Myron Scholes, intellectual godfather of the credit default swap, says blow ’em all up
This first article was printed on 3/6/09 and has received little note even though it is an incredibly easy and viable solution to a large part of the financial crisis. Myron Scholes was the creator of the infamous Black-Scholes model for pricing derivatives which won the Nobel Prize.
Myron Scholes, whose Black-Scholes option pricing model provided the intellectual underpinning for modern derivatives markets, thinks one particular derivatives market-that for credit default swaps-is due for a Red Adair style rescue.
Red Adair put out oil well fires by setting off gigantic explosions at the wellhead. "My belief is that the Red Adair solution is to blow up or burn the OTC market in credit default swaps," What that means, he elaborated, is that regulators should "try to close all contracts at mid-market prices" and then start up the market anew with clearer rules and shorter-duration contracts.
Credit Default Swaps (CDS) are speculative contracts (bets) written between two or more "counter parties." They are often complicated and sometimes bizarre – you can bet on anything that may be defined. They are a zero sum game, the counter-parties neither declare them an
asset or a liability – there is no real equity involved, just a pledge,
which allows the numbers to get huge.
Tax payers are being forced to pay hundreds of billions – maybe
trillions to "help unwind" the CDS’s when there is another solution
from their very creator – blow them all up! Or at a minimum, freeze
them to allow closer analysis. It’s been estimated that the total
derivatives market is around $1.5 quadrillion – many times the entire
GDP of the planet.
New York Times – A.I.G. Lists Banks It Paid With U.S. Bailout Funds
Financial companies that received multibillion-dollar payments owed by A.I.G. include Goldman Sachs ($12.9 billion), Merrill Lynch ($6.8 billion), Bank of America ($5.2 billion), Citigroup ($2.3 billion) and Wachovia ($1.5 billion).
Big foreign banks also received large sums from the rescue, including Société Générale of France and Deutsche Bank of Germany, which each received nearly $12 billion; Barclays of Britain ($8.5 billion); and UBS of Switzerland ($5 billion).
When A.I.G. received its first rescue loan of $85 billion from the Fed, in September, it forwarded about $22 billion to the companies holding its shakiest derivatives contracts. Those contracts required large collateral payments if A.I.G.’s credit was downgraded, as it was that month.
The big banks are being paid billions, and stand to make a lot more at the expense of the taxpayers for a mess that the banks created. We are threatened by government, the media and Wall Street –
"we can’t let them fail, it will destroy the world economy." No doubt,
derivatives have the capacity to do just that which is all the more
reason to diffuse them. Why isn’t Geithner doing anything about it?
Global Research – Geithner’s ‘Dirty Little Secret
What Geithner does not want the public to understand, his ‘dirty little secret’ is that the repeal of Glass-Steagall and the passage of the Commodity Futures Modernization Act in 2000 allowed the creation of a tiny handful of banks that would virtually monopolize key parts of the global ‘off-balance sheet’ or Over-The-Counter derivatives issuance.
Today five US banks according to data in the just-released Federal Office of Comptroller of the Currency’s Quarterly Report on Bank Trading and Derivatives Activity, hold 96% of all US bank derivatives positions in terms of nominal values, and an eye-popping 81% of the total net credit risk exposure in event of default.
The five are, in declining order of importance: JPMorgan Chase which holds a staggering $88 trillion in derivatives. Morgan Chase is followed by Bank of America with $38 trillion in derivatives, and Citibank with $32 trillion. Number four in the derivatives sweepstakes is Goldman Sachs with a ‘mere’ $30 trillion in derivatives. Number five, the merged Wells Fargo-Wachovia Bank, drops dramatically in size to $5 trillion. Number six, Britain’s HSBC Bank USA has $3.7 trillion.
The Government bailouts of AIG to over $180 billion to date has primarily gone to pay off AIG’s Credit Default Swap obligations to counterparty gamblers Goldman Sachs, Citibank, JP Morgan Chase, Bank of America, the banks who believe they are ‘too big to fail.’ In effect, these five institutions today believe they are so large that they can dictate the policy of the Federal Government. Some have called it a bankers’ coup d’etat. "This is Geithner’s and Wall Street’s Dirty Little Secret that they desperately try to hide because it would focus voter attention on real solutions.
I know that both Obama and Geithner are working hard…I just wonder who they are working for.
"I know that both Obama and Geithner are working hard…I just wonder who they are working for."
Hey, that’s what Kucinich said to Kashkari!
mainecooncat – you gotta love Kucinich – at least when he is not espousing socialism!