exponential growth accents human greed.

Exponential growth will always do an end run over any attempt to regulate [i.e the constitution]. Communism, democracy, fascism, capitalism, dictatorships, or monarchies; this old boy has no loyalty to any. He will however, eat one or two for breakfast.

As we speak skin cells are being correlated into functional neurons. Hammurabi economics needs to be completely replaced with behavioral economics. Surely we can colaborate to come up with something with good behavioral design elements.
04:24 PM on 03/13/2010
Nice. Kind of poetic. It's so true, people have blinders on the basic fundamental flaw in our current economic system:

- Compound interest grows exponentially, economies do not.

Allows rich people to sit back and "live on the interest". Explains why private debt is now $47 trillion (3X GDP) and has grown each and every year since WWII. Without every increasing debt, there would have been no growth at all, particularly since 1980.

So at some point, debts grow so large (public, private and financial) they can no longer be serviced unless there is some method to inflate the prices (e.g. value) of things like housing and further leveraging the debt "overhead" against the inflated asset (hello derivatives!). Tricks people into thinking they can get rich doing nothing but trading paper back and forth. Some do, but only those that know when to get out before it all crashes down.
12:21 PM on 03/10/2010
"More than a year has passed since former Treasury Secretary Henry Paulson went to Congress in September 2008 to plead for special powers and TARP money to bail out U.S. financial institutions. Yet there has been no meaningful financial reform."

Ya, Americans are still waiting for the anointed one to do something constructive and productive instead of distracting the attention elsewhere.
11:04 PM on 03/10/2010
Of course Obama would appear to be an anointed one as you republicans have spent the last 8 years bowing to Bush. You can get up but please talk like an adult.
09:52 AM on 03/17/2010
Thanks Turfkiller. Pay attention to the Senate bill for regulation. There's your answer for what's NOT happening. There is a reason this has been a bi-partisan "look the other way" in Congress. As Gordon Gecko so aptly put it, "Greed is good". If you are waiting for your elected officials to do "the right thing", you are waiting for Godot. The fix has been in for over 15 years, but the cover-up makes Watergate look like a two-bit burglary.
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HUFFPOST COMMUNITY MODERATOR
msjimmied
07:41 PM on 03/09/2010
The western banking industry's biggest export to the world is fraud....

http://seekingalpha.com/article/192440-fraud-the-western-banking-industry-s-fastest-growing-export

a tangent on the topic but well worth reading.
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HUFFPOST SUPER USER
blueken
Finger Picking blues man
04:00 PM on 03/09/2010
Any attempt to explain credit default swaps is a fool's errand in my opinion. If Liz Warren says they don't make any sense, I say they don't make any sense. One thing is for sure, they are dangerous. Sounds to me like Wall Street is placing bets on the failure of the financial system they are gameing.
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HUFFPOST SUPER USER
HANNIBAL1066
I've written on the Tea Party movement at politica
01:10 PM on 03/09/2010
Janet,

Another great article.

How would you link your grave concern over credit default swaps with what Simon Johnson is writing about here at HP and at Baseline Scenario that the banks are now "too big to save"?

In other words, me not being an economist, what risk are these speculators betting on regarding the US? Is it the risk that Johnson writes about?
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castlerider
"A man's home is his castle"
12:12 PM on 03/09/2010
Ms. Tavakoli, thank you so much for this article, for taking the time to do it and for including this revealing and actually quite historic interview. Others may not see the significance of it all, but I sure do.

I'm sharing it with everyone I know and respect so they can have an opportunity to learn what's really happened to this country and its economy that you tell in such a calm, concise and complete manner.

You're a goddess.... Your grace and style can only be admired as one must appreciate your knowledge enough to take into account the absolute urgency and the cataclysmic consequences of what our society is enduring due to the manipulation of our system due to outright greed.
11:22 AM on 03/09/2010
This woman speaks the truth in a concise and eloquently simple manner. Send her to the White House, stat!
Americans need someone who understands the system and is on the People's side on Financial issues. No more predatory lending(credit cards) and ambiguous mortgages sold to second and third parties (without our knowledge).
Is it any wonder that we're inundated with "Sell your old gold and jewellery for top prices!" ads on TV.
There is certainly a huge demand for gold in unsettling times.
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castlerider
"A man's home is his castle"
11:42 AM on 03/09/2010
Her and Elizabeth Warren should be given the chair in our all important financial positions that protect the people's money.

Between the 2 of them, they could really incite major corrections that would be felt for generations. Banks have enough control of our nation that they would incite incredibly serious havoc, and find a way to blame them for it. It's what they're good at, better then anyone.... manipulate the stupidity of our nation and convince people to go against their better interests and side with them or their puppets.

Hopefully, Obama sees all this and knows that changes that will overcome this huge behemoth will take time and will need a leader who is placing "sleeper" policies that can fly under the radar so that victory against these criminals can be assured. ... A very difficult and serious challenge. Like Ms Tavakoli says under no uncertain terms, "if you don't think this will happen again, that's just utter daydreaming... We've seen this happen AGAIN and again...."
.
09:59 AM on 03/09/2010
Ever notice whenever you play the game Monopoly how as soon as a hotel goes up on Park Avenue or Boardwalk, you end up landing on it? Rome is burning still, and there seems to be a unified element , a group, somewhere in this world that wants to make sure it is leveled once and for all. WE ARE FROZEN in our tracks, without answers, and politicians, whose roots are from the very industries that need to be dismanted, are in control of our dimming future. When unemployment runs out for the last time, you will see the rage...and that will make Gold go up regardless of the fat belly speculators who have -NO NATION - none, that they call their own.

Look back just after WWII ended, the USA gave money to Europe to rebuild under Congerssional decree and General Charles deGaulle, the new President of France, DEMANDED that HE be paid in GOLD ( not dollars like the other nations). A minor slip up by the politians who thought they were doing a good deed ended up nearly wrecking our economy (and began the tension between France and the USA which still exists). If the speculators are allowed to require payment in gold, the borrower is indeed open for permanent slavery....there is not enough gold to ever repay the debt, and that is the real issue here.
09:52 AM on 03/09/2010
The Credit Default Swap (CDS) market seems to have been brought into existence for two principal reasons:

1) To enable banks to profit from the coming collapse of the fiat money system
2) To provide a mechanism for this collapse to be managed

Now in the previous collapse of the US housing market, Goldman Sachs' CDS bets were held by AIG and ultimately had to be covered by the US taxpayer (or Chinese lender). This was because AIG didn't have the "assets" to cover their CDS exposure.

My question is which financial entities are out there currently writing CDS contracts for countries sovereign debt defaults. There is no way they will be able to cover that liability and as in AIG taxpayer bailout...which nations taxpayers are going to bail out that financial institution when countries start to default.

A CDS is only worth something if the counterparty can pay it off...

We are witnessing financial warfare and the weapons in this war are
1) banks
2) financial press
3) think tanks
4) credit rating agencies
5) fiat printing presses

I personally think that Europe should bail Greece out, because there is no point in financial discipline in a fiat system where default is not defined as quantitative easing (i.e. money printing)

Just print the money like US and UK till Asia says enough is enough...
10:46 AM on 03/09/2010
CDS, like pretty much every other derivative contract, started out as a humble, boring hedging instrument. Whilst not a full history on the subject, Gillian Tett's book, "Fool's Gold", is a pretty good outline of what the people who invented these products were thinking. But one example, the original CDS practitioners would not touch mortgage risk - they decided they did not have good enough data on historic performance.
09:30 AM on 03/09/2010
Maybe Obama will force all to turn in their gold like the great FDR did...
12:52 AM on 03/09/2010
I think it's interesting that manipulation has been replaced by speculation. I also think it's interesting that the entire premise of derivatives is nothing more than a manipulated bet. It has been said that the derivatives market is inflated to 1000 times the value of everything valuable on the planet earth and that there is over a quadrillion dollars(1.25) written worldwide.That's a lot of of unregulated insurance. As I understand it, derivatives is likened to me having a mult million dollar policy on a neighbor's house while I also figure out a way to shake the person out of their own bed. The clincher with the gold market is that when things fail , or the next bubble bursts, unless you are in posession of real gold as opposed to a paper certificate, then you are going to be sol. Speculators know they are manipulators. Simple.
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Kye154
12:41 AM on 03/09/2010
Acttually Janet, the problem goes back further and deeper than that. See: http://www.mathaba.net/news/?x=551732.

Imagine what would happen to all these credit derivatives, if say Saudi Arabia or Canada (who we get most of our oil from), decided to trade in Euros instead of dollars. Or, say if the credit card market soured, or if the commercial property bubble bursted. You will bet the foreign markets will be demanding gold, and the credit derivatives will end up being traded for that. Speculation on gold will be wilder than anyone can imagine now, and it will traumatize the US, and shut down the economy completely. It is a certainty this will happen, and I for one agree, the government needs to get off its dead duff and start regulating the markets, nationalize the banks, and abolishing credit derivatives outright.. The idea the markets will in some way take care of themselves is sheer fiction.
01:38 AM on 03/09/2010
Yes. I've been saying for some time now that all CDSs should be made unenforceable in court. They don't need to be regulated at all. Congress just needs to pass a law making them unenforceable. That effectively abolishes them without the need to hire a single regulator, FBI agent or judge. If people can't enforce these contracts, they will cease to exist.
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07:40 AM on 03/09/2010
They are fundamentally "securities fraud" anyway.

I say, "fundamentally."

Think it through and you will see what I mean. "I'm here to sell you the Brooklyn Bridge." Now, I'm back here to sell you a promise that, if the other guy can't pay for the Brooklyn Bridge (you see, I sold it simultaneously to ten thousand of you...), I'll guarantee payment. Now, I'm going to take that contract and sell it...

Flim.

Flam.

This is -precisely- what landed Mr. Ponzi in jail. Except now it wears the cloak of legitimacy. The fraud has become institutionalized. And yet, the so-called "securities" are, and they remain, fundamentally Worthless. They represent a "security interest" that does not exist; that could never exist.

The expressed desire to obtain payment in gold bars is simply an expression of the growing realization that the music has stopped; that the flim has flammed; that no one wants to be holding the bag, when in truth, "there's a fool born every minute," and "the greater fool" just might be Heap Big Bank.
09:37 AM on 03/09/2010
Personally, I don't know how you can make existing contracts unenforceable retroactively. And even then, how do you explain this decision to firms that use CDS to hedge credit exposure? Think the saying here is throwing out the baby with the bathwater...

Another idea, however, is having the law treat CDS as insurance products. That will chase a lot of the speculative activity out of the arena, at least temporarily.