Notional Value

Crossposted from The Stars Hollow Gazette

Recently some people of my acquaintance have had traffic accidents that damaged their cars (fortunately there were no injuries).

They had insurance which, over the lifetime of the vehicle, amounted to much more than its replacement cost.  So an adjuster came out and examined the damage, determined whether or not repair exceeded replacement cost and issued a check for the lower of the two values.

In the mean time the insurance company had the use of the payment money which they invested and collected the profits of that investment.

At least that’s the way insurance is supposed to work.

Accountancy is boring.  I want to be a Lion Tamer!

What If Lehman Happened Today?

By Michael Hirsh and Stacy Kaper, National Journal

Updated: December 1, 2011 5:19 p.m.

And now Gensler-a former Goldman Sachs executive whose stand against his erstwhile Wall Street comrades has won praise from progressives-is facing down the biggest Goliath of all. Europe’s raging financial crisis may not leave Gensler the time he needs to get a handle on the vast global market in derivatives, the arcane instruments used to bet on everything from interest rates to currencies to credit default swaps on the Continent. At $708 trillion (yes, trillion), the derivatives trade is already much larger than it was during the 2008 crisis. Just as last time, this opaque market may hold the key to whether the evolving eurozone disaster causes another market meltdown worldwide. With a staff of only 712 (roughly unchanged from the 1990s, when financial products where much less complex), the CFTC must regulate markets seven times the size of the futures market it used to oversee. Mostly, it supervises America’s $300 trillion portion of the global derivatives trade. “Until we complete this task, the American people remain at risk,” Gensler warned in an interview with National Journal at his office in downtown Washington. “We are midstream” in rule-writing and in requiring firms to report their trading positions, he admits. “The only thing that we would have right now is the data that banks and others are voluntarily reporting.” Even after the rules are written, Gensler says, “we won’t necessarily have the cops on the beat to oversee the market.”

The most frightening (but still very plausible) scenario is that some of the CDS dealers won’t have capital to pay off the swaps as they are “triggered” by the plummeting value of European bonds. That shortfall could lead to defaults on trillions of dollars in other types of derivatives. Something similar occurred when Lehman Brothers collapsed in September 2008; it failed to make good on nearly 10,000 contracts for swaps and derivatives. Lehman was severely over-leveraged, relied too heavily on short-term funding, and ultimately succumbed to a liquidity run. “That’s exactly what’s going to bring the system down,” says Michael Greenberger, a derivatives expert at the University of Maryland who once served as a senior CFTC official. “Here you’ve got people holding on to potentially valueless government debt.”

A panic may be just around the corner. The International Swaps and Derivatives Association appears to be trying to tighten its standards for paying out credit default swaps on euro debt, making it more difficult to collect on them, the Financial Times reported this week. That decision has angered the firms holding the CDS insurance. The situation also has similarities to 2008 and the failure of American International Group, the world’s biggest dealer of credit default swaps, which required a $150 billion bailout by the U.S. government. AIG imploded because it couldn’t keep up with the triggers that required it to post more collateral. “The real problem is that CDS moves the financial consequences of a default much further up the line,” says Dennis Kelleher, the head of Better Markets, a D.C.-based activist group. “So, long before someone defaults, be it an institution or a country, anyone who has written insurance-ie, credit default swaps-has to start posting massive amounts of collateral.”

“We still don’t have transparency in the swaps market,” Gensler says. “There is $20 of swaps for every dollar in our economy.”

Or so it would have been, if certain modern theories about the shape of the world had not proved to be disastrously wrong.

1 comment

  1. ek hornbeck

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