The London Loophole

[Luke T.]

I am curious about something. (http://www.skepticalcommunity.com/phpbb2/viewtopic.php?t=23141)

Last year, there was a much ado about rising oil prices. And some people were trying to pin the blame on the devalued dollar, rising demand in China and India, and such.

I want to show you something:

An Oracle of Oil Predicts $200-a-Barrel Crude (http://www.nytimes.com/2008/05/21/business/21oil.html)

An analyst at Goldman Sachs, Mr. Murti has become the talk of the oil market by issuing one sensational forecast after another. A few years ago, rivals scoffed when he predicted oil would breach $100 a barrel. Few are laughing now. Oil shattered yet another record on Tuesday, touching $129.60 on the New York Mercantile Exchange. Gas at $4 a gallon is arriving just in time for those long summer drives.

Mr. Murti, 39, argues that the world’s seemingly unquenchable thirst for oil means prices will keep rising from here and stay above $100 into 2011. Others disagree, arguing that prices could abruptly tumble if speculators in the market rush for the exits. But the grim calculus of Mr. Murti’s prediction, issued in March and reconfirmed two weeks ago, is enough to give anyone pause: in an America of $200 oil, gasoline could cost more than $6 a gallon.

But here's the thing. This guy works for Goldman Sachs. And while analysts and traders are supposed to have a wall of separation between them, I think we all know better by now. So if Goldman Sachs happens to issue a shriek that oil is going to go up, up, up, then gee whiz you better buy some of that black gold commodity from our traders while you have the chance!

At Goldman’s annual meeting, Henry M. Paulson Jr., then the bank’s chief executive and now Treasury secretary, found himself defending Mr. Murti.

“Our traders were as surprised as everyone else was,” Mr. Paulson reportedly said. “Our research department is totally independent. Our trading departments have no say about this.”

Methinks he doth protest too much.

This is the same guy and the same company that invented mortgage derivatives, sold them in astronomical mass quantities, and then shorted them. Their integrity is zilch.


“Even if you disagree with their views, the problem is that Goldman does carry so much credibility,” said Nauman Barakat, senior vice president for global energy futures at Macquarie Futures USA. “There are a lot of traders who are going to buy based on their reports.”

Credibility, my ass. It's a setup. The very same investment money which blew up the real estate bubble was blowing up the oil bubble.

I never had a doubt in my military mind that it was speculators.

Maybe you have heard about the "Enron loophole." Let me get into that for a moment.

During the depression of the 1930s (1936, to be precise), Congress passed the Commodities Exchange Act which, among other things, prohibited speculators from owning more than a set percentage of a commodity.

The whole reason this Act was passed was precisely because speculators had been manipulating commodities for decades and causing wild price flucuations EXACTLY like we are seeing today. For the most part, the speculation was in grains and other farm products. Congress had wrangled with various pieces of legislation over the years, but the Supreme Court kept declaring them unconsitutional.

The Commodities Exchange Act of 1936, however, was not struck down and was the key legislation governing commodities trading for several decades.

The most important thing about the Act is that it requires all commodities trading to be public, and thus transparent.

This act limited the size individual traders could hold in commodities. It did not limit the positions that all traders put together could hold. It also had a list of commodities to which it applied, and so those commodities not on the list were still prone to massive manipulation.

Every time one commodity was manipulated, Congress would amend the Commodities Exchange Act to include that commodity, and so the speculators would move on to another commodity. And the market kept inventing derivatives and options to get around the regulations.

Then, in the 70s, the Commodities Future Trading Commission was created to try to rein in the speculators. But the CFTC and the SEC kept stepping on each other's toes, arguing over who had jurisdiction over what. And then in 2000, the Commodity Futures Modernization Act was written to draw lines of turf, and was signed by Bill Clinton.

Contained within that new Act was the famed "Enron Loophole". Supposedly put in by Phil Gramm.

To explain how the Enron Loophole works, I will use some hypothetical illustrations.

Here's the first:

Farmer Jones is an apple farmer. John Smith owns and operates a grocery store chain. Jones and Smith have an arrangement. During normal times, Smith buys apples from Jones for a dollar a bushel. This makes life very predictable for both Smith and Jones. Jones knows how much money he will make from year to year, and Smith knows what his apple expenses and profits will be from year to year. Of course, variables such as weather and fertilizer prices and such will affect the outcome, but for the most part, life is as stable as it gets, and the customer can pretty much count on the price of apples being stable as well.

Enter Dick Sneed. He's a speculator, and he has a virtually unlimited supply of investor money. He's swimming in funds.

Sneed approaches Jones and tells him, "I will buy your apples for two dollars a bushel."

Jones would be a fool to turn down an offer that will double his income, and so he goes for it.


http://i43.tinypic.com/f3xmoi.jpg
I'm going to take those record profits.

Depending on how many bushels Sneed buys, Jones will have less and less apples to sell to Smith. Not only that, he can now demand more from Smith. Hey, you buy my apples for two bucks a bushel, too, or I will sell them all to Sneed.

Now Sneed, being the wealthiest, can buy up all the apples and "corner the market". And then Grocer Smith will have to go to Sneed for his apples instead of Farmer Jones. And Sneed can pretty much name his price.

And that is how a commodity is manipulated.

Not only that, Sneed can buy Jones's apples before they are even grown! He can buy all of the apples grown for the next two years.

Enter the Commodities Exchange Act. Henceforth, all apple deals traded in the US must be made on a public exchange, and no trader is allowed to buy more than ten percent of apples up for trade.

Apple stability returns. Sneed can't manipulate apples any more. Grocer Smith buys his apples on the public exchange, along with everyone else. Now even Smith can lock in a purchase of apples ahead of time, before they are actually available.

And then came Enron.

{to be cont'd}

[Luke T.]

Second illustration:

Fred Watt owns an energy company. Jim Widget owns a factory. Jim doesn't feel like dealing with the ups and downs of a commodities exchange. He wants a locked in price for his energy needs for the next ten years. He can build his own power plant out back, I suppose, but that's not very practical for Jim. Jim would rather have a place to go to buy his energy directly from someone who can give him what he wants. Fred Watt seems like that kind of guy.

But that darned Commodities Exchange Act (CEA) prevents him from being able to do that.

Fred has a lot of potential customers who would like to be able to deal with him on a one on one basis. And Fred would also like to find a way to corner the market, but he's keeping that little secret to himself.

Fred Watt wants to go back to the Farmer Jones/Grocer Smith model. Only he wants to be be both Jones and Smith. And so Fred makes a recommendation to Congress to change the law in his favor (http://www.ustreas.gov/press/releases/reports/otcact.pdf).

The Working Group has concluded that under many circumstances, the trading of financial derivatives by eligible swap participants4 should be excluded from the CEA. To do otherwise would perpetuate legal uncertainty or impose unnecessary regulatory burdens and constraints upon the development of these markets in the United States. The Working Group has also concluded that it is important to remove legal impediments to the development of electronic trading systems, which have the potential to increase market liquidity and transparency, and appropriately regulated clearing systems, which can reduce systemic risk by allowing for the mutualization of risks among market participants and by facilitating offset and netting of
contractual obligations.

Specifically, with respect to OTC derivatives, the Working Group is unanimously recommending:
· An exclusion from the CEA for bilateral transactions between sophisticated counterparties (other than transactions that involve non-financial commodities with finite supplies);
· An exclusion from the CEA for electronic trading systems for derivatives, provided that the systems limit participation to sophisticated counterparties trading for their own accounts and are not used to trade contracts that involve non-financial commodities with finite supplies;

And so Congress goes along with it, and thus was born the Commodity Futures Modernization Act of 2000 (http://www.cftc.gov/stellent/groups/public/@lrrulesandstatutoryauthority/documents/file/ogchr5660.pdf).

SEC. 104. EXCLUDED ELECTRONIC TRADING FACILITIES.
Section 2 of the Commodity Exchange Act (7 U.S.C.
2, 2a, 3, 4, 4a) is further amended by adding at the end
the following:
``(e) EXCLUDED ELECTRONIC TRADING FACILITIES.--
``(1) IN GENERAL.--Nothing in this Act (other
than section 12(e)(2)(B)) governs or is applicable to
an electronic trading facility that limits transactions
authorized to be conducted on its facilities to those
satisfying the requirements of section 2(d)(2), 2(g),
or 2(h)(3).
``(2) EFFECT ON AUTHORITY TO ESTABLISH
AND OPERATE. -- Nothing in this Act shall prohibit a
board of trade designated by the Commission as a
contract market or derivatives transaction execution
facility, or operating as an exempt board of trade
from establishing and operating an electronic trading
facility excluded under this Act pursuant to
paragraph (1).
`(3) EFFECT ON TRANSACTIONS.--No failure
by an electronic trading facility to limit transactions
as required by paragraph (1) of this subsection or
to comply with section 2(h)(5) shall in itself affect
the legality, validity, or enforceability of an agreement,
contract, or transaction entered into or traded

How about that last paragraph, eh? Pretty, ain't she?

This effectively eliminated the ban on the amount of a commodity a single trader could buy!

And it was all allowed to be done off the public exchange. Thus the term "dark market".

So Jim could sign a contract with Fred for all of his energy needs for the next ten or twenty years, with no federal oversight. Fred and Jim would work out the price between themselves.

Suppose they sign a contract which says Fred will provide Jim eleventy zillion watts of power over the next ten years for a total price of 100 million dollars. Jim will pay that 100 million over the course of the next ten years, but thanks to the wonders of mark to market accounting, Fred can declare all 100 million dollars on this quarter's financial report!

Now that Fred can make one on one deals, he can corner the market one customer at a time. Acting like Grocer Smith, he can buy up all the natural gas from each supplier on his private electronic trading network, and then turn around and act like Farmer Jones and sell that gas to his customers on the same private network. All out of sight of the feds.

Since Fred has bought up all the natural gas, there isn't any available on the public commodities exchange. So everyone has to go to Fred on Fred's Private Exchange to get their natural gas. Fred is also Sneed!

And all Congress can do is say, "@#$%!"

{to be cont'd}

[Luke T.]

Enron's gone now, brought down by making promises they couldn't keep. They sold more energy futures than there was energy. Idiots.

But the loophole remained and others were using it and manipulating commodities with it. Nothing had changed. Everyone remembers last year, but how many remember the same thing happening in 2006? I do.

It was pretty obvious what had to be done. Close the Enron loophole. But the GOP was not amenable to closing it.

Then the Democrats got custody of Congress. And they put an Enron loophole killing provision in...the 2008 Farm Bill! Yeah!

Remember that Farm Bill? Sure you do. That's the one Bush said a very strange thing about (http://www.boston.com/news/nation/washington/articles/2008/05/21/bush_vetoes_farm_bill/).

"People are not going to want to see their taxes increase."

Bush threatened to veto it, claiming it was too expensive. A $300 billion barrel of pork, that's true. But a budget buster? The irony was just too rich, after six years of budget busting spending by the GOP and Bush.

Maybe what Bush REALLY hated about the 2008 Farm Bill (http://www.govtrack.us/congress/billtext.xpd?bill=h110-2419) was Title XIII, which closed the Enron loophole.

Bush threatened to veto the Farm Bill, and actually did veto it, but it subsequently passed with a veto-proof majority in both houses.

So maybe Bush's farm bill veto wasn't about pork, but about the Enron loophole.

http://i39.tinypic.com/2jbp9n8.jpg
And now you know the rest of the story!



But wait, there's more. A lot more.

There is another loophole. The "London Loophole".

Congress tried to close the London Loophole last year, but they tied the legislation to a windfall profits tax (http://www.csmonitor.com/2008/0611/p25s13-usec.html), and so it didn't make it. But then they wrote a House version (http://www.govtrack.us/congress/billtext.xpd?bill=h110-6284) and a Senate version (http://thomas.loc.gov/cgi-bin/query/z?c110:S.3129:) of a bill which just contained legislation to close the London Loophole, but it was sent to die in committee. You will notice both versions were written within days of the windfall profits tax bill being killed.

And that is what has me curious.

Why was the London Loophole killed, even when detached from any other legislation?

Why has Congress not revitalized it?

Something odd going on.


{to be cont'd}

[Luke T.]

All US trades of oil must be done on a public exchange.

However, there is a commodities trading organization called Intercontinental Exchange, Inc. (ICE) which is based in Atlanta which is allowed to trade on the London commodities exchange without any position limits due to a 1999 agreement between the US Commodities Future Trading Commission (CFTC) and Intercontinental Exchange (back when it was known as the International Petroleum Exchange).

The House and Senate were working on closing that loophole.

And then the loophole killing bill was itself killed.

So Congress elminated the Enron loophole, and there was one man left standing. And just as Congress fixed their sights on that one man, they stopped.


Curious.

[Luke T.]

Guess who founded ICE.




Morgan Stanley, Goldman Sachs, British Petroleum, Deutsche Bank and Royal Dutch Shell.





Last year, the Chairman and the chief economist at the CFTC were both claiming that the high price of oil was due to simple supply and demand market forces.

In May. Right about the time the Enron loophole was killed by the Farm Bill, and just before the London loophole legislation was killed in committee.

I smell a big hairy rat. These two are owned by ICE. I'd bet on it. With real money.


http://commerce.senate.gov/public/_files/IMGJune3Testimony0.pdf

Read that.


{to be cont'd}

[Luke T.]

Okay. Five day ago (http://www.bloomberg.com/apps/news?pid=20601087&sid=afJz1FLOy1nI&refer=home):

The U.S. Securities and Exchange Commission granted an exemption for Intercontinental Exchange Inc. to begin guaranteeing credit-default swaps. The company said it would begin clearing next week.

The SEC exemption represented the last regulatory approval needed by Atlanta-based Intercontinental. Its larger competitor, CME Group Inc., hasn’t received an SEC exemption, and agency spokesman John Nester said he didn’t know when a decision would be made.


The SEC approval is the third government action granted to Intercontinental this week. On March 3, its proposed acquisition of Clearing Corp., a Chicago clearinghouse owned by eight of the largest dealers in the credit-default swap market, was approved by the Federal Trade Commission and the Justice Department. Yesterday the Federal Reserve Board, which will oversee the clearinghouse, granted a request to begin clearing.

Clearing Corp. shareholders including JPMorgan Chase & Co., Goldman Sachs Group Inc. and UBS AG, received $39 million in cash from Intercontinental in the acquisition, as well as the Clearing Corp.’s cash on hand and a 50-50 profit-sharing agreement with Intercontinental on the revenue generated from processing the swaps.

The SEC exemption for Intercontinental Exchange but not CME Group is “regrettable at best, and an unfortunate example of bad government,” said Commodity Futures Trading Commissioner Bart Chilton.

I'm telling you. A big hairy rat. This time the new CFTC commissioner (not the same guy as last summer) is calling the SEC crooked.

SEC, ICE, Goldman Sachs, CFTC.

All in bed together, people.

Who is watching the watchers?

Nobody.

[Luke T.]

Rival beats CME, Citadel in swaps race (http://www.chicagobusiness.com/cgi-bin/news.pl?id=33233)

CME Group Inc. and Citadel Investment Group appear to have lost the race to launch the first U.S. clearinghouse in the $27-trillion market for credit-default swaps.

$27 trillion.

Rival IntercontinentalExchange Inc. Friday said it received approval from the Securities and Exchange Commission and will start clearing the contracts Monday. The Atlanta-based energy market will clear the swaps though New York-based ICE Trust, which is overseen by the Federal Reserve Bank of New York and backed by Wall Street firms including Bank of America Corp., Barclays Capital PLC, Citigroup Inc., Credit Suisse, Deutsche Bank A.G., Goldman Sachs Group Inc., J. P. Morgan Chase & Co., Merrill Lynch & Co., Morgan Stanley & Co. and UBS A.G.


ICE wins approval to clear credit default swaps (http://www.chicagotribune.com/business/chi-ice-credit-default-swaps-mar4,0,1677938.story)


Moving the multi-trillion dollar market for credit default swaps into exchange clearinghouses has been a priority of federal regulators.


You remember what job Treasury Secretary Geithner had when he was hired away by Obama?

New York Federal Reserve president and CEO.

Okay. Maybe that's pushing the conspiracy a little too far.


{to be cont'd}

[Luke T.]

In January 2006, CFTC regulators allowed ICE Futures Europe to start trading a futures contract for West Texas Intermediate, or WTI, crude oil, a type of crude oil that is produced and delivered only in the United States. Up until that point, the WTI crude-oil contracts traded exclusively on the regulated Nymex exchange.

2006. Remember I asked if anyone remembered the oil spike of 2006?

A dry run, maybe?

Under political pressure, the CFTC told a Senate panel on May 29 it would start collecting daily trading data for all U.S. oil contracts traded in London from British regulators. The trading commission also said British regulators would now notify them whenever traders exceeded speculation limits that apply to oil contracts traded in New York.

But such trading isn't limited to London. Over the years, the CFTC has exempted itself from regulating a variety of contracts in 16 other foreign exchanges.

In May 2007, regulators allowed the Dubai Mercantile Exchange to install trading terminals in the United States, but be regulated by the Dubai Financial Services Authority. On May 16, the Dubai exchange announced that, in partnership with Nymex, it had received CFTC approval to begin trading WTI contracts as well.

The CFTC is not doing its job and working for us, folks. It is working for the bad guys.

http://www.nj.com/business/index.ssf/2008/07/oils_price_rise_is_helped_by_l.html

Speaking of swaps...

The size and position limits the CFTC places on speculators are designed to prevent manipulation and distortion, experts said.

But in its push to deregulate the markets, the CFTC reclassified investment banks such as Goldman Sachs and Morgan Stanley as "commercial hedgers," when these banks hedge over-the-counter swap transactions.

In other words, they are not subject to any limitations on the size of the positions they can take when it comes to commodities. And they don't have to file the daily reports that enable regulators to monitor all traders of size to ensure no one is manipulating the futures markets.

"The real shocking thing about this loophole is that speculators of all stripes can use to access the futures market," said Michael Masters, president of Masters Capital, a hedge fund in St. Croix, Virgin Islands, who has testified at congressional hearings.

He said this has helped fuel the boom in commodities trading. Money flowing into commodity index trading strategies has risen to $260 billion as of March 2008, from $13 billion at the end of 2003.

At the same time, the prices of the 25 commodities that comprise these indices have risen an average of 183 percent in those same five years.

{to be cont'd}

[Luke T.]

I've been thinking about this CDS clearinghouse contract the CFTC has granted ICE, and I think I am hating it, actually.

These things should be outright banned, not moved to a public exchange.

At least a public exchange with a clearinhouse is better than the way things have been, but all that really does is legitimize gambling. There is no actual commodity being exchanged. It is 100 percent speculation.

Let me give another hypothetical illustration why this latest ICE boon is a bad idea.

Suppose your neighbor owns a house worth $200,000. And suppose you want to insure your neighbor's house for that much.

You are prevented from doing that because you don't have an "insurable interest". It isn't your house. You don't have $200,000 of your own money riding on that house. Your neighbor does, and that is why he can buy insurance. He has something to lose if the house burns down. Insurance is his way of hedging against losing his $200,000.

No insurance company is therefore going to sell you insurance on a house that is not your own.

In the world of the Credit Default Swap (CDS), you are allowed to buy insurance on your neighbor's house. You can hedge against someone else's Mortgage Backed Security (MBS) from defaulting. Even though you personally do not have anything to lose.

Now why would an insurance company sell you insurance on a house you don't own? Well, I will tell you.

The insurance company is convinced that nothing bad is ever going to happen to that house.

So why not take your money? If you are crazy enough to pay premiums on a house that is never going to burn down, who are they to refuse it? From their warped perspective, it is pure profit with no risk.

I kid you not, that is how the sellers of CDSs saw things. They believed that MBSs were not going to default because they believed the price of real estate would go up forever. So the way they saw it, selling a CDS was free money coming in.

Except the house did burn down. And now the insurance company has to pay up. And it turns out they sold insurance to not just you but nine other people, too. And so they have to pay out $2 million instead of $200,000.

Morons, right?

All of this was done out of the public eye. It was done on Bob's Private Exchange. AIG was a big seller of credit default swaps.

To make matters worse, when you bought a CDS on Bob's Private Exchange, you had no idea who you were buying it from. And if you sold a CDS on Bob's Private Exchange, you had no idea who you were selling it to.

The prophets of credit default swaps will tell you that they are good yardsticks for measuring risk. The more people who buy insurance against a house burning down means the risk of it actually burning down are going up. These people obviously know something and that is why so many are buying them.

If the risk is going up, you can charge a higher premium. More free money coming in!

If you are the tenth person buying insurance on the house, your premium would be higher than the guy who bought the first policy. So maybe the guy who bought the first policy sells the tenth guy his policy for less than what the tenth guy would have had to pay the originator.

If Buyer 1 pays 100 dollars a month for a CDS, and Buyer 10 is being charged 600 dollars a month, then Buyer 1 can sell his policy for 300 dollars a month to Buyer 10. Buyer 1 makes 200 dollar profit, and Buyer 10 saves 300 dollars. Win/win.

Except when the house burns down, Buyer 10 is going to go to Buyer 1 to collect, not the insurance company.

Chain reaction.

A credit default swap is not insurance. It is pure gambling. It is someone with no insurable interest betting on someone else's house burning down.

And if ten people are betting that your house is going to burn down, and they have been paying good money to make that bet, how safe are you going to feel in your house? If it were me, I 'd be laying awake all night listening for arsonists.

Now the CFTC is legitimizing this practice by opening up a public exchange for credit default swaps. They are selling this as "No more Bob's Private Exchange!" As if it all being out in the open is all that needed to be fixed.

They are treating CDSs like they are a commodity! As if they are apples.

Here is my next prediction: The CDS exchange is going to have to dip into their guaranty fund one day. For the first time in the history of any exchange.

What a clearinghouse does is ensure the seller and the buyer are both able to meet their ends of the bargain. If a company sells an insurance policy, they will have to put down a certain percentage of the full value of the policy. A margin. So if a buyer of a CDS is insuring a $200,000 house, the seller of the CDS has to prove they have $200,000 to cover the bet and they have to give the clearinghouse a $20,000 margin, say.

The buyer of the CDS will have to show their ability to pay the premiums to the clearinghouse.

ICE has won permission to act as the CDS exchange clearinghouse.

A clearinghouse must contribute to a guaranty fund. That fund is there to cover any defaults on the part of a buyer or seller. Suppose a seller of a CDS sells fire insurance on a $200,000 house, and then the house burns down and the seller can't come up with the $200,000. At that point, the guaranty fund would pay off the policy.

So a CDS exchange guaranty fund would be default insurance for default insurance!

I don't think it has been necessary for a guaranty fund to ever be drawn upon in any commodities exchange. That is one hell of a powerful statement about the efficiency of the commodities exchange market.

But I think that track record is about to be marred.

This CDS exchange brings a whole new level of gambling to the commodities markets. It is an outrage, IMHO.

You can "gamble" on the price of oil rising or falling. But only one person can be be the highest bidder on any specific barrel of oil. Not ten. One.

The CDS market allows a theoretically infinite number of people to bet on whether or not you will default on your mortgage.

Taking it from the dark market to the public market doesn't make the problem all better. This is a dangerous precedent being given official sanction.

[Luke T.]

Some information to support my last post:


Now the CFTC is legitimizing this practice by opening up a public exchange for credit default swaps. They are selling this as "No more Bob's Private Exchange!" As if it all being out in the open is all that needed to be fixed.


SEC approves ICE credit-default swap clearing plan (http://www.marketwatch.com/news/story/SEC-approves-ICE-credit-default/story.aspx?guid={09B88530-658B-4D25-A216-A80969515DC3})

The SEC's approval of ICE US Trust, which exempts the clearinghouse from certain securities laws, marks a big step toward the U.S. government's efforts to offer clearing for over-the-counter derivatives like credit-default swaps, which alone make up an estimated $27 trillion market.
"Regulatory approval allows ICE Trust to bring to market the most comprehensive range of credit-default swap clearing and risk management services available today," said Jeffrey C. Sprecher, chairman and chief executive of ICE.
ICE shares, which closed up 4% at $60.39 Friday, climbed to $61.99 in after-hours trading.
Some critics believe these complex instruments have played a role in the financial crisis. As evidence, they point to the near-collapse of American International Group (AIG), which issued credit-default swaps without having enough collateral to fulfill the provisions in those contracts.
Clearing, regulators believe, will help reduce risks that credit-default swaps pose to financial system and provide regulators with a window into the now opaque market.


Participation in the open exchange is voluntary. So CDSs can and are still being sold in the dark market.

About the guaranty fund. Remember who I said founded ICE:

Morgan Stanley, Goldman Sachs, British Petroleum, Deutsche Bank and Royal Dutch Shell.

And now from the article:

But there are strong indications that ICE's platform will be put to use. A consortium of banks have already signed on as initial clearing members, including Bank of America and its Merrill Lynch unit, Barclays Capital, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Morgan Stanley and UBS. Each has contributed to the guaranty fund and completed "rigorous technical testing" in recent months, according to ICE.

Priming their own pump to attract others.



Out of five who had their houses insured by the horde, three burned down. Merrill Lynch, Bear Stearns, Lehman Brothers.

Two were left standing. Goldman Sachs and Morgan Stanley.

Somebody's been playing with matches.






Okay. Done.

[a_unique_person]

dr;tl

Can you give us a one paragraph abstract so I can see if it's all worth reading?

[Luke T.]

dr;tl

Can you give us a one paragraph abstract so I can see if it's all worth reading?

I'm going to make a prediction.

Sooner or later, inflation is going to kick in. All this stimulus spending is going to come at a heavy price.

Right about that time, oil prices are going to skyrocket again. This topic explains exactly why and how.

At that time, everyone is going to either say "supply and demand and inflation are to blame" or "that Enron loophole is to blame". And then it will be explained the Enron loophole is closed.

So "supply and demand and inflation" will become the meme.

Meanwhile, Intercontinental Exchange, Inc. (ICE) will be laughing up its sleeve, making another killing.

And the Republicans will squeeze out an ocean of electoral milk by blaming the Democrats for the high oil prices.

"Drill, baby, drill!"

Everyone will be wrong.

I have pointed out all the dots, and connected them. And I have written what ICE is up to lately. A credit default swap exchange clearinghouse.

These guys are fixing to be a major force in our economy. Major. Force.

And the people who are supposed to be leveling the playing field are actually helping them keep the competition off the field entirely.

That's why the reading is so long. It's called "extraordinary evidence".

[Luke T.]

If you think this is too much reading, wait til you see what I am cooking up for everything you need to know about "Bank Stress Tests".

[Luke T.]

I suppose I could have started a topic about zionists or Rush Limbaugh or what a commie Obama is or how Bush killed America or something.

[dudalb]

This is truly a Golden Age for Economic Conspiracy Theories.

[Luke T.]

This is truly a Golden Age for Economic Conspiracy Theories.

Truly a Golden Age for Short Attention Spans.

[Beerina]

http://i43.tinypic.com/f3xmoi.jpg
I'm going to take those record profits.


Just as an aside, no she isn't. The oil would just route around sophomoric populists to countries that wouldn't take the profits. Then she'd lose the next election for not understanding economics and creating an actual, physical shortage of oil in the US where one didn't exist.

Of course, she knows this, and never had any real intention to do anything other than a token tax at most. It's meaningless filler to reinforce the memes that drive her followers to follow her.

[The Atheist]

I'm going to make a prediction.

Sooner or later, inflation is going to kick in. All this stimulus spending is going to come at a heavy price.

That's it?

An immense increase in money supply will lead to massive inflation?

Wow. Whoda thunkit?

Alas, Luke, your "prediction" is not new or original.

Nice to see you breaking your principles and boring us fartless with your pet love, however. SC finally run out of members to throw your ramblings at?

Unnecessary personalization is in violation of forum rules.

[bignickel]

I read a hefty portion of that, but I don't think I can understand it all.

I think some of the people in the Economics, Business and Finance subforum could understand it better.

Maybe this should be moved to that forum?

[Eddie Dane]

I read a hefty portion of that, but I don't think I can understand it all.

I think some of the people in the Economics, Business and Finance subforum could understand it better.

Maybe this should be moved to that forum?

That was the first thing I thought when I read (a piece of) this theory.

Cut it, throw it in the water with Scrutinizer and Francesca and wait for them to smell the blood....

[blutoski]

I'm going to make a prediction.

Sooner or later, inflation is going to kick in.

Hm. How would you distinguish this claim from my counter-hypothesis:

"The economy is cyclic in nature - low inflation periods alternate with high inflation periods."

[Puppycow]

That's it?

An immense increase in money supply will lead to massive inflation?

Wow. Whoda thunkit?

Alas, Luke, your "prediction" is not new or original.

Nice to see you breaking your principles and boring us fartless with your pet love, however. SC finally run out of members to throw your ramblings at?

I actually see things the opposite way.
Don't you think that the effect of an "immense increase in money supply" will be cancelled out by this:
World loses more than $50 trillion (http://washingtontimes.com/news/2009/mar/10/world-loses-over-50-trillion/)

That's how I see it. Does that change your mind?
If not, are there any signs of high inflation yet? When do you think that we will start to see signs of it?

[brumsen]

I actually see things the opposite way.
Don't you think that the effect of an "immense increase in money supply" will be cancelled out by this:
World loses more than $50 trillion (http://washingtontimes.com/news/2009/mar/10/world-loses-over-50-trillion/)

My (admittedly limited) understanding of the matter is that these 50 trillion represented richess that we didn't actually possess.The money supply had become incredibly over-inflated through complex financial products and inflated fiat money supply. But we all believed in it and that somehow kept things going until the bubble burst.
Now to compensate this, central banks are attempting to re-inflate the bubble. But who is going to be tricked into thinking that this money represents real assets and hard purchasing power? Whether we'll get inflation or not will depend on that.

[Soapy Sam]

Luke - good to see you.
On your theory- I'm perhaps too cynical to buy it.
You're asking us to accept that business people are highly intelligent and evil.

My own theory runs more towards rather stupid and greedy.

[The Atheist]

That's how I see it. Does that change your mind?
If not, are there any signs of high inflation yet? When do you think that we will start to see signs of it?

I think we might be seeing signs of it in the dead cat bounce taking place at the moment in the US sharemarket. No fundamentals exist to rate a recovery of 10% this week; unemployment is still rising, and I find it hard to imagine corporate investors are driving the gains. I imagine Buffett's still waiting, given comments as the over-valued nature of S & P by up to 40% last week.

There's a lot of cash in the system and it won't all stay under mattresses.

[Puppycow]

My (admittedly limited) understanding of the matter is that these 50 trillion represented richess that we didn't actually possess.The money supply had become incredibly over-inflated through complex financial products and inflated fiat money supply. But we all believed in it and that somehow kept things going until the bubble burst.
Now to compensate this, central banks are attempting to re-inflate the bubble. But who is going to be tricked into thinking that this money represents real assets and hard purchasing power? Whether we'll get inflation or not will depend on that.

I admit that I don't fully understand it either, but I tend to think that the deflationary effect is same for practical purposes when the market value of assets plummets.
All of the same physical stuff that was there before the crash is still there. It was not a natural disaster that actually destroyed buildings and other infrastructure. I guess that houses are now worth less because there's too many of them and many of their occupants can't afford to pay their mortgages, but they are the same houses that were previously valued at a much higher value and could be used as collateral for loans.
This is why I don't think we will see inflation until real estate prices start to rise again or at least bottom out.
ETA: and if real estate prices start to rise again, that means that the economic problem that caused the crisis is over, right?

[Puppycow]

I think we might be seeing signs of it in the dead cat bounce taking place at the moment in the US sharemarket. No fundamentals exist to rate a recovery of 10% this week; unemployment is still rising, and I find it hard to imagine corporate investors are driving the gains. I imagine Buffett's still waiting, given comments as the over-valued nature of S & P by up to 40% last week.

There's a lot of cash in the system and it won't all stay under mattresses.

We'll see. My prediction is that we won't see high consumer inflation until the real estate market bottoms out. (Rising stock prices are not consumer inflation).
The basis for my prediction is the last couple decades in Japan.

[The Atheist]

This is why I don't think we will see inflation until real estate prices start to rise again or at least bottom out.

You'd think that would be true, so the test may be coming soon. The first increase in building data of any kind happened in Feb, with condo permits up, so that, plus the effect of Penny Mac should see the bottom reached. I can't see mortgages being discounted further than they already are.

ETA: and if real estate prices start to rise again, that means that the economic problem that caused the crisis is over, right?

Not necessarily.

I think the whole situation is a lot more complex than that.

We'll see. My prediction is that we won't see high consumer inflation until the real estate market bottoms out. (Rising stock prices are not consumer inflation).

I know that; I was pointing out that there seems to be some confidence returning, which would herald the start of inflationary pressure - if it isn't just a bear rally, and if there is going to be inflation.

I don't think inflation is a guaranteed result of the crash or the money-print, but we have the experience of vast increases in money supply and it usually leads to a bout of inflation.

This time is a bit different, because none of us has ever seen the scale of carnage which has happened already and the nationalisation of banks.

The basis for my prediction is the last couple decades in Japan.

Can't say I've followed the Japanese economy to any extent, but I recall the problems being more stagflation than inflation. Were zillions of yen printed?

[Puppycow]

Can't say I've followed the Japanese economy to any extent, but I recall the problems being more stagflation than inflation. Were zillions of yen printed?

Japan has had a problem with stagnation rather than stagflation. Stagflation is stagnation + inflation. Japan has had stagnation + deflation.

It seems that zillions of yen were indeed printed:
Quant easing in Japan (http://en.wikipedia.org/wiki/Quantitative_easing#Recent_experience):

Recent experience

Quantitative easing was used notably by the Bank of Japan (BOJ) to fight domestic deflation in the early 2000s.[3]
. . .
In Japan's case, the BOJ had been maintaining short-term interest rates at close to their minimum attainable zero values since 1999. With quantitative easing, it flooded commercial banks with excess liquidity to promote private lending, leaving them with large stocks of excess reserves, and therefore little risk of a liquidity shortage.[7] The BOJ accomplished this by buying more government bonds than would be required to set the interest rate to zero. It also bought asset-backed securities and equities, and extended the terms of its commercial paper purchasing operation. [8]

Meanwhile, the rate of inflation has been mostly negative to just barely above zero during those years:
Japan - Inflation rate (consumer prices) (%) (http://www.indexmundi.com/g/g.aspx?c=ja&v=71)
Year| Inflation rate (consumer prices) (%)
2000| -0.8
2001| -0.7
2002| -0.9
2003| -0.9
2004| -0.3
2005| -0.1
2006| -0.3
2007| 0.3
2008| 0

Also, Japan's public debt was between 170% and 198% of GDP according to the most recent estimates (http://en.wikipedia.org/wiki/List_of_countries_by_public_debt), whereas that of the US was between 60% and 73% of its GDP according to the same estimates. I have heard projections that the US debt may rise to about 90% of GDP, which would still be only about half of that in Japan. Yet, inflation is nowhere in sight here.
The only explanation I can think of is that the people of Japan, unlike the government, are net savers and creditors rather than spendthrift debtors. This is a big difference from the US. But I don't know whether that difference suggests that inflation will be more likely to occur in the US. If anything, the credit squeeze would seem to force Americans to cut back on spending even more, because they don't have large savings accounts to fall back on.

[The Atheist]

Japan has had a problem with stagnation rather than stagflation.

Gotcha. I told you I don't take much notice.

The only explanation I can think of is that the people of Japan, unlike the government, are net savers and creditors rather than spendthrift debtors. This is a big difference from the US. But I don't know whether that difference suggests that inflation will be more likely to occur in the US. If anything, the credit squeeze would seem to force Americans to cut back on spending even more, because they don't have large savings accounts to fall back on.

The big difference is that Japan was country with an under-performing economy in a sea of buoyant economies. I go along with the cultural difference on savings, though, but what difference it makes, we'll have to wait to find out, because USA's economy has always been centred on internal consumption, unlike Japan's which has been based on value-added exports.

[The Atheist]

Coincidentally, after this thread, my next stop was Bloomberg, where Bernanke mentioned inflation (http://www.bloomberg.com/apps/news?pid=20601087&sid=a96UYa3hNIh0&refer=home)as part of a look at the wider picture:

“I’m mostly worried about the economy,” said Bernanke. “We do think inflation will be quite low over the next couple of years. At the same time, we have to be very careful to make sure we are prepared to withdraw monetary stimulus at the appropriate time to make sure that down the road we don’t have inflation.”

It's clear that he can see inflationary pressure later, but I guess that owning all the banks gives him a strong hand to deal with it.

[bobrayner]

USA's economy has always been centred on internal consumption, unlike Japan's which has been based on value-added exports.
They're hardly polar opposites. Japan's exports are 15.8% of GDP; USA's exports are 9.1%.

(According to this (http://en.wikipedia.org/wiki/Economy_of_Japan) and this (http://en.wikipedia.org/wiki/Economy_of_the_United_States) on wikipedia; I'll freely admit that if I could be bothered to get fresh data from the horse's mouth, it might yield slightly different percentages but my point still stands)

[Psi Baba]

Wow, and we thought Bernie Madoff was a crook! Good post, Luke. I did read all of it (with the exception of the 32-page testimony of Michael Greenberger). I would suggest members at least read post #9 if nothing else.

There is a good article in the March issue of WIRED about David X. Li's copula-based correlation model which escalated the proliferation of credit default swaps. Much of the article parallels what Luke wrote here, especially about the possibility of no upper limit to the amount of CDS that could be generated on mortgages or bonds. The problem with the model was that instead of using historical loan default data, it used historical CDS pricing data, which had a less than a ten year history (at the time of the publication of Li's paper in 2000), to generate correlations between the likelihoods of housing prices falling or defaults occurring. These correlations are ordinarily extremely difficult to pin down--too many disparate data points. Li's model basically reduced correlation to a single constant. Hedge fund manager Nassim Nicholas Taleb stated, "People got very excited about the Gaussian copula because of its mathematical elegance, but the thing never worked. Anything that relies on correlation is charlatanism."

With each passing day, I grow convinced that there is less and less difference between our financial system and a plain old Ponzi scheme. It's just that one is simple and the other is disguised in a convoluted Rube Goldberg apparatus called "high finance." I don't know if it's irony or what that the two largest such schemes in history have collapsed at around the same time. I would be loathe to suggest a correlation.

[The Atheist]

They're hardly polar opposites. Japan's exports are 15.8% of GDP; USA's exports are 9.1%.

I'll believe the numbers, I admitted I knew precious little about the Jap economy.

I was right!

:bgrin:

Whether that means other countries will follow the path Japan did, we'll have to wait & see.

With each passing day, I grow convinced that there is less and less difference between our financial system and a plain old Ponzi scheme.

Correct, as commentators have noted.

[Darth Rotor]

Luke - good to see you.
On your theory- I'm perhaps too cynical to buy it.
You're asking us to accept that business people are highly intelligent and evil.

My own theory runs more towards rather stupid and greedy.

Try intelligent and greedy, and at times blinded by greed.

That's my take on financiers.

DR

[Almo]

Try intelligent and greedy, and at times blinded by greed.

That's my take on financiers.

DR

I think I have to agree on this one.

[mhaze]

I actually see things the opposite way.
Don't you think that the effect of an "immense increase in money supply" will be cancelled out by this:
World loses more than $50 trillion (http://washingtontimes.com/news/2009/mar/10/world-loses-over-50-trillion/)

That's how I see it. Does that change your mind?
If not, are there any signs of high inflation yet? When do you think that we will start to see signs of it?Huh? When the new money starts to circulate. How about when investment capital flees Treasury bills, because better rates are elsewhere. When several nations sucessfully push for a non-US$ based reserve currency? What does the world market care about the US FED policy in the medium term?

Duhh....

[bobrayner]

Huh? When the new money starts to circulate. How about when investment capital flees Treasury bills, because better rates are elsewhere. When several nations sucessfully push for a non-US$ based reserve currency? What does the world market care about the US FED policy in the medium term?

Duhh....
"Reserve currency" isn't boolean. There isn't a single global "reserve currency" which gets the label stamped on every banknote or bond.

Some governments (not nations) are currently increasing reserves in other currencies. Many governments (not nations) already have substantial reserves in a currency other than dollars.

In a more general sense, reserves are also held by millions of individual economic actors such as people and businesses, and I'm fairly sure many of them would be wary of calls by other governments to control which currency is held as a reserve.

[mhaze]

"Reserve currency" isn't boolean. There isn't a single global "reserve currency" which gets the label stamped on every banknote or bond.

Some governments (not nations) are currently increasing reserves in other currencies. Many governments (not nations) already have substantial reserves in a currency other than dollars.....Right. The US dollar has primary "reserve currency status" with about 2/3 the business.

However the question was "when do you think we would start to see inflation".

From this vantage a shift to Euros or whatever, from the US dollar would be a real problem. It would be a factor that could cause us to start to see inflation.