Buffet and Cuban apparently came out recently giving their usual spiel against derivatives like CDSs and ETFs. And of course, Cramer followed it up with a big speech on how this justifies his prejudices against the products and the people who make them.
I know lots of you hate derivatives, because you blame the 2008 housing bubble on derivatives held in the banking industry.
There’s something to be said for what these products allow; traditionally, you could either invest in a company or avoid it. Short selling allowed for limited bets against certain sorts of behavior, but generally speaking, it’s risky and there are limits to what it can accomplish.
CDS’s, however, can permit someone to really bet directly against anything; from governments to organizations. Anywhere a promise has been made, the insurance of that promise can create profit potential for the avid disbeliever.
Because of that point, now we have charges being leveled by the old establishment that this is “anti-social” or “morally corrupt” and that the practice should be disbarred.
Why?
Before you jump on the anti-derivative bandwagon, I just want to state an opinion. It is something that, as a capitalist, I firmly believe with all my heart and soul.
Good decisions deserve to be rewarded, and bad decisions should not be.
How many times, throughout my life, have I heard you people bitch about governments? About their waste and their incompetence; how many times have you complained that they don’t deserve to spend “your money.”
Now, for what is perhaps the first time in history, not only can the bad choices of heads of state be called out almost immediately, but also the judicious individuals with the spine to call out the lies and false promises can be rewarded and entrusted with further resources and the accompanying power and authority over them. And after years of considering yourself one of those individuals with the courage to call it like it is, now when it matters most you choose to bat against the people who have always been on your side.
Do you want to know how it is that things never change?
Has it ever occurred to you that if Italy’s yields had not blown out when they did, people would still be piling into Italian debt, and Silvio Berlusconi would still be at the helm? Does it strike you as ironic that this “reckless behavior” of betting directly against European governments, this “anti-social” crusade, has directly stemmed the flow of money from the private sector into the empty guarantees of these snake-oil salesmen?
For how many more years would the European countries have been able to limp along, gobbling up precious investment, if the CDS market hadn’t said “enough?”
But no, because the act of forcing Europe’s hand had the unpleasant side effect of forcing people to question their financial wellbeing, now you’re up in arms against the men and women whose only crime was to point out the obvious.
Now you side with Warren Buffet, one of the most politically active members of the establishment around, because he has some cute phrases and looks like your grandfather?
Do you know why Buffet really hates derivatives? Because they change the game.
You need to get some courage and decide what you believe. If you truly believe that the elected officials of the world are unworthy, unintelligent, and deserving of removal, then you need to grow a pair and accept that this is a way of getting rid of them. And yes, it will be accompanied by some pain.
Or you can side with the EU career politicians who are fighting for their lives and with all their desperation to hold onto the keys of the kingdom, even though there are others who are more deserving. You can help fight their battle for them, and let them stay in a position to spend valuable resources on all sorts of nonsense; let them keep giving themselves and their friends kickbacks galore and indulge in their wildest fantasies. And yes, this route lets you put your head back in the sand.
But don’t pretend like you actually care about political corruption and having competent governance, and then with the same breath strike down one of the most powerful tools for facilitating that transition. It sounds stupid.
The market is most definitely not perfect; and these instruments are facilitating all sort of new, questionable choices to be made. However, if it’s between having bad choices with more freedom, or bad choices with less freedom, you might as well go with option number one.
At least with the first one, those who try and take advantage of the system can be punished for it, and those who have value to add can find their reward.
Any instrument that has the power to help force out the incompetent prime ministers of two countries in the same week has my support.
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Very well said Cain.
I’m not necessarily a fan of financial products that require a team of mathematicians and physicists to price, but I can’t disagree with your view point. If you know that someone is not only going to profit off of your mistakes, but is going to aggressively try to get rich off of your downfall, it changes the way you make decisions.
we do not need no stinking mathematical pricing, throw the buyers and sellers into the ring and let them agree on the price …
Exactly. That’s why all these political types are up in arms over the financial products being developed.
They force consequences to materialize quickly. That adds transparency to the system.
Of course they oppose derivatives; look how many elected officials have fallen at the hands of something as innocent looking as bond insurance.
Good stuff, as always, Cain.
“…fallen at the hands of something as innocent looking as bond insurance.”
Can you ‘splain this for those of us who don’t get a lot of market time (or have much trading/investing experience beyond stocks)? I thought the issue for Signore Bunga-Bunga was the spike in yields on sovereign bonds (owing to a wretchedly non-dynamic economy and labor market, etc). I didn’t know of a bond insurance connection.
Thanks.
CDS levels were more prominent with the Greek portion of this crisis. Right now yields are the perceived issue.
Where I get defensive of CDS contracts is their usefulness of gauging the markets real sentiment towards underlying assets. The CDS market almost always prices in catastrophe before the market itself figures out the problem.
I would argue that the EU trying to fuck over CDS holders actually forced the yield spike we’re witnessing now.
And also yes they are blowing out too. http://blogs.wsj.com/marketbeat/2011/11/15/euro-zone-cds-prices-breaking-records/?mod=yahoo_hs
Got it. Thanks, Cain!
Cain, give me bad choices with more freedom, I just cannot resist temptation !!!
Firstly, I hate derivatives in their current form and our current system. You have companies selling insurance, they KNOWINGLY CAN NOT COVER WHEN IF IT COMES DUE. If the government were to allow these companies to go bankrupt then I wouldn’t have a problem with it.
Secondly, I don’t know how any reasonable investor would like derivatives. It’s as if companies are forcing you to invest with fucking beer goggles. “O wow, this company looks greats!” Only to wake up and find out they have a couple billion in off balance sheet derivatives. Complete bullshit.
I would like derivatives if the following would happen: #1 Governments didn’t bail ANYONE out. #2 Companies disclosed WTF they held. Pretty simple in my eyes, till that happens fuck derivatives.
Take a look at the latest SEC filings; companies who have derivative exposure are now required to disclose derivatives under a special section in the report.
I hope they are actually being marked at Mark-to-market, rather then mark-to-imagination with those bullshit valuation models. I’ll look into the discloser, but if I see anything being marked to fantasy models rather then the open market, then its completely meaningless to me.
Then everything on those records is meaningless to you. If you have a problem with the derivatives because they are using that financial loophole, you must necessarily have the same problem with their real assets, which are being valued by the same standards.
How is a derivative in the tier 3 category different than a mortgage-backed loan, or a commodity, or an unsecured loan, or property, or any other asset that has been placed in the tier 3?
Your problem is then with financial accounting, not derivatives.
It’s different in the fact that when they are lying with some mortgage-backed loan, its not a gameover type of play. When they are lying with derivatives, its an instant. “We’re dead!”
Anyways, your probably right, this whole mark-to-imagination really pisses me off. Why cant we all just imagine what our house is worth, then borrow against it?
Depends on the derivative, there are plenty of negative carry trade products with limited loss potential.
Stock certs are derivatives… suppose it’s time for physical gold in the fire proof safe. CDS are nothing but insurance – I suppose anyone “exposed” should “take it on the chin like a man” and betting should be outlawed. Personal opinion: nothing wrong with derivatives, other than sticky non-transparent markets. Question ought to have been: Based on its tax base, how much can Greece afford to service, and at what rate? New questions are: What can the rest of the PIIGS service and at what rates? Make governments more transparent and responsive and CDS would be priced “correctly” all-the-way-along!
“Good decisions deserve to be rewarded, and bad decisions should not be.”
I completely agree which is why these are a problem.
The problem is not with the principal of CDS and such, but the SIZE of them and MAGNITUDE of the leverage is the problem… You can leverage, and use it as collateral to leverage more.
If it all goes bust, there isn’t enough money in the world for those who bet to make the payment, that is the real problem.
It’s like the story of the man that realized the whole town was rigged with TNT, so he loaded up on insurance, told the neighbors and moved town. When news broke of every house in the neighborhood going down, he failed to realize the insurance agency not only wouldn’t have been able to afford it anyways, but the agency itself went up in flames along with the town he bought the insurance in. So he lost his insurance money and his house. The difference is, in real life, the “insurance” agency itself (the big banks) are loading up the TNT themselves making everyone paranoid so they buy more insurance, and if on goes, it’s so interconnected it all goes. The banks have NO reason at this point to scale back the leverage because if it goes bust, they go under anyways.
That is a serious problem. The problem is the SOCIALISM that comes OUT of the unlimited magnitude of it to keep the system alive and that it will potentially take down everyone with it. It’s the bailouts that happen because there isn’t enough money in the system to pay the obligations. AIG was bailed out because it owed GS money. THAT is not capitalism.
As for being able to bet against governments, you can, it’s called gold. Gold has always been a bet against the government’s mismanagement of the money supply.
So add derivatives to the covered scope of capital requirements. I don’t have a problem with people trading the instruments having to put up capital like they do with margin requirements for a short account.
But freaking out and saying “oh well they all have to go.” No, derivatives are just instruments, like any other. You don’t banish stoves because some jackass lights his house on fire; you add safety mechanisms.
And guys like Buffet who seem to feel that you have only two options pertaining to investments; invest in or ignore; can piss off.