If shareholders realized they they are getting the same shaft as depositors a major impediment to true bank reform could be swept away. Senior bank employees are using complexity of operations (which is more myth than reality) to hobble shareholder control and progressive era legislation to hobble depositor control.
Let the senior financiers keep their salaries and bonuses, and let them do with their banks what they will. If, however, their bank fails, let the bankers themselves fail. Let the value of their houses, cars, yachts, paintings, etc. be assigned to the firm's creditors. James Grant: Let the Bankers Fail
As the news of Wall Street's underhanded dealings goes mainstream thanks to the SEC's case against Goldman Sachs, the idea of letting the bankers fail never seemed so sweet to so many in recent history. Yet, failure might have nasty consequences. Just as one wouldn't want a skyscraper to topple over in a crowded city, one wouldn't want the TBTF banks to collapse. Better, I think, to effect a controlled demolition.
While he has been opining about finance more wisely and for far longer than I, Mr. Grant's ire may be somewhat misdirected (although the effect of his proposed renewal of the fear of God seems a wise idea) at shareholders, when senior bank employees are those whose behavior must be modified. They take the least risk and benefit the most.
Explaining the problem's emergence, Mr. Grant draws our attention to the FDIC, an institution ostensibly designed to benefit the man on the street whose limited life savings might be lost in a bank failure. An additional effect, however, was to shield bank owners from liability, at state expense.
Another key effect, particularly when the lender of last resort (in the US, the Federal Reserve) supports banks rather than credit markets more generally, was to dampen depositors' desire and hamstring their capacity to demolish a bank. It is no surprise that the vigor with which Big Finance worked to repeal Glass Steagle was not directed at FDIC or Federal Reserve legislation.
Banking is a curious business, as Louis Brandeis noted in Other People's Money: The goose that lays golden eggs has been considered a most valuable possession. But even more profitable is the privilege of taking the golden eggs laid by someone else's goose. Bankers, by which he meant bank shareholders, combined their equity capital with deposits, in 1929 at a deposit to equity ratio of roughly 10 to 1 and kept a majority of the profits thereof.
Prior to Fed support of banks, depositors had a significant controlling interest (whether they were aware of this is another issue). A bank run was the means by which they exerted this control. As noted, this control was greatly diminished (but not lost), and obscured by the Fed and FDIC.
Of course, what is good for the goose is good for the gander. Bank shareholders had it good for a while, but lately they too have been getting the shaft from senior bank employees, who may not have any investment in the bank. As noted here, (full article here) at the Big 4 US Banks (BAC, C, JPM, WFC) depositors were paid $25B on their investment of $2.5T, shareholders were paid $18B on their investment of $660B and employees were paid $111B for their time.
If shareholders realized they they are getting the same shaft as depositors a major impediment to true bank reform could be swept away. Senior bank employees are using complexity of operations (which is more myth than reality) to hobble shareholder control and progressive era legislation to hobble depositor control. Simon Johnson and James Kwak should take note. Explaining that shareholders' interests are aligned with depositors' might ignite the controlled demolition of TBTF.
Why should senior bank employees with the least "skin in the game" reap the largest benefits?
A controlled demolition of TBTF might proceed something like this:
1) Depositors could begin to reassert their lost control by withdrawing money from the Big Banks (there already is such a movement underway).
2) Minimally, shareholders could begin to reassert their lost control by wiser appointments to the Boards of Directors with the view that cost control includes direction as well as magnitude (to wit, why should shareholders pay for lobbying which enriches employees and not them). Preferably, sell the shares and reinvest the capital in various smaller banks, presumably some of whom might be the recipients of moved depositor funds and none of whom have significant derivatives' exposure. In a controlled demolition of TBTF, the numerous banks left standing should benefit significantly.
3) Depositors and shareholders could understand that institution size dilutes control and allows employees to usurp control leaving you (or the state) to deal with the risk.
4) If an aligned group of depositors (aka voters) and shareholders (aka those funding the lobbying) demanded action, change would come. One key change: The Fed would need to stop supporting banks and instead support markets mitigating collateral damage from the demolition. They should open lines of communication with the hundreds of banks with assets between $1B and $100B. They will also need to deal with foreign depositors at the TBTF banks and begin to unravel the nightmare of derivatives (admittedly a task easier said than done).
Instead of a full frontal approach, TBTF should be imploded from within. Those with "skin in the game" need to take back control.
It's your money, and only your wisdom (not the government's or bank employees') will keep it safe and perhaps allow it to grow. Concentration of money occurs when investment is passive. Move Your Money!
One might even consider moving one's money out of the banking system entirely during the renovation through the purchase of Gold.
Showing posts with label C. Show all posts
Showing posts with label C. Show all posts
Friday, April 23, 2010
Saturday, April 03, 2010
GoldiSachs and the TBTF Banks
GoldiSachs and her friend MorganStanley were tired (of worrying about insolvency) so they went upstairs in the Banks' home and found a bed labeled TBTF that was just right. In contrast to the children's story, GoldiSachs and MorganStanley were welcomed into the club.
In March of 2008, years of poor investment decisions finally caught up to Bear Stearns, forcing the firm to accept a $2 per share bid (later revised to $10) from JPMorgan (financed by loans from the NY Fed). A once mighty financial firm which had survived the Great Depression was no more. Adding insult to injury, its final 5 year stock price chart, which depicted a dive from over $150 to the single digits could easily have been mistaken for that of a dead Tech firm which never generated a dime in profits.
Coincidentally, the Federal Reserve announced the creation of the Primary Dealer Credit Facility (PDCF) which allowed any Primary Dealer not already authorized to borrow at the Fed's Discount Window, to, in effect, enjoy the privilege of discounting their securities if they were cash poor.
Despite the new access to Fed liquidity, however, stock prices of Primary Dealers, who, inter alia, sell US government debt, were under assault within 6 months. Lehman Brothers did not survive the assault, declaring bankruptcy on September 15.
Perhaps due to the thinning ranks of Primary Dealers (in the previous 2 years, 5 Banks, ABN AMRO, CIBC, Nomura Securities, Lehman Brothers and the aforementioned Bear Stearns, had left the club or died) or some other reason (more on that in my next post) the Fed and Treasury made the hitherto unsaid policy of Too Big To Fail (TBTF), explicit, and welcomed GS and MS into the club (which, according to Simon Johnson and James Kwak, numbers 13), declaring the new entrants Bank Holding Companies (BHCs), for emphasis.
A recent check of the Fed's NIC (a wonderful resource on BHC data) demonstrates that GS and MS fit into the BHC club about as well as I fit into the crowd on my first visit to Beijing many years ago. Their source and use of funds are quite different as are their arenas of profit. They are investment firms, more closely related to Hedge Funds than banks. I'm all in favor of investment firms, however, I don't agree that, if TBTF is wise policy (which, at this stage, I doubt) they should be included in the protected group.
I still, on the topic of sticking out from the crowd, remember being asked to join a picture of a Chinese family during a visit to the Great Wall, because, I suspect, this rural family rarely saw white people and wanted to show the folks at home their great adventure.
Banks, as I recently argued, always and everywhere earn their money lending. As the table below demonstrates, however, the meaning of the term "bank" is being diluted at roughly the same pace as the US$. Admittedly, the banks themselves, in their desire to be more like Hedge Funds, are helping the dilution of meaning. This makes me wonder if the next GS to join the club will be George Soros. Perhaps if he becomes a primary dealer....
click for larger version
As you can see, GS and MS needed no help in provisioning against bad loans (one argument, with some merit, in favor of TBTF is that the banks provided more mortgage credit than they otherwise would have if the government wasn't promoting home ownership). These investment houses earn money from, inter alia, Investment Banking, Brokerage and Proprietary Trading.
Proprietary Trading is the arena one tends to find "rogue traders" like John Rusnak, Brian Hunter of Amaranth fame and this fellow from France. A policy of TBTF might well bail out a "rogue bank"or the banks' creditors, perhaps it already has. This isn't to suggest I'm against prop trading (it's one way I earn my keep) I just don't see the positives (if any) outweighing the negatives.
A thoughtful reader at Seeking Alpha wanted a more explicit statement of TBTF effects which inspired the use of "scam" in my last post.
TBTF direct effects include, as he noted, creditors avoiding "haircuts" (reduction or total loss of investment), and, as I added, employees and owners equally avoiding "haircuts" (reduction in compensation and loss of investment).
I used the term "scam" in reference to the latter two effects. Reductions in compensation and dividend outflow would go right to the bottom line, mitigating the need for equity and liquidity support.
TBTF rewards failure, which creates its own ill effects, and it will impose financial costs on families across the US as the effects of the changes in the Fed's System Open Market Account (latest data seen below) and growth in US Federal Debt manifest. Further, supporting firms which failed to see the collapse coming, or minimally to adjust their exposure accordingly, removes from the list of positives the one social virtue of trading I needed to know to become licensed as a securities' dealer- price discovery.
While I agree with the reader that US financial authorities had trade-offs in mind (I didn't use "total" in my original title) when TBTF became explicit (some going beyond finance, as I'll discuss in my next post) some are taking advantage or "scamming" the public in the lax environment.
Take a good look at aggregated employee compensation in the first table.
The ultimate question of TBTF is not "if" it will end. It will. Such arrangements always end. The Medici were known as God's Bankers, under the protection of the Vatican- the best shield going at the time- and they went under. Money, like water, eventually finds a way to flow around (or through) constraints.
The question is, will we end TBTF or will it end us, in our current form?
In March of 2008, years of poor investment decisions finally caught up to Bear Stearns, forcing the firm to accept a $2 per share bid (later revised to $10) from JPMorgan (financed by loans from the NY Fed). A once mighty financial firm which had survived the Great Depression was no more. Adding insult to injury, its final 5 year stock price chart, which depicted a dive from over $150 to the single digits could easily have been mistaken for that of a dead Tech firm which never generated a dime in profits.
Coincidentally, the Federal Reserve announced the creation of the Primary Dealer Credit Facility (PDCF) which allowed any Primary Dealer not already authorized to borrow at the Fed's Discount Window, to, in effect, enjoy the privilege of discounting their securities if they were cash poor.
Despite the new access to Fed liquidity, however, stock prices of Primary Dealers, who, inter alia, sell US government debt, were under assault within 6 months. Lehman Brothers did not survive the assault, declaring bankruptcy on September 15.
Perhaps due to the thinning ranks of Primary Dealers (in the previous 2 years, 5 Banks, ABN AMRO, CIBC, Nomura Securities, Lehman Brothers and the aforementioned Bear Stearns, had left the club or died) or some other reason (more on that in my next post) the Fed and Treasury made the hitherto unsaid policy of Too Big To Fail (TBTF), explicit, and welcomed GS and MS into the club (which, according to Simon Johnson and James Kwak, numbers 13), declaring the new entrants Bank Holding Companies (BHCs), for emphasis.
A recent check of the Fed's NIC (a wonderful resource on BHC data) demonstrates that GS and MS fit into the BHC club about as well as I fit into the crowd on my first visit to Beijing many years ago. Their source and use of funds are quite different as are their arenas of profit. They are investment firms, more closely related to Hedge Funds than banks. I'm all in favor of investment firms, however, I don't agree that, if TBTF is wise policy (which, at this stage, I doubt) they should be included in the protected group.
I still, on the topic of sticking out from the crowd, remember being asked to join a picture of a Chinese family during a visit to the Great Wall, because, I suspect, this rural family rarely saw white people and wanted to show the folks at home their great adventure.
Banks, as I recently argued, always and everywhere earn their money lending. As the table below demonstrates, however, the meaning of the term "bank" is being diluted at roughly the same pace as the US$. Admittedly, the banks themselves, in their desire to be more like Hedge Funds, are helping the dilution of meaning. This makes me wonder if the next GS to join the club will be George Soros. Perhaps if he becomes a primary dealer....
As you can see, GS and MS needed no help in provisioning against bad loans (one argument, with some merit, in favor of TBTF is that the banks provided more mortgage credit than they otherwise would have if the government wasn't promoting home ownership). These investment houses earn money from, inter alia, Investment Banking, Brokerage and Proprietary Trading.
Proprietary Trading is the arena one tends to find "rogue traders" like John Rusnak, Brian Hunter of Amaranth fame and this fellow from France. A policy of TBTF might well bail out a "rogue bank"or the banks' creditors, perhaps it already has. This isn't to suggest I'm against prop trading (it's one way I earn my keep) I just don't see the positives (if any) outweighing the negatives.
A thoughtful reader at Seeking Alpha wanted a more explicit statement of TBTF effects which inspired the use of "scam" in my last post.
TBTF direct effects include, as he noted, creditors avoiding "haircuts" (reduction or total loss of investment), and, as I added, employees and owners equally avoiding "haircuts" (reduction in compensation and loss of investment).
I used the term "scam" in reference to the latter two effects. Reductions in compensation and dividend outflow would go right to the bottom line, mitigating the need for equity and liquidity support.
TBTF rewards failure, which creates its own ill effects, and it will impose financial costs on families across the US as the effects of the changes in the Fed's System Open Market Account (latest data seen below) and growth in US Federal Debt manifest. Further, supporting firms which failed to see the collapse coming, or minimally to adjust their exposure accordingly, removes from the list of positives the one social virtue of trading I needed to know to become licensed as a securities' dealer- price discovery.
While I agree with the reader that US financial authorities had trade-offs in mind (I didn't use "total" in my original title) when TBTF became explicit (some going beyond finance, as I'll discuss in my next post) some are taking advantage or "scamming" the public in the lax environment.
Take a good look at aggregated employee compensation in the first table.
The ultimate question of TBTF is not "if" it will end. It will. Such arrangements always end. The Medici were known as God's Bankers, under the protection of the Vatican- the best shield going at the time- and they went under. Money, like water, eventually finds a way to flow around (or through) constraints.
The question is, will we end TBTF or will it end us, in our current form?
Thursday, October 01, 2009
From Black Scholes to Black Holes (part 4- Finance)
Were a modern-day financial Rip Van Winkle to awake today having slumbered for the past 20 years, he would observe a capital market vastly different from the one he knew. Introduction: From Black Scholes to Black Holes
It's been 16 years since the above noted book-a collection of essays explainging how one models the risks associated with certain derivative securities- was published and the introductory statement is more true now than then. In 1992, the notional amount of interest rate derivative exposure in US banks was about 77% of GDP. The graph below shows the growth since.
I begin this 4th look at the US economy from a flow of funds perspective with derivatives to "cut to the chase." This isn't to diminish the still currently intractable problems of mortgage finance, but that topic has been ably covered by many others. Further, as hard as it may be to believe, the problems associated with mortgage finance pale in comparison to those associated with derivatives. Warren Buffett famously called these securities financial weapons of mass destruction, but I think he understated the problem. These securities are far worse- a Ponzi scheme even Carlo wouldn't have dreamed of. We can choose to fire a WMD, but these securities have taken on a life of their own and they will, in my view, drag everything financially tied to them into oblivion- into a black hole.
The intent of the book From Black Scholes to Black Holes, to cloak these securities in an aura of cool, is quite ironic in its, apparently unintended, prescience. Black Holes are singularities in Einstein's space-time continuum which swallow, for want of a better term, everything that comes near. They are the Charybdis-es of space. Derivatives are the Charybdis-es of finance. They are creating their own ever stronger gravitational field that has already swallowed 3 of the 8 major US players since 1998. The 5 banks which remain are increasingly linked together.
Last night, after perusing the derivatives data from the BIS and Office of the Comptroller of the Currency (OCC), I was wondering what the end game would be, happened to glance at my book shelf and the book title jumped out at me. "It's a Black Hole," I realized. In the end the remaining banks will merge into one and money, instead of light, would never be able to escape as the fallacy of netting benefits- the assumption that they are all similarly valued- is exposed.
In the OCC Report on Derivatives, the benefits of netting are explained: For a portfolio of contracts with a single counterparty where the bank has a legally enforceable bilateral netting agreement, contracts with negative values may be used to offset contracts with positive values. This process generates a “net” current credit exposure (NCCE)
I had some experience with this fallacy of netting when I was trading FX derivatives for Chase. When Drexel Burnham collapsed I had to "net out" - put on the opposite trade with the same counterparty- the exposure of my option portfolios with Drexel's. While this seems easy to describe there was a problem. They didn't value their options at the same values we did. In some cases I was short low delta (far out of the money) options I had marked to the (lower) at-the-money value. Who should take that revaluation loss? In other cases, I might have to net out a position I needed only to find that replacing it was far more expensive than our agreed upon price.
Fortunately, markets I was trading at that time were not excessively volatile, which would have made the procedure even more difficult. Even more fortunately, the notional amounts were orders of magnitude less than currently carried by US banks.
50 basis points (a fairly trivial change in an option value, or, if you prefer, an aggressive post Volcker Fed tightening) on $100M (roughly the size of trade back then) is $500K. 50 basis points on $7Tln (or 1/5th (5 banks left) of the notional exposure in interest rate derivatives with maturities between 1-5 years) is $35B (7 times the total net income for JPM in 2008).
Why has interest rate derivative exposure grown so much over the past few years? The search for profits in an ultra low interest rate environment seems, in part, a good answer as the graph below depicts.
The other answer is that, as I discovered, the easiest way to make money from a derivatives portfolio is to grow it. Increasing risk in the far dates that is mispriced in your favor can cover many sins as derivatives mature.
Warren Buffett describes the pain of going in reverse on (winding down) such portfolios: When Berkshire purchased General Re in 1998, we knew we could not get our minds around its book of 23,218 derivatives contracts, made with 884 counterparties (many of which we had never heard of). So we decided to close up shop. Though we were under no pressure and were operating in benign markets as we exited, it took us five years and more than $400 million in losses to largely complete the task. Upon leaving, our feelings about the business mirrored a line in a country song: “I liked you better before I got to know you so well.” General Re's derivatives exposure was orders of magnitude less than that of GS, C, or JPM.
The OCC seeks to assure us that they have things under control: While market or product concentrations are normally a concern for bank supervisors, there are three important mitigating factors with respect to derivatives activities. First, there are a number of other providers of derivatives products whose activity is not reflected in the data in this report. Second, because the highly specialized business of structuring, trading, and managing derivatives transactions requires sophisticated tools and expertise, derivatives activity is concentrated in those institutions that have the resources needed to be able to operate this business in a safe and sound manner. Third, the OCC and other supervisors have examiners on-site at the largest banks to continuously evaluate the credit, market, operation, reputation, and compliance risks of derivatives.
In addition to the assumed virtues of netting, the OCC seeks to calm you with VaR (value at risk analysis) analysis (about the shortcomings of which, more here). The average VaR in 2008 relative to 2008 net income according to 10K and 10Q SEC reports is roughly 3% for JPM, C, and BoA and higher for GS. In the event revenues from interest rate derivative trading for Q1 2009 was $9B. Those tails sure seem to be fatter than assumed. If you can make it, as all traders eventually learn, you can certainly lose it.
Perhaps now we can see why the Fed is being so tentative with talk of removing stimulus and raising rates. 50 basis points can wipe out a bank. Imagine if the Fed is faced with the situation of a full blown currency crisis- the Scylla near the Charybdis- and needs to lift the Fed Funds rate 200, 300 or 500 basis points swiftly- a policy response chosen by the Fed in the late 70s/early 80s and many other Central Banks since.
In that event, the black hole becomes operative and another type of derivative, the credit default swap starts sucking the financial life out of the remaining big banks.
Since Q3 2007, credit default derivatives have generated $28B in losses. As of Q2 2009 there were still some $13.44Tln in notional exposure or 95% of GDP. What happens if only 1 bank is left? even if that bank has successfully bet on the collapse of the other 4? Who pays?
From Black Scholes to Black Holes indeed. In my view, the sooner, the better. If Warren Buffet's experience is any guide, an implosion of the 5 biggest banks seems a better alternative to an attempt to wind down these portfolios.
It's been 16 years since the above noted book-a collection of essays explainging how one models the risks associated with certain derivative securities- was published and the introductory statement is more true now than then. In 1992, the notional amount of interest rate derivative exposure in US banks was about 77% of GDP. The graph below shows the growth since.
I begin this 4th look at the US economy from a flow of funds perspective with derivatives to "cut to the chase." This isn't to diminish the still currently intractable problems of mortgage finance, but that topic has been ably covered by many others. Further, as hard as it may be to believe, the problems associated with mortgage finance pale in comparison to those associated with derivatives. Warren Buffett famously called these securities financial weapons of mass destruction, but I think he understated the problem. These securities are far worse- a Ponzi scheme even Carlo wouldn't have dreamed of. We can choose to fire a WMD, but these securities have taken on a life of their own and they will, in my view, drag everything financially tied to them into oblivion- into a black hole.
The intent of the book From Black Scholes to Black Holes, to cloak these securities in an aura of cool, is quite ironic in its, apparently unintended, prescience. Black Holes are singularities in Einstein's space-time continuum which swallow, for want of a better term, everything that comes near. They are the Charybdis-es of space. Derivatives are the Charybdis-es of finance. They are creating their own ever stronger gravitational field that has already swallowed 3 of the 8 major US players since 1998. The 5 banks which remain are increasingly linked together.
Last night, after perusing the derivatives data from the BIS and Office of the Comptroller of the Currency (OCC), I was wondering what the end game would be, happened to glance at my book shelf and the book title jumped out at me. "It's a Black Hole," I realized. In the end the remaining banks will merge into one and money, instead of light, would never be able to escape as the fallacy of netting benefits- the assumption that they are all similarly valued- is exposed.
In the OCC Report on Derivatives, the benefits of netting are explained: For a portfolio of contracts with a single counterparty where the bank has a legally enforceable bilateral netting agreement, contracts with negative values may be used to offset contracts with positive values. This process generates a “net” current credit exposure (NCCE)
I had some experience with this fallacy of netting when I was trading FX derivatives for Chase. When Drexel Burnham collapsed I had to "net out" - put on the opposite trade with the same counterparty- the exposure of my option portfolios with Drexel's. While this seems easy to describe there was a problem. They didn't value their options at the same values we did. In some cases I was short low delta (far out of the money) options I had marked to the (lower) at-the-money value. Who should take that revaluation loss? In other cases, I might have to net out a position I needed only to find that replacing it was far more expensive than our agreed upon price.
Fortunately, markets I was trading at that time were not excessively volatile, which would have made the procedure even more difficult. Even more fortunately, the notional amounts were orders of magnitude less than currently carried by US banks.
50 basis points (a fairly trivial change in an option value, or, if you prefer, an aggressive post Volcker Fed tightening) on $100M (roughly the size of trade back then) is $500K. 50 basis points on $7Tln (or 1/5th (5 banks left) of the notional exposure in interest rate derivatives with maturities between 1-5 years) is $35B (7 times the total net income for JPM in 2008).
Why has interest rate derivative exposure grown so much over the past few years? The search for profits in an ultra low interest rate environment seems, in part, a good answer as the graph below depicts.
The other answer is that, as I discovered, the easiest way to make money from a derivatives portfolio is to grow it. Increasing risk in the far dates that is mispriced in your favor can cover many sins as derivatives mature.
Warren Buffett describes the pain of going in reverse on (winding down) such portfolios: When Berkshire purchased General Re in 1998, we knew we could not get our minds around its book of 23,218 derivatives contracts, made with 884 counterparties (many of which we had never heard of). So we decided to close up shop. Though we were under no pressure and were operating in benign markets as we exited, it took us five years and more than $400 million in losses to largely complete the task. Upon leaving, our feelings about the business mirrored a line in a country song: “I liked you better before I got to know you so well.” General Re's derivatives exposure was orders of magnitude less than that of GS, C, or JPM.
The OCC seeks to assure us that they have things under control: While market or product concentrations are normally a concern for bank supervisors, there are three important mitigating factors with respect to derivatives activities. First, there are a number of other providers of derivatives products whose activity is not reflected in the data in this report. Second, because the highly specialized business of structuring, trading, and managing derivatives transactions requires sophisticated tools and expertise, derivatives activity is concentrated in those institutions that have the resources needed to be able to operate this business in a safe and sound manner. Third, the OCC and other supervisors have examiners on-site at the largest banks to continuously evaluate the credit, market, operation, reputation, and compliance risks of derivatives.
In addition to the assumed virtues of netting, the OCC seeks to calm you with VaR (value at risk analysis) analysis (about the shortcomings of which, more here). The average VaR in 2008 relative to 2008 net income according to 10K and 10Q SEC reports is roughly 3% for JPM, C, and BoA and higher for GS. In the event revenues from interest rate derivative trading for Q1 2009 was $9B. Those tails sure seem to be fatter than assumed. If you can make it, as all traders eventually learn, you can certainly lose it.
Perhaps now we can see why the Fed is being so tentative with talk of removing stimulus and raising rates. 50 basis points can wipe out a bank. Imagine if the Fed is faced with the situation of a full blown currency crisis- the Scylla near the Charybdis- and needs to lift the Fed Funds rate 200, 300 or 500 basis points swiftly- a policy response chosen by the Fed in the late 70s/early 80s and many other Central Banks since.
In that event, the black hole becomes operative and another type of derivative, the credit default swap starts sucking the financial life out of the remaining big banks.
Since Q3 2007, credit default derivatives have generated $28B in losses. As of Q2 2009 there were still some $13.44Tln in notional exposure or 95% of GDP. What happens if only 1 bank is left? even if that bank has successfully bet on the collapse of the other 4? Who pays?
From Black Scholes to Black Holes indeed. In my view, the sooner, the better. If Warren Buffet's experience is any guide, an implosion of the 5 biggest banks seems a better alternative to an attempt to wind down these portfolios.
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