1000 Alitalia in one shot: so' forti 'sti Amerikani .... (II)

23 settembre 2008 michele boldrin
I apologize for being so verbose, but while writing I am trying to also clear my mind of its many confusions. Because nFA is a blog read by many people, I am also trying to make the argument at least partially understandable to readers not trained in formal economic theory. A machine translation into the Italian language is available (click the flag), which I hope to turn into readable, instead of laughable, Italian tomorrow.

''Back to Earth''
I ended the first part with a puzzle that seemed unsolvable. This was
just to make sure I could keep your attention, because things are not
nearly as bad as I made them appear; at least they are not nearly as
bad when financial markets function "properly" and "normally". Here's
why. As Filippo noted,
the notional amounts are seldom if ever paid: they are used only to
calculate the actual payments taking place between the two
counterparts. Consider the case of a simple interest rate swap on a
notional amount of $100 million. Neither party expects to ever have to
pay $100 million to the other; instead A will pay to B the difference
(0.7%, say) between the fixed and the floating rate in the reference
period, time $100 million, that is $700K, which is a lot less than the
notional. Also, many derivatives often expire without any payment or
only a few payments taking place, other are balanced by the issuing of
similar derivatives with the opposite sign, and so on. Further, for
derivatives traded in organized markets (e.g. futures)
on top of the fact that at settlement one must pay only the net loss
(receive the net gain), the organized exchanges ask for margin deposits
that are proportional to the open positions and force their closure
whenever those margins cannot be reasonably met. In other words, I
wanted to scare my readers a bit ... to drive home a point that Warren Buffet has repeated a number of times and to which everyone, including financial economists, have paid little attention.

The OTC derivatives market allows for the establishment of contractual
obligations between financial institutions that may be impossible to
satisfy, even in principle. In particular, OTC derivatives allow for
the creation of a "pyramid" of financial promises that cannot possibly
be satisfied because the amount to be paid, in certain states of the
world, is larger than the value of total world wealth in those same
states of the world. Call this point 1.

In models where individual portfolios are fully observable, beliefs
over future states of the world are common (or, at least, they have a
common support) and markets are dynamically complete, the situation
conjectured in point 1 is impossible. This is because either B, before
beginning to tango, will be able to correctly assess A's
creditworthiness in all future states of the world and make sure it
holds enough net real assets to back its promises to pay, or the rising
costs that A faces in financing its portfolio positions will force it
to diversify away its risk until the previous condition is in fact met,
i.e. A has enough real equities to pay for its derivative commitments
in case those come due and X (i.e. shit, for those that just tuned in)
happens. Because economic theorists studying financial markets almost
always assume these conditions to be satisfied, the fear that point 1
raises in the layman was not shared, until now, by financial economists.

Which begs the next question: along which dimensions did actual US
financial markets violate the assumptions above? How about "all, and
then some"? While I believe that "some" is the key, let me go through
"all" first.
'' ''
''Earth is, indeed, different from the standard model''
We teach that financial markets serve two purposes. They allow society
to transfer resources from those who did the saving to those that would
like to do the investing, which is good. We also teach that financial
markets arrange transactions shifting the bearing of risks from those
who do not want them to those who want them, in exchange for a fee. The
latter function is considered of the utmost importance by financial
economists, who spend a large amount of time showing how risk-bearing
is reduced as financial markets become more "complete" - i.e. more
independent securities are created; derivatives have been shown to be
able to play a key role in this beneficial process - and economic
allocations more efficient, in the sense of Pareto. An important caveat
here is that we assume that there are two kinds of risks: the
individual or diversifiable one (I gain, you lose) and the aggregate or
undiversifiable one (we lose, or gain, together). While financial
markets are magically capable of "dissolving" the first kind of risk,
they cannot do the same for the second. The second is just shifted from
one person to another in exchange for a fee, but the grand total
remains constant independently of how many fancy securities there are
out there. Let's keep this in mind.

We never teach that financial markets can be used to take bets, but
this is what the second function implies. If A transfers some aggregate
risk to B, then A may believe to be safer because B is now bearing its
burden. But this is not really true unless B is capable, and willing,
to cover the risk by means of actual equities, should the downside
event take place. Hence, as before in point 1, risk-shifting is bounded
by the total amount of resources available at any given point in time
and, specifically, is bounded by the amount of actual equities the
seller of insurance owns relative to the insurance it promised through
derivative contracts. If you think of it this way, the whole thing
becomes quite obvious, no? That's why, traditionally, we (i.e. the
regulators and independent overseers that are supposed to act on behalf
of citizens) make sure that insurance companies own lots of big and
fancy buildings, good land, safe stock, oil fields, and so on ...
pretty much like AIG did, right? Let us keep also this in mind.

Now, let me go back to my old example of A, B, C, etc. and make it a
bit closer to what we are talking about. In the updated story B is a
bank, holding a mortgage of $100 on a house with a market value of
$111. B may have purchased that mortgage from someone else, which
originated that mortgage by assessing incorrectly the risk that the
borrower may default ... or which may have made a small - and for sure
unintentional - mistake when typing in the income of the borrower in
the loan application form (say, $70 instead of $50, which makes a big
difference for the implied probability of defaulting ...). This does
not matter at this point: clearly LOTS of things like these happened
in the US mortgage market between 2000 and 2006, but our focus here is
on the continuation. Hence, B values the mortgage at $100 on the asset
side of its books, posting $100 in own capital on the other side, and
nothing else. The banker running B feels there is a 50% probability
that the borrower will default, in which case, via the foreclosure
process, it would end up receiving only $50. B does not like to hold
this risk, as it means that its net capital is really only $75 (i.e.
$100 - 50x0.5), while the shareholders will approve the banker's hefty
bonus of $15 only if net capital is at least $90. Hence B goes to A and
buys insurance, say in the form of a CDS,
promising to pay $90 no matter what in exchange for the proceedings
from the mortgage. You may ask if A is stupid or something, and the
short answer is "no". Clearly, something is happening here that is
creating a profit, for B, of $15 out of thin air: the mortgage has an
expected value of $75, so why should A promise B $90 for sure? There
are various explanations for this, all of which I believe apply to the
US 2000-2008. Here they are:

1. A assigns only a probability of 20% to the default event. People
make random mistakes, we assume, so there are equally as many As assigning a probability of 80% to the default event. But
these two groups do not cancel out because the first will
sell insurance whereas the second will do nothing. Think of this kind
of As as comprising all the "dumb/unlucky guys" that are always around
financial markets but become particularly frequent when the market is

2. B intentionally packages the mortgage in some "vehicle" that is
confusing enough to lead A to believe it is better than it is. Indeed,
this is
what private information means, in this world! Think of these As as
those guys that said "oops, we did not know what we had purchased",
like UBS or SG.

3. A's own capital is only $4, which it will not mind losing should the
default occur: 10/2 -4/2 = 3, which means a positive expected profits.
Assume A is an investment bank, or an insurer, and pick your name among
the now famous ones.

4. A is "betting" by taking up risk that cannot be diversified because
it goes always the same way. For example, it may be purchasing very many
of these mortgages (at a price of $90) by borrowing on the
money market or issuing bonds. A (or should I call it F&F?) pays very low interest rates because markets perceive the Federal Government is backing A's liabilities.

5. The interbank market is flooded with liquidity at a very low nominal
rate, say 1.5%. A cannot find any liquid security paying a decent
return, while these deals on mortgages are liquid and seem to be paying
a hefty return as long as the borrowers do not default. Call A

6. There is another character, called A', from which A plans to buy
insurance against the risk of losing $40 in case of default. The
character called A' satisfies one or more of the characteristics 1.-5.
and charges $8 for this.

7. Repeat 6. as many times as you please, because the OTC derivatives
market, which is neither regulated nor centrally organized, allows you
to do so. All you need is that S&P, Moodys and friends keep saying
you are a great credit. You pay their fees, so chances are they will.

Let me take home my second point.

Actual financial markets are much more imperfect than our
theoretical models, whose crucial assumptions are often violated. This
is well known, and things have always been like this, hence per se this
is not big deal. What the existence of an unregulated OTC derivatives
market plagued by private information allows is to leverage these
common "frictions" dozens of time, creating, under the appropriate
circumstances, a snowball that is, indeed quite big. Call this point 2.

'' ''
''All assumptions are violated, and then some''
Let me conclude for today with the "some" that, in my opinion, happens
to be the crucial one. That is: if point 3, coming next, had not been
true the fact that points 1 and 2 were would have created some
problems, but not the disaster we are apparently facing. It would have
been, in other words, business as usual on Wall Street.

The key thing is that the probability of default on nominal loans with
variable rates (and mortgages are nominal loans with, in recent years,
very variable rates) is endogenous. It depends, first and foremost, on
the nominal interest rate applied to the loan, which, in turn, depends
on the nominal interest rate clearing the short term interbank markets
that, in turn, is controlled by the Federal Funds rate. When those
rates are low the rates on mortgages are low and liquidity is abundant:
very many mortgages are issued and, if one has reasons to believe that
the short term rates will stay low for quite a while, it is reasonable
to expect the default rates will remain low. When those nominal rates
increase, and nominal incomes do not increase likewise, the probability
of default on those mortgages increases. This is what happened in the US during the 2001-2007 period due to the Federal Reserve "countercyclical" monetary policy.

Now, this is pretty normal and if those mortgages were held by the
banks that had issued them and the latter had not yet "taken profits"
on those mortgages, they would have set aside capital reserves to cover those
losses. This is what is currently happening in Spain that has also seen
a gigantic (in fact, proportionally much bigger than the US one) real
estate boom (1997-2006) followed by a bust in the last two years. In
Spain default rates on mortgages have tripled and interest rates have increased but, because (a) most
mortgages are held by the banks that issued them, and neither (b) have
been heavily securitized through derivatives nor, (c) have the "nominal
profits" on those derivatives been cashed-in (either in the form of
dividends or gigantic bonuses to the investment bankers) the financial
system is very far from coming apart. In fact, it posted record profits
even during the first semester of 2008, which I find rather surprising.
In other words, for reasons that should by now be clear, the "nominal
profits from derivatives issuing and trading" were not "taken" but set
aside till the end of the life of the underlying mortgages. The
opposite happened in the US.

What happened in the US, then? Simple: a derivative is a contract that
involves a sequence of payments over a period of time. If you make real
profits or not from a given derivative contract can be decided only
once the derivative expires and the whole sequence of implied payments
has been settled. But the current functioning of the OTC derivative
market allows something different to happen. Using our simple example,
here's the story. A mortgage is issued that, at current nominal rates,
has a low probability of default. Insuring it is cheap and, by
securitizing it, profits can be taken right away as the financing of
the security is obtained at low nominal rates, insurance is cheap and
the mortgage is off our hands in three days. This is quite fine, if the
probability of default on that mortgage does not change due to altered (by the Fed's actions) conditions in the borrowing and
lending markets. Should conditions remain constant, those initial
profits would correspond to actual profits also at expiration. But in
the meanwhile interest rates increase and default rates raise
accordingly. This means that the derivative security linked to the
underlying mortgage is actually loosing value and its prices should
drop. But you have it in the book for 100 and writing it down to 80
is a problem, so for a while you borrow on the money market to finance
the payments that, for example, the CDS you signed on forces you to.
The opacity of the OTC markets allows you to do so, maybe by entering in
even more derivative contracts. This goes on as long as you appear to be
credit worthy to the counterparts, which is not forever. In the
meanwhile pseudo profits are made, dividends are paid (these are
peanuts) and bonuses are also paid to you (these are not peanuts). From
the point of view of the theory this is money that should "stay in" (in
the form of capital reserves of the investment bank or the insurer underwriting
the CDS) to cover (via its capitalization at risk-adjusted market
rates) for possible future losses. But this is not what happened: the
capital reserves to cover future losses did not "stay in", they went
out to the mansion in the Hamptons. Call this point 3.

When shit hits the fan, oops X happens, you have no capital reserves, hence you
are not credit worthy, hence no one lend to you and you are maybe
insolvent and certainly illiquid. Hence you go the way of Bear Sterns
or Lehman Brothers ...

To quote, with a small [alteration], Robert Solow:

[...] the hedge-fund operators [read: investment bankers] and
others [fill in the name of your preferred banker] may earn perfectly
enormous incomes. (Margaret Blair of the Brookings Institution was one
of the first to point this out.) If they are clever enough, and they
are, they can arrange their compensation packages so that they batten
on profits and are shielded from losses.

This is because, in the actual financial environment of USA 2001-2008,
(pseudo) profits from derivatives came earlier - when interest rates
were low, hence expected default rates were low - and (very real)
losses came later - when interest rates increased, hence actual default
rates also did - and had to be absorbed by the little capital left in
the firm, which was not enough. The actual capital reserves had been
taken out by calling them "profits". This is point 3 again, only shortened.

Because it is late, I hope it is now clear why it took the convergence
of all three contingencies, summarized as points 1, 2 and 3, for this
disaster to happen. Any two of them without the third would have not, I
believe, caused the big mess we are currently into.

In this sense this
is an "exceptional event", and it needs not imply the "end of capitalism". But, in an another sense, it is and was a
perfectly predictable event: various people wiser than myself (e.g. Mr.
Warren Buffett) had pretty much predicted it a few years back. We, the academic economists, were blind to the facts and did not see it happening because we assumed the deviations of reality from our "standard model" to be quantitatively small. We were mostly wrong, and a few wiser people were right. More than anything, though, I believe we did not see that the particular nature of derivative contracts (their being "zero sum games, if no one cheats") together with the private information that plagues the OTC derivative markets allowed for gigantic (pseudo) profits-taking of funds that were, according to the theory and should have been in fact, capital reserves that had to be "left in the firm" to serve until the life of the derivative contract. But derivative contracts, these misterious zero net supply securities, allow for redistributing wealth from B to A at points in time that preceed their expiration, and redistributing to oneself very large sums of money (in a perfectly "legal" way) is a temptation no one can easily resist. Investment bankers may not be wizards, as they often portray themselves, but they are certainly humans.

correctly bygones are bygones and, in the unlikely event this
analysis will be found convincing, it still does not tell us what to do
NOW given the current circumstances. In particular, should we go the way that
Bernanke and Paulson are pushing us to go? Is there another and better
way? I am not sure, but I believe a narrow but clear other way can be
found on the basis of this analysis and similar ones developed by other. To the issue of "WHAT TO DO NOW" I hope to turn soon in the third part of these thoughts.

36 commenti (espandi tutti)

Caro Michele, davvero complimenti. Chiaro ed esauriente, come al solito, anzi più del solito. Solo due brevi commenti:

1. non mi pare di aver letto nel tuo post che le decisioni della Fed sul tasso di interesse sono prese guardando anche (soprattutto?) all'economia reale, non solo alla pura finanza dei derivatives. Questo spiega perché può verificarsi una politica monetaria che oggettivamente si trova prima ad edificare e poi (doverosamente?) a bruciare la gigantesca piramide di carta che così bene descrivi. L'inevitabile doppio ruoli della liquidità, ovvero finanziare l'economia reale delle equities e alimentare la piramide dei derivatives, è a mio avviso un aspetto essenziale della questione.

2. le tue ammissioni sul "fallimento" degli economisti ti fanno onore. Scherzando un po', potrei chiederti se hai iniziato ad indossare calzini a pois e/o pensi di riciclarti come commercialista in Valtellina... Più seriamente, mi piacerebbe una discussione con te ed altri (non in questo post, però) sulle responsabilità della formazione accademica degli operatori finanziari alla luce di tue affermazioni tipo:

Because economic theorists studying financial markets almost always assume these conditions to be satisfied, the fear that point 1 raises in the layman was not shared, until now, by financial economists.

We, the academic economists, were blind to the facts and did not see it happening because we assumed the deviations of reality from our "standard model" to be quantitatively small. We were mostly wrong, and a few wiser people were right.

Non credi che un po' più di storia economica (e magari anche di storia della teoria economica), e un po' meno di fancy math, avrebbe potuto insegnare qualcosa ai rampanti banchieri USA when still in their business school? Oppure, it's only a matter of regulation failure?

It would be good to start part III by briefly describing what would happen if the US Gov does not intervene.

I admit that I have carefully read only the first part of the story. The have had only a quick look at the second part. I have the impression that Michele is partially missing the main point.

The core of the picture that he is outlining is that OTC derivatives are the main culprits for what is currently happening. Surely he knows that he is not the only one supporting this argument. I remember that George Soros and, in Italy, Guido Rossi were also blaming the size of OTC derivative market (OTC Credit Default Swaps on the top). They say: derivatives are non trasparent and allow dealers to cheat (each other ? or the public opinion ?). I dare say that the first point has been already addressed by OTC derivative dealer since several years through collateral agreements. The  counterparties of  OTC deals agree to check jointly, on a daily basis, the evaluation of the  contracts they have traded (note that these contracts are not all long or all short but somewhat balanced) and the one which is net debtor will provide some cash collateral in order to mitigate counterparty (i.e. credit) risk. In case two dealers are pricing the same contract in two different ways they have a strong incentive to check their pricing models.

OTC derivatives look much like a scapegoat rather than a culprit. The current crisis is mainly related to something else: asset backed securities and the like (which in their more sophisticated forms include derivative components as well). Together with leverage well beyond safe levels. What were doing regulators in the meanwhile ? Looking at the bright side (conspicuos profits that banks were gaining until one a half year ago, you know money is always right). What were doing rating agencies ? Making money through commissions generated by new and new issues of ABSs (that were eventually repackaged into new things and new ABS backed securities). Where did rating agencies indipendency go ? Gone (at a fair price though). Almost everybody was on board. Well, a proper explanation require much more time and words. But this is the substance.

What else ? The main director of  the bailout is going to be Mr. Paulson. Actually it seems they are deciding to give the key of the stable to the wolf himself. No doubt he is a smart guy. No doubt about who he will favour when facing the choice between taxpayer interest and Wall Street (i.e. Goldman Sachs) interest. I suppose that in comparison the well known conflict of interest of Mr. Silvio Berlusconi will pale. One question arise. If the money of all can be used to back heavily a few, what can be said when the most will try to seize the richness of the few ?


We essentially agree, Amadeus, but let me try to clarify in three steps.

First, I agree with you that,

The current crisis is mainly related to something else: asset backed
securities and the like (which in their more sophisticated forms
include derivative components as well). Together with leverage well
beyond safe levels. What were doing regulators in the meanwhile ?
Looking at the bright side (conspicuos profits that banks were gaining
until one a half year ago, you know money is always right). What were
doing rating agencies ? Making money through commissions generated by
new and new issues of ABSs (that were eventually repackaged into new
things and new ABS backed securities). Where did rating agencies
indipendency go ? Gone (at a fair price though). Almost everybody was
on board. Well, a proper explanation require much more time and words.
But this is the substance.

I thought this is what my example and all the "violations of the standard model" I describe are  meant to say. If, after all those words, I did not succeed, I should reconsider my writing.

BUT, and this is the second point, without the use of a very large amount of OTC derivatives ($60 trilion only in CDSs) the whole packaging and siphoning around of ABSs would have been much harder, if not impossible. First because a lot of that took place in the form of derivatives and, second and more important, because all the (pseudo, ex-post) insuring of the underlying risk would have been impossibile.

Finally, and it is my third, without the "smart pricing" of derivatives, the economically unjustified "profits taking" activity that has turned the now so needed capital reserves into mansions in the Hamptons, airplanes and trophy wifes, would have been impossible. And most of the collapses we are witnessing would have not happened.

I am not trying to make the OTC market the culprit of the whole story! Far from me. When I write that all three conditions are needed for such a mess to happen, I strictly mean it: what a triple witch decade this is! 

Finally, one must accept that some observations are correct even if they force us to agree with characters we do not find particularly admirable, e.g. Mr. Soros. You mention all these good measures taken on the OTC markets: correct. Still, after the fact it is easy to see that they must have been pretty ineffective if hundred of billions in CDS contracts are being defaulted upon. Evidently the various parties had not carefully and daily checked the credit worthiness of the various counterparties, no? Again, the OTC market is not the culprit but it is hard to deny it is one of them. 

Thanks for your reply. You prefer to emphasize some market features (OTC derivatives and CDSs) that you consider potentially dangerous. I think that such potential danger exists but what has happened has less to do with sophisticated and more with simple instruments that have progressively turned into sophisticated ones (Sogen has been damaged by an employee who were trading simple index futures). As I said previously there is a widespread attitude toward reciprocal control in OTC markets, aimed at reducing counterparty risk. I allow to your main argument that in the CDS OTC market it is spreading the opinion that the outstanding amount of such contracts is much greater than the actual amount of bonds (which are the standard CDS's underlying assets) issued by the companies/banks which are the targets of such derivatives. You should consider that such outstanding amount does not net out offsetting positions and that someone could buy protections on his loans as well.
Actually this means that the picture is somewhat worse and maybe is not an unlikely product of unlucky events.
Let's start from the beginning. In the '90s the big (american) investments banks were making profits because of two main reasons: they were actually smarter in pricing and trading derivatives (were they had competitive advantages) and they were ready to exploit the bull bond market which was driven by the "secular" fall of interest rates after inflation was eventually curbed. When such conditions come to an end, because interest cannot turn negative they were looking for new revenues. In the meanwhile their competitive advantages were reducing. Here came the dotcom/tech bubble. They gained big commissions and fees by bringing into the market the new companies, helping mergers and takeovers spurred by the bouyant market. They did not take big risks and the stocks were placed into the market. At the end the losses were borne by the investors. The bubble bursted and then, to fight the recessionary winds, Mr. Greenspan cut the interest to historical low levels. This provided the fuel for the next trip. Low rates spurred mortgages. Unfortunately they are booked and accounted on an accrual basis. Then came the IB who turned the flows into present value through securitization. Origination of new securities took place starting again to pour commissions into IB pockets. Mortgages were tranched into securities segmented according to their riskiness which was related to some kind of preferred rights to reimbursement over the mortgage pools that were given to the best rated securities. Rating was the new trick and rating agencies were called in to help the new business. They provided bright ratings. Initially it made sense: only (or mainly) prime mortgages were addressed. But when prime mortgages were exploited they cannot do without securitization commissions any more and they started to look at more risky loans. Actually the true lenders were strictly tuned because they needed new business as well and they were transferring the risks! Rating agencies started to close their eyes. They simply required to slightly increase the risky tranches of the subprime mortgage pools. But the commission hunger was endless. Someone devised new ABS backed by...other ABSs (unsold tranches...), CDO backed by ABS, CDO squared backed by ABS on ABSs. Insurance companies provided their guarantee and rating agencies endorsed. This time the rubbish was sold only partly. It remained in the books of the IBs (and other banks as well). Here one little explanation is needed. According to regulatory constraints banks are due to set aside their capital in a fixed proportion of their loans for credit risk. Securities are different. They fall under market risk and the main banks are allowed to calculate the riskiness of their portfolio and the capital required according to their own internal model (though validated by the regulators). Such models usually allow a substantial reduction of required capital. Here you have the unprecedented leverage. You simply need to turn credit risk into market risk through well suited and well rated securities (you do not strictly need CDSs even if you can find them somewhere). When the market was quiet the volatility of such securities was very low and the calculated risk and capital were small. They were rated and priced as if the house market was going the grow forever. Some (willing ?)confusion was added by the fact that the rating labels provided by the agencies were exactly following the same patterns used for corporate bonds. They eventually said that some misunderstanding was possible: the same letters do not have exactly the same meaning...

The story can go on, but it's late and I need to stop here.

OTC derivatives look much like a scapegoat rather than a culprit. The
current crisis is mainly related to something else: asset backed
securities and the like (which in their more sophisticated forms
include derivative components as well). Together with leverage well
beyond safe levels. What were doing regulators in the meanwhile ?
Looking at the bright side (conspicuos profits that banks were gaining
until one a half year ago, you know money is always right). What were
doing rating agencies ? Making money through commissions generated by
new and new issues of ABSs (that were eventually repackaged into new
things and new ABS backed securities). Where did rating agencies
indipendency go ? Gone (at a fair price though). Almost everybody was
on board. Well, a proper explanation require much more time and words.
But this is the substance.

Gia', ma la colpa a ben guardare non e' neppure loro:

- Le rating agencies facevano quello che uno si aspetta da ogni entita' privata, cioe' massimizzare i profitti per il loro azionisti: fidarsene come se fossero imparziali e' da ingenui se fatto da investitori privati, e pura follia se fatto da istituzioni pubbliche come la BIS (su questo, vedi l'opinione che esprimevo poco piu' di un anno fa).

- I regolatori, poi, facevano quello che gli era stato detto di fare, guardando al proprio cortile e ignorando quello accanto. Ad esempio, se la FED per statuto non era responsabile per la supervisione ne' delle banche d'investimento ne' delle assicurazioni come AIG (o MBIA e Ambac, altri disastri in attesa di succedere di cui ora tutti sembrano essersi dimenticati), non le si puo' far carico di essersi addormentata al volante.

Le responsabilita' semmai ricadono su chi definisce i compiti e i poteri dei regolatori, cioe' dei rappresentanti democraticamente eletti a Presidenza e Congresso: i quali in questi giorni, sia a destra che a sinistra, si atteggiano invece ad autentici difensori del pubblico interesse nello stile del capitano Renault di Casablanca ("I'm shocked, shocked to find that gambling is going on in here!", salvo intascare un secondo dopo i proventi delle sue vincite - are you listening, Robert "Citi" Rubin?). 

I'll write this in my laughable Italian. Apologies. Ovviamente qualcosa va fatto per evitare il disastro del sistema finanziario americano, ci sono due aspetti che però trovo in un certo senso divertenti:

1) Il piano del Tesoro, per quello che ne capisce, prevede che il congresso firmi un assegno in bianco al Ministro delle Finanze (che come avete ricordato è un ex Goldman Sachs). A confronto, l'intervento per salvare Alitalia sembra essere ispirato da Von Hayek. Nella 'socialista' Unione Europea un intervento di stato di questo tipo non sarebbe mai stato ammesso anche perchè, a occhio, fa a cazzotti col potere di controllo che il Parlamento dovrebbe avere col Governo.

2) Dopo i ripetuti salvataggi di istituzioni finanziarie il rischio sovrano degli Stati Uniti è aumentato: di conseguenza il prezzo delle obbligazioni pubbliche già emesse scenderà. Dato che una parte consistente del debito estero statunitense è finanziato da acquisti esteri di obbligazioni e azioni, la discesa dei prezzi dei treasuries, unita al deprezzamento del dollaro e alla caduta dei prezzi di borsa, equivale a un parziale default del debito estero.

Se ci pensate, tutto questo è tipicamente americano, se solo si considera la parte di continente a Sud del Rio Grande: lì i Governi intervenivano (e in parte inteverngono ancora ) massicciamente nell'economia passando sopra al parlamento, e ogni tanto, quanto la situazione va fuori controllo, decidono di non pagare più di debiti. Bienvenidos a Latinoamerica, queridos Yanquis! 



lemonade stand

ne'elam 23/9/2008 - 15:08

If I get the point the key is how bad unregulated, well ill-regulated, markets perform (i.e OTC). Nihil sub sole novum. Few years ago Enron went bankrupt using similar tricks. Now we running across this same situation again. But Lehman, Fannie, Freddie and AIG make Enron look like a lemonade stand.

can't wait for the third episode.

[now, if michele was a seasoned pusher he would charge us for the third part. i claim intellectual property rights on this idea, hence sharing of profits if implemented]

A me sembra di essere tornato all'Università , grazie Michele per avermi tolto vent'anni in un colpo solo, anche il racconto a puntate mi ha ricordato il mio professore di Economia Politica (Mariano D'Antonio, Keynesiano, da sei mesi assessore "tecnico" nella Giunta Regionale Campana di Bassolino, attento Michele, è una fine che non auguro a nessuno), che arrivato sul più bello ci diceva: "il resto a domani e studiatevi la curva di domanda !"

Attendo le tue conclusioni, le mie per quel che valgono sono: salvare F&F ed il resto che vada in malora ! Tra l'altro concordo con Oronzo Canà (il proprio nome no?) che tutti quelli che hanno titoli del Tesoro Americano rischiano una bella svalutazione, ma non è la prima volta che gli USA fanno pagare ad altri i propri debiti.

Oggi alcuni benestanti amerikani hanno ricevuto questo messaggio di e-mail. L'ho ricevuto anche io, purtroppo ... Che sia spam?

From: Minister of the Treasury Paulson
Dear American:
I need to ask you to support an urgent secret business relationship with a
transfer of funds of great magnitude.
I am Ministry of the Treasury of the Republic of America. My country has had
crisis that has caused need for large transfer of funds of 700 billion
dollars US. If you would assist me in this transfer, it would be most
profitable to you.
I am working with Mr. Phil Gramm, lobbyist for UBS, who will be my
replacement as Ministry of the Treasury in January. As a Senator, you may
know him as the leader of the American banking deregulation movement in the
1990s. This transactin is 100% safe.
This is a matter of great urgency. We need blank check. We need funds as
quickly as possible. We cannot directly transfer funds in the names of our
close friends because we are constantly under surveillance. My family lawyer
advised me that I should look for reliable and trustworthy person who will
act as a next of kin so funds can be transferred.
Please reply with all of your bank account, IRA and college fund account
numbers and those of your children and grandchildren to
wallstreetbailout@treasury.gov so that we may transfer your commission for
this transaction. After I receive confirmation of transfer, I will respond
with detailed information about safeguards that will be used to protect the
Yours Faithfully Minister of Treasury Paulson


... ma temo che verra' trattata come tale dal signore che ha inviato la precedente.  Io, comunque, l'ho firmata, assieme a molti altri colleghi ...

To the Speaker of the House of Representatives and the President pro tempore of the
As economists, we want to express to Congress our great concern for the plan
proposed by Treasury Secretary Paulson to deal with the financial crisis. We are
well aware of the difficulty of the current financial situation and we agree with
the need for bold action to ensure that the financial system continues to function.
We see three fatal pitfalls in the currently proposed plan:
1) Its fairness. The plan is a subsidy to investors at taxpayers'expense. Investors
who took risks to earn profits must also bear the losses.  Not every business
failure carries "systemic risk." The government can ensure a well-functioning
financial industry, able to make new loans to creditworthy borrowers, without
bailing out particular investors and institutions whose choices proved unwise.
2) Its ambiguity. Neither the mission of the new agency nor its oversight are clear.
If  taxpayers are to buy illiquid and opaque assets from troubled sellers, the
terms, occasions, and methods of such purchases must be crystal clear ahead of time
and carefully monitored afterwards.
3) Its long-term effects.  If the plan is enacted, its effects will be with us for a
generation. For all their recent troubles, America's dynamic and innovative private
capital markets have brought the nation unparalleled prosperity.  Fundamentally
weakening those markets in order to calm short-run disruptions is desperately
For these reasons we ask Congress not to rush, to hold appropriate hearings, and to
carefully consider the right course of action. The manifest intention to intervene
has already calmed the markets and given us all the opportunity to wisely determine
the future of the financial industry and the U.S. economy for years to come.



who took risks to earn profits must also bear the losses. Not every
business failure carries “systemic risk”.


spiegarlo anche a chi, nella terra di Pantalone, va cianciando di
risarcimenti ai cosiddetti "piccoli investitori .....


... di questa lettera a Paulson comprende il gotha dell'economia accademica attuale, io credo che qualche effetto avrà. Ieri Paulson è stato massacrato dai lawmakers, dovrà per forza di cose trattare. Il problema è capire se la trattativa andrà nella giusta direzione; dalle premesse e dalle cose lette in giro, mi pare di no, per cui tenere alta la pressione dell'opinione pubblica mi pare necessario, e questa lettera va in quella direzione.

Grazie per il gotha. e' interessante per i nomi che mancano, specie a Chicago (dove e' nata) - manca Becker e manca Lucas, ma c'e' Heckman.

Adesso Lucas c'è, c'è stato un update. Sbaglio o, come si diceva poco fa con un amico, c'è una evidente connotazione Chicago-Minnesota-Northwestern (sia current faculty che gente "allevata" a litri di fresh water)? Abbastanza curioso...

Non sbagli. Infatti i promotori erano un po' preoccupati di questo e hanno cercato altre firme. Ma un po' il network di amicizie e un po' l'ideologia.... 

e un po' l'ideologia...

Ideologia? Quale ideologia? It is economic SCIENCE my friend, science! 

Scherzi a parte, credo che conti piu' il networking in questo caso anche se in Cambridge (MA) avranno paura di firmare per non apparire troppo free markets. Senno', la prossima volta che vogliono un'altra bella iniezione di moneta "to jolt the economy" e creare un'altro be disastro come questo, corrono il rischio che qualcuno glielo ricordi ... ok, time to find time to write down my plan!

mi lascia piuttosto indifferente. "Bisognerebbe discutere di piu, riflettere meglio..." BAH! Nessuna proposta tecnica concreta, che invece aiuterebbe.

I congressisti farebbero meglio di smetterla di proporre amendamenti che non servono, cestinare la lettera e ascoltare qualcuno che veramente se ne intende:





e sopratutto questa:


L'opinione di Warren Buffett in materia di finanza e investimenti va sempre rispettata, ma in questo caso potrebbe non essere del tutto disinteressata. Quando si hanno grosse somme investite in banche e altre imprese del settore finanziario, la prospettiva può non essere strettamente quella del benessere pubblico.

Io credo che il Congresso ascolterà l'appello degli economisti per una discussione lunga ma non per una discussione attenta, e lo farà out of self-interest. Il tema della crisi finanziaria mette chiaramente a disagio l'establishment repubblicano e la campagna presidenziale di McCain; un po' anche i democratici, a dir la verità, ma almeno stando ai polls è chiaro che il prezzo più salato in termini di consenso lo stanno pagando i repubblicani. I Democrats hanno quindi interesse a che il tema resti nelle news il più a lungo possibile. Aiuta il loro candidato alla presidenza e aiuta direttamente congressmen e senatori che sono up for re-election a novembre, soprattutto  quelli di distretti elettorali potenzialmente ''swing''.

Conclusione: siccome sono i democratici ad avere la maggioranza sia alla camera dei deputati sia al senato, aspettatevi un luuuuungo dibattito sul bailout, condito da poco buonsenso e tanto populismo stile ''wall street ci succhia il sangue'' da parte dei democratici. I repubblicani, come hanno sempre fatto almeno dopo l'11 settembre, cercheranno invece di seppellire qualunque discussione urlando che la situazione è urgente, che ne va della sicurezza nazionale, e che occorre dare poteri dittatoriali al governo sennó arriva il babau e ci mangia tutti. In questo ambiente, come italiano, io mi sentirò un pochino più a casa.

L'opinione di Warren Buffett in materia di finanza e investimenti va sempre rispettata, ma in questo caso potrebbe non essere del tutto disinteressata. Quando si hanno grosse somme investite in banche e altre imprese del settore finanziario, la prospettiva può non essere strettamente quella del benessere pubblico.

Gia'. Gli addetti ai lavori stanno cominciando a commentare l'operazione di Buffett. Bottom line:

Vote of Confidence my ass . . .

Il politico pensera', leggendo quella lettera, che il gotha dell'economia poteva anche svegliarsi prima (*). Non voglio essere sarcastico, solo cinico, considerato quale e' l'opinione che la politica ha dell'economia negli ultimi anni (le dichiarazioni di McCain e Clinton tra le ultime). E c'e' da dire che su questo argomento il politico la trova facile, nonostante il fatto che l'opinione pubblica sia effettivamente infuriata. 

Un paio di considerazioni.

La prima: tra il dissenso generale che ho visto al piano del bailout, questa di imitare la svezia mi sembra, da ignorante, l'unica cosa che si avvicina ad una proposta alternativa.

La seconda: il diritto di comprare cio' che vuole quando vuole e' stato dato non a Paulson, ma al ministero del tesoro. Paulson a Gennaio se ne va. Chissa' chi arriva. Si danno poteri che in molti definiscono anticostituzionali a qualcuno che ancora nemmeno si sa chi sia. 

(*) anche se, ragionando con lo stesso cinismo, dubito sarebbe servito a qualcosa fare le cassandre.

Mi sembra che almeno uno dei firmatari abbia effettivamente fatto delle proposte alternative:


La richiesta di assegnare al governo dei diritti di proprietà in cambio degli aiuti (parzialmente ispirata al modello svedese e al caso recente di N. Rock) comincia a prendere piede. In realtà dato il clima da "ultima spiaggia" che si sta creando (o stanno creando) dovrebbe discendere logicamente che il piano potrebbe avere anche delle importanti esternalità positive, anche per coloro che non aderiranno (a meno che nessuno aderisca nella speranza che lo facciano gli altri...) o no avranno una stretta necessità di aderire. Trattasi di un interessante gioco strategico per chi se ne intende. Anche i beneficiari indiretti saranno chiamati a versare il loro obolo ?!? 


non vorrei sbagliarmi (anche se probabilmente è così), ma io credo che zingales intenda la trasformazione dei creditori in azionisti come alternativa al bailout e quindi alla FED/tesoro che diventano creditori e poi azionisti.

Segnalo questo articolo di Mario Seminerio che trovo "abbastanza" sconvolgente, esp. per quanto riguarda l'Europa.

Segnalo questo articolo di Mario Seminerio che trovo "abbastanza" sconvolgente, esp. per quanto riguarda l'Europa.

Vedi anche quest'articolo di  Daniel Gros e Stefano Micossi, pubblicato in inglese anche sul Financial Times.

L'articolo di Gros e Micossi è citato anche nel mio pezzo.

Copio e incollo dal sito www.electoral-vote.com. Devo dire che l'esatta indicazione di ''bailouts of private institutions'' è impressionante. Che un partito faccia cose diverse da quelle dette nel programma non è così strano, nemmeno negli Stati Uniti, ma che lo faccia addirittura in campagna elettorale lascia un po' interdetti.

The Republican Party
platform adopted 3 weeks ago
explicitly opposes government bailouts of private companies. Here is the exact quote (from the section
"Rebuilding Homeownership"):

We do not support government bailouts of private institutions.
Government interference in the markets exacerbates problems in the marketplace and causes the
free market to take longer to correct itself. We believe in the free market as the best tool to
sustained prosperity and opportunity for all.

This plank in the GOP platform is not controversial within the party. Republicans have always believed that
when companies make bad business decisions the market will punish them and this is the deterrence for future
companies to think through their decisions carefully. The problem now is the utter hypocrisy of throwing
overboard a principle Republicans have held dear for a century.
If (big) companies lose the fear of bankruptcy because they expect the government to bail them out, they will take
unconscionable risks in the future. Maybe somebody should send Henry Paulson a copy of the Republican platform.

Maybe this is a little offtopic, but when I read point 3 I think about all the news about local italian governments making heavy use of derivatives.With little changes, the short version might become:

[...] the hedge-fund operators [read: mayors and governors] and
others [fill in the name of your preferred banker] may earn [spend] perfectly
enormous incomes [amounts]. (Margaret Blair of the Brookings Institution was one
of the first to point this out.) If they are clever enough, and they
are, they can arrange their compensation packages so that they batten
on profits and are shielded from losses [which will come after the end of their mandate].

I'm not sure if point 1 and 2 hold in this case, but my guess is that 1 does and 2 might be replaced by the implicit state warranty on local debt.

Should we expect a similar scenario in our  local governments?

Absolutely yes. Italian local governments, as documented in a past episode of Report on Rai3, have been exploiting derivatives offered to them by Italian and foreign banks, which were designed to give them money in the present and in the next few years of their mandate, while shifting all the duties and the reinboursements to after their present mandate. To add spice, the amount of money given to them by the banks now is about certain and does not reflect market fluctuations, while the money they have to return eventually is much larger than the one they should have returned by issuing ordinary bonds and furthermore it is significantly affected by market fluctuations. Often the risk of market fluctuations is entirely charged on the (stupid) Italian local governemnts, while the banks could not possibly loose because of market fluctuations. Of course the banks quite safely bet on the fact that the Italian central government will at all costs back up bankrupt local governments no matter how stupid, incompetent dishonest and corrupt they were. At some time, the Italian central government adopted regulations thar were intended to prevent local governments signing derivaties that were not centrally scrutinized and approved.

And who will back up a bankrupt central government no matter how stupid, incompetent dishonest and corrupt it is?

We have seen how financial crises in relatively tiny economies have rippled through other developing markets. If there is a financial tidal wave of American proportions, it seems to me that the Italian debt sand castle is the closest to shore.

But this is not my field. If someone more knowledgable can discuss the contagion risk for us, it would be very much appreciated. 

"Contagion", or whatever you want to call the fact that X in country A holds assets/liabilities against Y in country B) has little to do, if anything, with the size of either country A or B. It just depends upon having or not having closed/open financial markets and capital mobility.

In this specific case, I am afraid, the size of the country counts little. Dozens, hundreds, of hedge funds and other financial institutions seat in micro countries like Bahamas, Andorra, Liechtenstein and so on. Short of having one currency and one central bank for each small country (and closed capital markets on top of it) the two things are completely unrelated.

Let me chew on it.

I just want to make sure we talk about the same size. I understand that just because there is a crisis in a big (GDP) country like the US does not mean other big countries (France, Germany) are automatically at risk.

But if Uncle Sam decides to pull out his credit card, which is already stretched out, to help out within his household, it seems that it might have an impact on other countries struggling with hefty credit card bills.

I mean, it's not the first time Italy had a collapse. In 1992 the Lira was pegged to an overly strong Mark (German policy toward East Germany, etc...), it faced a recession (like now?), and the world economy was feeling the impact of a US real estate crisis (remember D.Trump being po' at the time?), kind of like now. And for the astrologers (but this is just a coincidental parallel), even then there was a Bush president fighting a war in Iraq.

Back then the Lira got a spanking, but right now the presence of the Euro makes things a bit harder to undestand (for me). I just wonder if having this fragile Italian situation "pegged" to this strong Euro is not worsening the situation and delaying the inevitable, kind of like Argentina pegged to the strong $.

I don't know, but a weak growth (if not negative), rising inflation, and potentially rising rates, is a recepy for trouble ahead for a highly indebted "entity".

Am I wrong? 

No idea. I do not even understand what you say, frankly.

Tradotto: non so se hai torto o ragione. Non capisco neanche cosa sostieni, e non credo sia l'inglese. 

Non so neppure io se ho torto o ragione.

Quello che voglio dire e' che spesso gli economisti si concentrano a spiegare quello che e' successo (cosa molto importante), ma tante volte non si sentono (o non vengono ascoltati) avvertire di un pericolo imminente.

Ora, io non sono in grado di quantificare nessuna previsione (non sono un esperto di mercati finanziari), e forse mi sono fatto spaventare da Bush che rassicurava sull'FDIC. Pero' mi chiedevo che impatto potesse avere sull'Euorpa (e in particolare sull'Italia) quest'ultima crisi.

Forse la risposta e' niente di che, pero' se c'e' qualcuno che se ne intende e ha dei numeri per fare qualche previsione per quanto riguarda la situazione italiana, sarebbe interessante.

I've seen that episode, but I don't trust them when they talk about this kind of stuff, and for a good reason: they are even more clueless about economics than me.

In this case, they spent most of the time blaming the banks for selling a contract favorable to them, and local governors for buyng things they don't understand.While they do have a point here, they didn't even consider the other scenario, where the governor knows it's a bad business for the government but a  good one for himself.And I'm pretty positive that both events do happen in real life.

I do trust report on the field work to collect the facts, not on the analisys.

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