The Incredible Shrinking Harvard?

Living in the Past wrote:

xcrunner5 wrote:

I disagree entirely with our other friend who speaks as if he is an academic with very little knowledge of what is actually ocurring in closed door meetings.

Nice personal attack. That's a lot easier than responding to my point regarding Phil Gramm's bill allowing the CDS racket to expand out of control and both trigger and worsen the financial meltdown.

OK - I'll respond.

First, CDS is regarded as one of the most influential innovations of the last century. It is essential to managing financial risk by hedging exposure to a specific counterparty.

Second, it is NOT security and therefore can not be relegated as such. Would you regulate interest rate swaps, equity derivatives, commodity derivatives or weather derivatives - of course not.

Third, there is no need to have CDS traded on an active exchange since the underlying reference obligations are public instruments that are readily available. If you can't pick up any number of pulications to determine if spreads are widening or tightening on the reference obligation and understand the implications, then yes CDS are VERY dangerous because you don't have an understanding of the underlying.

Fourth, counterparties shouldn't be requried to disclose their CDS. This would create mass chaos in the market. Can you imagine one counterparty having to disclose to another counterparty that they are buying defualt protection on them when said counterparty is a major client?

Fifth, the problem is not CDS. The issue is that the CDS couldn't be unwound in an orderly fashion because the insurers provided the protection were going bankrupt. It is no different than if there was an immediate need to unwind massive amounts of life insurance and the life companies couldn't honor them. To that point, if Mr. Frank wouldn't have loosened underwriting standards, the underlying collateral wouldnt have been so tarnished that it brought down an industry and prohibited the insurance companies from honoring the contracts that were written. CDS was going to expan regardless of the bill because (as mentiond above, it is a critical tool for managing risk and is widespread across many many industries.

Finally, my comment wasn't a personal attack if it is the truth. You can read every article ever publish and still not understand the reasons for the collapse unless you actually dealt with these issues every day of your life. That's not an attack, but the truth.

These are good points all. And my fear is that the takeaway is going to be that these instruments are nothing but "weapons of mass financial destruction," without any regard for their utility, just because of the nepotism and conflicts of interest that compromised the collateral and the leveraging of said instruments.

Sagarin wrote:

These are good points all. And my fear is that the takeaway is going to be that these instruments are nothing but "weapons of mass financial destruction," without any regard for their utility, just because of the nepotism and conflicts of interest that compromised the collateral and the leveraging of said instruments.

Ha. I was expecting the "weapons of mass financial destruction" quote to be used very very soon. It's a great quote and certianly was used very well by the media to stir up the public. However, the oracle of omaha wasnt referring to CDS when he made the specific statement. In fact, if you review his consoldated financial statements you will find that he has in fact used CDS quite regularly as both a buyer and seller over the past several years. Some trades worked, while others didnt.

The bottom line is that this is a very very complicated situation that was compounded when several events occured simultaneously creating a perfect storm. I most definetly believe that the financial industry needs further regulation, but it has been regulated by people that have no understanding of what their regulating and are simply doing it for personal political gain. Furthermore, the media has identified the several points that help sell newspapers while ignoring everything else.

xcrunner5 wrote:

Finally, my comment wasn't a personal attack if it is the truth.

Here's the attack:

"I disagree entirely with our other friend who speaks as if he is an academic..."

All I did was regurgitate what I picked up from the business media. How is that speaking like an academic?

As for CDS's, you are saying that the problem is that they couldn't be unwound, but that's because of the massive leverage and the weakness of the underlying instruments (I'm speaking as a layman here). If there had been adequate disclosure (either through the SEC or some other means), investors would have withdrawn their money from entities who were getting way out on the risk curve, like AIG.

Now, could you please explain to this layman (perhaps with an example) how the following would have allowed investors to steer clear of AIG?

"If you can't pick up any number of pulications to determine if spreads are widening or tightening on the reference obligation and understand the implications, then yes CDS are VERY dangerous because you don't have an understanding of the underlying."

Everyone knows that investors are idiots. They would all have been investing in Bernie Madoff if only they could. That is why ponzi schemes and numbers games are illegal. To protect idiots. The mortgage scam was just taking advantage of this foolish greed in a way that was convenient for all those who should have done something to overlook it and let it run until it blew up.

With all due respect, if all you did was regurgitate what you picked up from the business media, I'd urge you to not always accept it as truth and study all sides of the debate before drawing a conclusion. Like most things, this is not B&W and instead somewhere in the grey.

With regards to your other question, Life Companies like AIG have an interesting business model. They sell life insurance with the intent of investing the premiums to create returns that are in excess of the insurance claims that they must pay out. In most cases, Life Cos invest in high quality assets that generat a return of ~5-10%. However, in the mid 2000s life co's changed their business models to generate returns of ~15-20% to compete with alternative investments in the market. All life insurance slid down the credit curve to generate these excess returns with AIG being the most aggresive, but clearly not the only one. XL and MBIA among other were equally as aggresive. Others such as Hartford, Northwest Mutual, Principal and AEGON were slightyly less aggresive.

It was common knowledge in the financial world that AIG was in trouble as early as 2007. There were many research reports published outlining the risk these companies had to complex securities that may result in a bad outcome. This knowledge was learned from reviewing the financial statements of these Cos. You are correct that they don't have to report CDS as securities, but they nonetheless have to report them and, more importantly have to report their indirect exposure to the underlying debt instruments. You could have easily looked at these financial statements to understand that you weren't comfortable with their investment profile. Certianly the financial world did as AIGs stock plummetted beginning at least 12-months before the collapse and their debt spread widening to historical levels...again all in 2007. Finally, most stock analysts had "sell" or "over valued" guidance on AIG well before the collapse. These were clear signs that all was not well at AIG. While no one knew the severity of the market meltdown, there were big flashing red warning signs to stay clear of AIG a long time ago.

xcrunner5 wrote:

Like most things, this is not B&W and instead somewhere in the grey.

That was my main point earlier. Maybe you'd like to revise this statement:

"If you really want to talk about whose fault this all is, lets trace this back to Mr. Barney Frank demanding that underwriting standards be loosened in the late 1990s because it was the right of every American to own a house."

Nope, I stand by that statement (and I'm a democrat). If not for the government believing it was every american's right to own a home and thereby lowering underwriting standards, we wouldnt have the problem we have today. That was the spark that ignited the fire and everything else just helped determine the size of the blaze. The liberal media and the democrat controlled government dont want to admit that it was a failed democrat agenda that created this and thus you don't hear about it. However, it was not the CDO, the CDS or the bankers that created them that made Johnny Bad Credit default on his home loan that was securitized in these structures.

xcrunner5 wrote:

The liberal media and the democrat controlled government dont want to admit that it was a failed democrat agenda that created this and thus you don't hear about it. However, it was not the CDO, the CDS or the bankers that created them that made Johnny Bad Credit default on his home loan that was securitized in these structures.

Again, you're seeing things in black and white. I agree with you about the flawed policy of homeownership for everyone, but it wasn't just the policy of the Democrats. The "ownership society" of George Bush played a supporting role. I also agree that the CDO and CDS did not make people default on their loans.

We seem to disagree about the role of CDS leverage by certain banks in bringing the world banking system to the brink of collapse. The loan defaults by themselves would have been sufficient to cause a recession (speaking from a layman's viewpoint), but the financial engineering is what led to TARP, the bailout of banks, and a step closer to socialism. Of course, the CDOs and CDSs were ultimately tied to the bad loans. When the loans went sour, so did the derviatives. So we're back to gray.

But again, I'm speaking only as a layman, not an academic.

But there wouldnt have been financial engineering if the govt wouldn't have lowered underwriting standards thereby creating more borrowers and loans that the banks didn't have the capacity to hold on balance sheet. This required the banks to create financial instruments to distribute the risk. Banks respond and revolve to market conditions, but it is the government that creates the conditions themselves.

ah TARP...the biggest CDO ever created and managed by the largest hedge fund in the world. Ultimately, it all starts and ends with the government comes back to the government right? They created the problem, didn't act quickly enough and are now trying to financially engineer there way out of it.

In a way you can blame it all on bad government because every one in business is just going to exploit whatever opportunity they can get away with and if the government turns a blind eye there is no scam they wont try. Certainly our government has proven to be too conflicted to be of any use in preventing such situations.

xcrunner5 wrote:

But there wouldnt have been financial engineering if the govt wouldn't have lowered underwriting standards thereby creating more borrowers and loans that the banks didn't have the capacity to hold on balance sheet. This required the banks to create financial instruments to distribute the risk. Banks respond and revolve to market conditions, but it is the government that creates the conditions themselves.

It seems that there are two sides to the coin here. The banks made "liar loans" not because the govternment forced them to do so but because they collected fees and didn't have to worry too much about borrower risk, since the underwriters were eager to package loans and market them to institutional investors and investment banks.

Similarly, the govternment did not force companies like AIG to get ridiculously overleveraged by assuming CDS counterparty obligations. You can blame the government for not doing more to stop it, but it was the financial engineers who put their companies and the world banking system at risk.

Should have written "government" but I forgot to strike the "t" after I decided to use the full word. Next time, I'll try to remember to preview before posting. Sorry.

I'm going to bed...have to go to work tomorrow and deal with the issues we are debating. Let me know what the business press reports in several months.

xcrunner5 wrote:

Second, it is NOT security and therefore can not be relegated as such. Would you regulate interest rate swaps, equity derivatives, commodity derivatives or weather derivatives - of course not..

Which equity and commodity derivative aren't regulated?

Love to see Harvard go down. My kid is 4.0, I.B., AP's and I'B's all 5. Him and 12 other kids. Harvard took a minority kid with basically b's and freakin c's! It is a total joke the whole school is laughing their butts off. So is the kid that got in. They even transported him out there free. What a joke. Hope Harvard burns to the ground.

So

Harvard takes your child - good place

Harvard doesn't take your kid - bad place that should go down in flames.

You REALLY worship the Harvard brand...you live for it...and you are communicating this to your child. Excellent parenting!

What do you think the these kids are morons! Why don't you tell that to the other 10 kids in his class. They know why they can't get in the big schools. Are you an idiot! These kids are way beyond any of your bullshit liberal parenting! They don't go for this minority crap. You liberals and your national teachers union better be careful. These kids don't give a crap about all the affirmative action. They worked their asses off and get crapped on. They don't care what happened 150 yrs ago. Or even in the 60's You tell these kids your bullshit and they will spit in your face. Like we all should be doing. Everyone of these kids scored over 2100 in the SAT. This kid that got in is laughing with his 1480.

Having taken the SATs on the old scale of 1600, I dont really know what this means.

Not getting into Harvard = getting crapped on. REALLY? Then the majority of applicants are getting crapped on.

It sounds like envy.

So they go to Yale or Princeton instead. Who cares? The end product is the same.

We had a (white) guy a year ahead of me in high school w/ very average grades, SATs of 980, and he applied to Brown. Everybody discouraged him from doing it, and he got in and did very very well there. So score one for Vartan Gregorian.

The point is to admit students who will do well in the environment. Its not some reward for hard work in high school.

I know plenty of parents like you. Crawl back into your gin bottle and keep thinking of ways to live out your failed dreams through your children.