Deb­watch on a new ISP

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I have just moved the blog to a new ISP after my pre­vi­ous provider IXWeb­host­ing proved to have intractable prob­lems with mal­ware.

The new host­ing is being pro­vided pro bono by Cyanide Web Host­ing, which I greatly appre­ci­ate.

Some posts may have been lost in the process, but that was prefer­able to putting up with a site that dis­trib­uted viruses to all and sundry. So if you have made a post and it hasn’t turned up here, please re-sub­mit.

I have also been away for a cou­ple of days when there was quite a bit of traf­fic on the blog, and I’m not sure that I’ll be able to respond to all queries that came in dur­ing that time. My apolo­gies, but traf­fic on the blog is get­ting hard enough to cope with on a day by day basis, let alone when I take a cou­ple of days break from the inter­net.

That said, I’d like to sec­ond a recent subscriber’s obser­va­tion about the qual­ity of and civil­ity of dis­cus­sions on the blog. That’s some­thing that reflects the users who have signed on, and I appre­ci­ate it too–and learn quite a bit from the dis­cus­sions myself.

All the best, and wel­come aboard Cyanide’s web server.

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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  • Hi Every­one, and esp­cially al49er,

    The best data source on the scale of deriv­a­tives and their sub­sets is main­tained by the Bank of Inter­na­tional Set­tle­ments (BIS).

    The BIS is also the only for­mal body that “got” the finan­cial cri­sis before it hap­pened.

    The essen­tial fea­ture of all these deriv­a­tives is that they are a “tails I win, heads you win” bet between two par­ties. How­ever, what hap­pens if the bloke you bet with is actu­ally bank­rupt? Then you can “win” and lose all at once.

    My favourite such instru­ments are Credit Default Swaps (notional value as at June 2008: US$57 tril­lion out of the US$684 tril­lion total), where Firm A and Firm B take a bet over the sur­vival of Firm C. If Firm C goes bank­rupt, then A “wins”; if it doesn’t, then B “loses”–though B might be a bank charg­ing a fee to A for the fee.

    Of course, the CDS con­tract assumes that both A and B will con­tinue to exist, even though they’re bet­ting over whether C will go bank­rupt!

    These are spun as a form of insur­ance, but legit­i­mate insur­ance com­pa­nies main­tain a reserve to cover them in the event that an insured against event actu­ally hap­pens. No such require­ments are placed on deriv­a­tives traders, with the result that the bank­ruptcy of C could actu­ally expose B to a claim from A that will bank­rupt B as well.

    Sud­denly the win­ner A finds itself as an unse­cured cred­i­tor in the bank­ruptcy of B, and there­fore has to take a con­tin­gency charge against its own assets that might bank­rupt it as well.

    That’s the fun and games of deriv­a­tives, and even today it still has a long way to play out.


    My best answers for you;

    what deriv­a­tives are?-Exceedingly com­plex con­tracts of insur­ance between 2 par­ties that have a life of the under­ly­ing secu­rity (mort­gage)- say 15 years for exam­ple. The deriv­a­tive is a very com­plex algo­rithm based insur­ance type con­tract- made by usu­ally an invest­ment bank then under­writ­ten by the bank then sold off to a party who wants to mit­i­gate risk (fees fees fees)from that under­ly­ing secu­rity. That party can then onsell at a small dis­count or hold to matu­rity whereby the seller of the deriv­a­tive in teory col­lects pre­mi­ums for hold­ing the risk . The deriv­a­tive “mar­ket” is like a stock mar­ket but facil­i­tates the buy­ing and sell­ing of deriv­a­tives which essen­tially dis­cov­ers its “mar­ket value”. The big dif­fer­ence is that the deriv­a­tives trade is largely UNREGULATED.

    How are they val­ued? They are val­ued ini­tially at their sell­ing price (say 100) then there­after what they are traded at (which as we know fluc­tu­ates) until matu­rity. When noth­ing trades ie no bid­ders (no buyers)only offers (sell­ers) what are they worth? Yes­ter­day say 95, now 5 or 3? ZERO??? Who knows? That is the scope of the mas­sive col­lapse in this mon­strous mar­ket.

    Who ben­e­fits?- Those who col­lect pre­mi­ums, until they dont (mom and dad pen­sion funds)because the other party can­not pay. Under­writ­ers who make and then sell these things on to mom and dad penion funds. Traders who profit by com­mis­sions and fees in the buy and sell of the deriv­a­tives mar­kets (invest­ment banks, bro­kers etc), those that trade the deriv­a­tives bet­ting on a rise or fall in price (hedge funds, SIVS, con­duits, BANKS,etc ) This was the biggest gravy train ever known to man. It has now imploded.

    You look at a major Inter­na­tional Bank and see sim­ply a bank- when inside it is a casino!!!


    What Steve said.….…..

  • al49er

    Bril­liant Steve & ‘Macca’, and thank you 

    my sus­pi­cion was that they were largely hol­low bull­dust instru­ments in the form of a ‘pass the parscle’ and make sure that YOU are not the smuck left hold­ing it AND that you have picked up all the avail­able fees and com­mis­sions along the way.

    So this is the ori­gin of the 10,000 bil­lion US$ ‘worth’ of “ghost assets”, ref­ered to in the GEAB Report to which I ref­ered in my post of jan 17.

    Isn’t it just stun­ning to realise that prob­a­bly 97% ( my guess) of the com­mu­nity has no idea of these ‘drivers’/factors in a big part of this fina­cial eco­nomic train wreck.

    And that the peo­ple who they are rely­ing on to fix it all (and quickly so things can get back to ‘nor­mal’ –doesn’t that con­cept crack you up) — like ‘super Kev’ and ‘St. Barack’ don’t want them to get an appre­ci­a­tion of what has gone on, in order that they will con­tinue to swal­low that they should keep ‘sign­ing up’ for their dream home, aided by their car­ing gov’t who has increased the sub­sidy ( read devel­op­ers extra margin),whilst ALSO con­tin­u­ing to spend spend spend !

    And gees if peo­ple really knew that the govts effec­tively sanc­tioned the cre­ation of these ‘products’/paper through slack reg­u­la­tory regimes and rat­ings author­i­ties,
    boy they might start caus­ing anar… oops
    I mean ‘social unrest’ !

    It gives “bug­gered” an entirely new dimen­sion.

  • Bull­turned­bear

    Hi Guys,

    Great dis­cus­sion. I’ve been out of the office all day and missed it.

    Deriv­a­tives (as per their name) are an asset or lia­bil­ity (a piece of paper) with has its value derived from an under­ly­ing “real” asset. Eg, a call option is a deriv­a­tive. It is a piece of paper that gives the holder the right to buy say a share or a prop­erty at a pre­de­ter­mined price within a fixed time. The lever­age (or mul­ti­ple expo­sure) is usu­ally 100 times. There­fore, a small rise in the price (or value) of the asset leads to a very large rise in the value of the option. The option goes up in value because the holder agreed to pay X for the share, but now the share is worth X+10. There­fore the option can be sold for more than it cost. They go down in value too.

    Now CDS (Credit default swaps) are also a deriv­a­tive. Their value is derived from bonds sold by com­pa­nies. The insur­ance descrip­tion (agreed there is no reserves like insur­ance com­pa­nies have) is a good way to describe them, because it helps one under­stand.

    Think of CDS this way. Assume you are a Japan­ese bank and you want to buy a Mac­quarie Bank bond for $100M. A bond is a fancy way to say a loan to Maquarie Bank. An Amer­i­can Bank then comes along and agrees to sell you a CDS. The CDS will insure you so that if MacBank defaults, you will recover all your prin­ci­pal. The num­bers worked some­thing like this. The inter­est you would earn on the bond would be say 6% but the CDS would cost 1%. There­fore net­ting you 5%. Rates for you to bor­row in Japan are only about 2.5%. Once you hedge the cur­rency (some extra cost), you are “guar­an­teed” to make a net 2% “risk free”!!! The Amer­i­can Bank makes 1% with no cap­i­tal cost. “free money”.

    The Amer­i­can bank loved this busi­ness, because they got money for noth­ing. The thought was that MacBank would never default. If
    macbank got into trou­ble they could just raise more equity in the mar­ket and pay out the bond. Easy money for all. So the Japan­ese banks started sell­ing CDS as well. In fact many banks and insur­ance com­pa­nies did.

    By the way. CDOs (col­lat­er­alised Debt Oblig­a­tions) are just a fancy name for secu­ri­tised loans. A bun­dle of loans. Say home loans or com­mer­cial prop­erty loans bun­dled up and sold off as a “diver­si­fied” low risk bond. Banks wrote CDS against these as well.

    Now the rub. When MacBank was never going to default that was fine. But now that rais­ing fresh cap­i­tal is get­ting harder and nobody knows the true expo­sures of banks, the risk of default is much higher. So what the Amer­i­can bank earned $1M (1%) a year from, might now cost them $30M, $50M or even $100M, depend­ing on what can be recov­ered if MacBank defaulted. 

    The word around when AIG (Amer­i­can Inter­na­tional Group) was nation­alised. Was that their CDS expo­sure was so big it would cause a domino effect and bring down all the other play­ers with them. So they said.

    Fur­ther­more it’s hard to on-sell the CDS because the con­tin­gent lia­bil­ity has sky­rock­eted. Also the cost of writ­ing new CDS has sky­rock­eted and so banks are very reluc­tant to buy bonds (with­out cover) so the bond mar­ket has frozen solid also.

    The con­clu­sion I reach is that when the pub­lic get tired of the waste­ful bailouts and the Gov­ern­ment tap is turned off. The sys­tem will melt down. (my guess is Sept/Oct this year) Only to start again from a much lower base.

  • Bull­turned­bear

    Whilst I think the com­ing depres­sion will be ter­ri­ble for many peo­ple. It is a nec­es­sary process. Not only did assets get into a bub­ble. So did con­sump­tion, wages and prof­its. All fueled by expo­nen­tially grow­ing debt.

    The upside will be that our kids will be able to buy (and actu­ally pay off) a house. We will rebuild a gen­uine sav­ings base that can sup­port pro­duc­tion. This will cre­ate sat­is­fy­ing jobs for Gen Y and their kids. Our kids will be able to start busi­nesses with­out masses of debt and risk.

    I don’t sub­scribe to the view that the world is over and it will never be good again. 

    For the next 10 years though many peo­ple will do it very tough. All power to human nature and good old Aussie ingineuity. Peo­ple will re-find joy in rela­tion­ships and for­get their love of money and things.

  • pru­dentsaver

    It’s very clear to me that the bub­ble from around 1994. first in stocks to 2000, then in hous­ing, com­modi­ties, etc, is due to Asian cur­rency manip­u­la­tion. That means, they buy trea­sury bonds and notes, to sup­press their own cur­ren­cies, and also boost demand for their goods from the west. When they no longer do this, then the series of dif­fer­ent bub­bles ends, their cur­ren­cies rise, and our inter­est rates rise to as there is no tomor­row, and no buy­ers for our national debts deficit. That means an highly infla­tion­ary reces­sion. I think of it as an inverse Asian cri­sis. The defla­tion is just an in-between phase, until fed starts to raise inter­est rates or mon­e­tize debt. If they did raise inter­est rates, and the dol­lar sur­vived, the Amer­i­can econ­omy would be ready for a big boom.

    Some economies are soon ready to raise inter­est rates ‚like Greece, Ire­land, UK ‚Por­tu­gal, Spain, Italy, so on, as their 10 year notes are show­ing signs of blow­ing up, espe­cially Greece. If this dis­as­ter spread to Spain that would really deflate the Span­ish prop­erty bub­ble. My guess is that Spain rather would rather buy their own debt than raise inter­est rates. That would bring hyper­in­fla­tion to Spain. A very likely sce­nario in my opin­ion.

    It will be inter­est­ing to see if these coun­tries choose 10–20 % short term inter­est rates, or mon­e­tiz­ing debt.

  • tom­myt

    Bull­turned­bear, thanks for that! but I must ask, why would human nature change after a brief spell of suf­fer­ing? espe­cially those ‘spivs’ who think that they are smarter?
    those same peo­ple (a la Bond, Skase etc) who believe in their ‘supe­ri­or­ity’ cou­pled with polit­i­cal ‘friendships’!Why would respon­si­ble debt takeover from irre­spon­si­ble debt and who would make them stop that type of actions?Would there be in a future econ­omy enough sav­ings to han­dle the ‘aspi­ra­tional greed’ of the same peo­ple who ( e.g. Storm )have done it to us the lsat 20 years?Government in my mind is not wise enough nor inde­pen­dent enough of these strong ‘forces’ to say “I will do it my way” But time will tell (or rather my kids will!)

  • Bull­turned­bear

    Hi Tom­myt,

    I believe peo­ple are already chang­ing their mind­sets. The changes are slow in Aus­tralia so far. But they are notice­able all the same. 

    Some exam­ples of change, are peo­ple talk­ing about sav­ing more, spend­ing less and find­ing a cheaper way.

    As people’s losses inten­sify they will become even more risk averse. That will mean less invest­ment. This flows from a change in psy­chol­ogy. Peo­ple will become more con­ser­v­a­tive and less osten­ta­tious. This will hap­pen as people’s mouths will match their chang­ing actions. Or the other way round.

    Remem­ber read­ing about the changes that occurred from the 1920s to the 1930s. Peo­ple changed from being risk tak­ing show offs to con­ser­v­a­tive homely types. This change was slow but very long last­ing. Some of the depres­sion gen­er­a­tion are still very con­ser­v­a­tive and risk averse today.