I considered calling this post “Dumb and Dumber.”

Dumb is thinking that only the losers in the last great speculation had anything to do with the problem, and not the winners.

Dumber is thinking that only the kind of speculation that caused the latest problem for taxpayers is worth preventing.

Can it really be that those speaking out against regulation of our major banks never heard of Nick Leeson or Yasuo Hamanaka?  Do they think the winners in the subprime CDS scam didn’t have anything to do with making the losses bigger and immediate for the losers?

Do you need a hint on why Leeson and Hamanaka are worth considering?  How about the name Hamanaka had in the market when he ran the proprietary metals trading unit of Sumitomo Bank — Mr. Copper?  Or the fact that Leeson sat almost exactly half way around the world from his head office as the senior proprietary trader in stock indices and their “basis” at Barings?

Do we need to have a US bank fail due to large speculative positions taken by proprietary traders before we figure out that proprietary trading is a risky activity that occasionally ends with institution-threatening losses?

If I bought into the pap on the financial news, that’s what I would have to conclude.

They seem to be saying that taxpayers should be exposed to the losses from each speculative leveraged activity a bank might enter into, at least until that particular activity costs US taxpayers a bundle.  Just costing Japanese taxpayers or destroying a 200 year old UK merchant bank is not reason enough.  Just being highly levered and illiquid, like private equity, is not reason enough.

While we’re at it, if losing on leveraged derivative bets took AIG down, shouldn’t we conclude that the winners in those bets were also too risky?


In a zero-sum game, the winners take the same amount of risk as the losers.  Just because they win a hand does not mean they are without risk.

Fannie and Freddie are widely reviled for being the current source of taxpayer credit losses.  But their losses are primarily on loans they guaranteed on verified 20% cash down, fully documented and checked income, conventional mortgage loans.  You know, the loans that every Fannie and Freddie critic call “safe.”

The real question is why those loans are so unsafe now.

The answer is that housing has declined by more than 20% over much of the country.  Given the fact that about 5% to 10% of us have to sell our homes every year, that means millions of those home owners have negative equity, and what would ordinarily be a home sale turns into a foreclosure.

I say that half the blame belongs to the winners who pushed every possible way to make their bets win.  They sold stock short (both with and without borrowing), they bought trillions of dollars of CDS “protection” from every bank or dealer that would do business with them, and they used the megaphone of the press to push  on the meme of “housing bubble” at every opportunity.

Do I fault them for doing everything they could to maximize their profits?  Except when they broke the law, no.

Do I blame them for the housing meltdown?  Given the fact that they accelerated the collapse of our private lending market, yes.  Whenever you remove half the customers from a market, the prices go down. Using short sales, CDS trading, and in the final stages literal removal of cash at Prime Brokerages, a group of profit-seekers made sure the only mortgage financing game left in town was the government.  To now say that they had nothing to do with the overburdening of that government-sponsored infrastructure is disingenuous.  Of course they did.

Did we let them do it by failing to require disclosure and capital set-asides for CDS?  Sure.  Did we make it worse by rewarding Fannie and Freddie “private” shareholders and management with decades of special treatment, low-cost borrowing and 100-1 leverage on their equity?  Absolutely.

We deserve to have rules of the game that protect innocent taxpayers from lopsided risk-taking.

What I do find reprehensible is the full frontal press and commentator attack against the effort to protect taxpayers from future raids by the same crew.

And in that crew, you have to include the losers, but also the winners.



2 Responses to Re-Regulation

  1. dwm says:

    Well said.

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