Hair on Fire

Recently by Michael S. Rozeff: Another Neo-Greenbacker Central Banking Scheme

Today I read a very technical article on credit derivatives as used by banks (and other institutions), and in the end I came away thinking "this is madness." There are so many hairy problems involved here in attempting to price these things and no one knows the answers. I think answers are unobtainable. The assumptions being made about measuring risks are untenable. In an "Austrian" world, no one can predict them and past distributions do not suffice. Banks doing large amounts of trading in derivatives do not know what their risks are. However, astoundingly, huge sums of money are recorded as gains and losses on accounting statements based on estimates of risk parameters that no one actually is sure of. I kept thinking that these banks are doing all this trading while having their deposits insured and the FED as a backup. This is a huge moral hazard problem. Mention was also made of the re-hypothecation issue that can set off unknown chain reactions of failures. The MF Global collapse is the canary in the mine. If the dollar had stayed anchored to gold, we would not have had the explosion in derivatives. They grew at first mainly as instruments to deal with the increased risks in interest rate and currency volatility. But now almost any company plays with these things. I have a hard time believing that it’s efficient for companies routinely to be using these as supposed hedges. It’s hard to find good reasons why such activities add value for stockholders. The financial companies and banks have used them off-balance sheet and to create excessive leverage, while regulators allowed it. The whiz kids at these banks could wave mathematical models and jargon at them endlessly, as they are doing again at Basel where there is yet another vain attempt to control the moral hazard in banks. The last time around, sovereign debts were thought to be riskless and always excellent collateral. If ever a system cried out for a complete reset, it is the monetary system.