Tuesday, March 13, 2012

Today's links

1--Another Plunge in 3-Month Rolling Average of Petroleum and Gasoline Usage, Mish

Excerpt: Note that petroleum usage is back to December 1995 thru February 1996 levels. Gasoline usage is back to December 2001 thru February 2002 levels....(see chart)

All data derived directly from the Data 10 section of the EIA download.

Contrary to popular belief, the decline in gasoline usage has little or nothing to do with cash-for clunkers or improved gas mileage in cars unless one fantasizes that gas mileage improvements started precisely in 2007.

Wallace comments "If this trend lasts for the rest of the year, Obama's stated goal of a 15% reduction in greenhouse gases based off 2005 numbers may be met this year instead of his 2015 goal

2--Dow Theory Signals Sluggish Economic Recovery, Bloomberg

Excerpt: Gross domestic product has expanded at an average annual rate of 2.5 percent since the recession ended in June 2009, making this the weakest recovery in at least six decades, according to data compiled by Bloomberg. Even though the U.S. has grown for 10 straight quarters, average hourly earnings rose 1.9 percent in February, near the smallest increase since April, and down from 3.7 percent in January 2009, Labor Department data show.

“The economy is going to strengthen, but it’s going to be a subpar recovery,” Jeffrey Saut, chief investment strategist at Raymond James & Associates in St. Petersburg, Florida, said in a phone interview on March 7. His firm oversees more than $300 billion. A level of “1,400 is doable this year on the S&P. Beyond that, we have to see how strong the recovery is,” he said. Should the S&P 500 end 2012 at 1,400, it would be an 11 percent gain for the year, or the third-biggest annual advance in six years.

Stocks of shipping companies peaked ahead of other equities in the two previous bull markets. While the technology bubble didn’t end until March 2000, the Dow transport average was already down 29 percent from its peak 10 months before.

Great Depression

The measure began its retreat three months before the S&P 500 hit an all-time high of 1,565.15 on Oct. 9, 2007 and gave way to the worst economic contraction since the Great Depression, which began after December 2007.

While S&P 500 companies exceeded analysts’ profit forecasts for a 12th straight quarter, earnings-per-share for the 472 companies that reported from Jan. 9 through March 9 rose 4.9 percent for the slowest rate since 2009, data compiled by Bloomberg show. Income will increase 13 percent this year, slowing from an average rate of 16 percent in the previous three years.

3--The US labour market is still a shambles, Joseph Stiglitz, Financial Times

Excerpt: It is understandable, given the number of times green shoots have been seen since the downturn began in December 2007, that there might be some skepticism about claims the recovery is finally under way. To me the question is what does it imply for policy? Does it mean we can be more relaxed about the demands for budget cuts emanating from fiscal conservatives? Or that the US Federal Reserve should start paying more attention to inflation, and begin contemplating raising interest rates? Even if this is not one of the many green shoots that soon turn brown, the economy will almost certainly need more stimulus if it is to return to full employment any time soon.

This is the inevitable conclusion from looking at the state of the labour market today. It is a shambles. ...

Today the American economy faces three big risks. First, a steeper European downturn, as a result of the excessive austerity and the euro crisis. Second, complacency that the economy will recover quickly without government support. Though every downturn comes to an end, that should not be of much comfort. Third, that we accept that an unemployment rate above 7 per cent is inevitable.

If my Cassandra forecast turns out to be wrong, stimulus can be cut. But if it turns out to be right, and we do too little, we will live to regret it.

4--Where Middle Class America Has Gone, modeled behavior

Excerpt: The long term trend in goods and government vs. everything else I think also shows part of what has happened to the American middle class.

Goods and Government are what we might have thought about as backbone jobs. These are police officers, fire fighters, school teachers, factory workers, construction workers. When you think of a stereotypical 1950s American, they are doing one of these jobs.

And, in the 1950s half of Americans were employed in these sectors. Yet, since then the labor market has radically shifted. (see chart)

5--Is the end near for 3-year-old bull market?, USA Today

Excerpt: The baby bull nobody believed in, the one that has earned little respect despite posting a 103% gain, the one that grew up in the shadow of the worst financial crisis since the Great Depression, turns 3 on Friday.

But despite a résumé that includes accomplishments such as being the first bull market to gain 100% in its first three years and the seventh-best percentage gainer of all time, this one enters its fourth year with still-skeptical investors asking the same question: Can it last?

"There are a lot of nervous investors who are still not buying into this rally," says Andrew Fitzpatrick, director of investments at Hinsdale Associates. A clear sign of the anxiety is reflected in the flow of funds into mutual funds and exchange traded funds. In this bull market as of January 2012, investors have stashed roughly $261 billion in stock funds and $708 billion in more-conservative bond funds, according to the Investment Company Institute, the mutual fund industry's trade group....

Standard & Poor's 500 index has doubled in value in the past three years, climbing as high as 1374 on March 1. The massive move erased all but 12% of the losses suffered in the last market downturn, the worst since the 1930s. In the same period, the Dow Jones industrial average fell from a peak of 14,164, to a low of 6547 before barreling back above 13,000 last week for the first time since May 2008....Wendy Hunt of Cincinnati couldn't agree more. The 39-year-old mother of two and her husband have been rewarded for sticking with stocks through the crisis and riding them back up.

"We're fully invested in stocks," she says. "We've stayed close to Apple and Berkshire Hathaway (billionaire Warren Buffett's conglomerate). We're super happy with how our consistent faithfulness to the market has paid off."

6--Market Shrinks First Time Since ‘09 on U.S. Buybacks, Offerings, Bloomberg

Excerpt: Stocks are getting scarcer in the U.S. for the first time since the bull market began as companies cut share sales to the lowest level since 2006 and buy back equity at the fastest pace in four years.

Amgen Inc., Hewlett-Packard Co. and 1,971 other U.S. companies repurchased $397 billion of stock last year, while they issued $169 billion of new equity, data compiled by Birinyi Associates Inc. and Bloomberg show. The combination reduced the Standard & Poor’s 500 Index divisor, a measure of outstanding shares, by 0.6 percent last quarter, the first drop since March 2009.

Shrinking supply supports prices and shows valuations are so low that executives would rather buy back shares than spend the cash to expand, according to Columbia Management Investment Advisers LLC and USAA Investment Management Co. Bears say dwindling growth prospects will limit gains and deter investors who pulled money from stock funds for eight straight months through December, the longest stretch in at least two decades.

“Having that equity base shrink and starting from a relatively pessimistic point usually sets up pretty well in the long term,” Laton Spahr, who helps oversee $325 billion as a money manager at Columbia Management, said in a Jan. 11 phone interview from Minneapolis. “It gives you some hope that valuations have perhaps bottome....

“Companies want to shrink the number of shares,” James Swanson, who helps oversee more than $200 billion as chief investment strategist at MFS Investment Management, said in a Jan. 11 interview in London. “It’s efficient balance-sheet management with bond yields where they are and share prices where they are.”...

The increase in buybacks last year suggests companies have fewer opportunities to invest in projects that will generate profit growth, said Russ Koesterich, the San Francisco-based global chief investment strategist at the iShares unit of BlackRock Inc., which manages about $3.3 trillion.

The International Monetary Fund will probably cut its forecast for global economic growth as Europe’s debt crisis persists, Christine Lagarde, the Washington-based fund’s managing director, said this month. S&P 500 companies relied on foreign sales for about 46 percent of total revenue in the past year, according to Howard Silverblatt, the senior index analyst at S&P in New York...

Profits Climb

S&P 500 earnings may increase about 9 percent this year to a record $105 a share, according to more than 9,000 analysts’ projections compiled by Bloomberg. At least 48 companies in the index are scheduled to report quarterly results this week. A majority have topped analysts’ profit estimates for two straight years, data compiled by Bloomberg show...

Eventually confidence will return as growth stabilizes,” Wasif Latif, vice president of equity investments at USAA Investment Management in San Antonio, which oversees about $50 billion, said in a Jan. 12 phone interview. “All of a sudden you’re going to notice that there won’t be enough shares around.”

7-- Mario Draghi's quiet revolution, IFR

Excerpt: At the same time, Draghi understands the diplomatic game. While pressing his candidacy for the ECB presidency last year, he was careful to cultivate an image in Germany as a steady central banker with a respected position in international economic and political circles. He got the job only after Germany’s man, Axel Weber, who opposed the ECB’s bond purchases and was unwilling to lead a Governing Council which backed such a policy, pulled out of the race.

That left Draghi as the favourite but also facing popular opposition in Germany, where the mass-selling tabloid Bild warned that the euro risked becoming a “spaghetti currency” if the Italian ran the ECB. The memory of hyper-inflation in the 1920s, when a wheelbarrow full of cash was needed to buy a loaf of bread, has left Germans with an almost visceral aversion to price rises. An Italian in charge was unimaginable to some.

Draghi worked with a German public relations consultant to help boost his cause, and has been careful to express admiration for Germany’s central bank, which Germans revere for protecting them against inflation in the post-war era.

“I have a great admiration for the tradition of the Bundesbank,” Draghi said at his debut news conference as ECB president on Nov. 3, just his third day in the job. But in the very next sentence he emphasised he will be his own man. “As for the future, let me do my work and we will have periodic checks whether I am in sync with that tradition or I deviate from that.”

“Go ahead and do what is right”

He already has. When he reshuffled the bank’s six-member Executive Board earlier this year he stripped Germany of its traditional hold on the bank’s powerful economics portfolio and appointed Belgian Peter Praet to the post. The move helped neutralise tension between Germany and France over whose candidate should replace the departing Stark, who like Weber, quit over the bond purchases.

8--Short-lived Reprieve, Athens News

Excerpt: The debt swap deal does not solve the problems of Greece at all," said Holger Schmieding, chief economist at Berenberg Bank. "Of course, without it, Greece would be in huge trouble. But Greece's problem is that it has to return to growth. Otherwise, no debt burden is sustainable."

The economy is estimated to have shrunk by about 15 percent since 2008, when it plunged into its deepest post-war recession, dragged down by tax hikes and wage and investment cuts meant to put public finances back on track. More than one in ten jobs have been destroyed, leaving over half of young people unemployed.

Self-defeating?

Further belt-tightening agreed in return for a new EU/IMF bailout, such as slashing the minimum wage by a fifth, might tip the country deeper into recession and hit state revenues, making it impossible to meet the debt and deficit targets set by the lenders as a condition for aid.

"There is a high risk that more austerity will be self-defeating," said Diego Iscaro, at IHS Global Insight, warning that the social situation could become "explosive" if unemployment kept rising in a country that has been rocked by almost daily anti-austerity protests.

Under the combined weight of austerity and delays in reforms needed to cut red tape and shrink the state, recession has been consistently worse than forecast by the EU and IMF since the first bailout was agreed in 2010.

In turn, the countryz has repeatedly missed its fiscal targets and fell further behind the rest of the eurozone to rank 90 out of 142 countries in the World Economic Forum's competitiveness index.

"The main reason that Greece is staying in the eurozone is because the alternative is really bad. But if you keep pressing and you don't give the economy some breathing space, sooner or later people may say that's enough," Iscaro said.

Opinion polls show Greeks still support euro membership but an increasing number are tempted to vote for parties that oppose the bailout reforms in snap elections which could take place as early as end April....

Even if the rescue plan does achieve its target to bring the debt down to 120 percent of GDP by 2020 from about 160 percent now, that is still much higher than is generally regarded as sustainable.

"We think there will have to be some form of more severe restructuring further down the line, that is likely to involve official creditors," said May at Capital Economics. "That would be the only way to get Greece's debt substantially lower."

The government's poor track record in implementing reforms required under the first bailout - including missing deficit and privatisation targets - means there will be very limited goodwill for any more slippages when EU and IMF inspectors arrive every three months to comb through the books.

9--Six in 10 Criticize War in Afghanistan; Most Favor Abandoning Training Mission, ABC News

Excerpt: Sixty percent of Americans say the war in Afghanistan has not been not worth fighting and just 30 percent believe the Afghan public supports the U.S. mission there — marking the sour state of attitudes on the war even before the shooting rampage allegedly by a U.S. soldier this weekend.

Indeed a majority in a new ABC News/Washington Post poll, 54 percent, say the United States should withdraw its forces from Afghanistan without completing its current effort to train Afghan forces to become self-sufficient

10--Easiest Credit Worldwide Shows No Signs of Abating as Fear Index Plummets, Bloomberg

Excerpt: Central bankers are taking a break rather than hitting the brake.

Even as they pause campaigns to spur economic growth, Federal Reserve Chairman Ben S. Bernanke, European Central Bank President Mario Draghi and counterparts at the Bank of England and Bank of Japan aren’t taking signs of recovery for granted. That’s a shift from 2011, when some greeted an improving outlook by considering or embracing tighter monetary policy, only to see expansion fade.

The bid to guarantee growth suggests officials at the four key central banks won’t hurry to pull down the $9 trillion wall of money on their combined balance sheets or boost interest rates stuck near record lows. They also stand ready to add more stimulus if the recent rebound proves another false dawn. ...

Having held its benchmark near zero since December 2008 and purchased $2.3 trillion in assets during its two quantitative- easing programs, the Fed said in September it will swap $400 billion of short-term debt with longer-term debt through June to further cut borrowing costs.

‘Juiced Up’

It “wants to keep things juiced up, even though things are looking a lot better now than they did,” said Eric Green, chief economist and head of rate strategy in New York at TD Securities Inc. and a former economist at the New York Fed. Unemployment has fallen from 9.1 percent in August, and companies created 734,000 jobs in the past three months, compared with 471,000 in September-November.

U.S. policy makers are signaling they may be open to more steps, such as a third round of bond purchases, or QE3. A “few” said economic conditions could warrant buying more “before long,” according to minutes of their January meeting....

Unable to cut much lower and forced into unconventional bank loans and asset purchases, U.S., Japan, euro-area and U.K. central banks have seen their combined balance sheet swell to about 25 percent of GDP from 10 percent in late 2008, according to Michala Marcussen, global chief economist at Societe Generale. She anticipates another 4 percentage point gain this year

11--Financial Repression Has Come Back to Stay: Carmen M. Reinhart, Bloomberg

Excerpt: Throughout history, debt-to-GDP ratios have been reduced in five ways: economic growth, substantive fiscal adjustment or austerity plans, explicit default or restructuring of private and/or public debt, a surprise burst in inflation, and a steady dose of financial repression that is accompanied by an equally steady dose of inflation. It is critical to note that the last two options -- inflation and financial repression -- are only viable for domestic-currency debts (the euro area is a special hybrid case).

Closed Channels

Some of these channels have been used in combination during historical episodes of debt reduction. Fiscal adjustment, however, is usually painful in the short run and politically difficult to deliver. Debt restructuring leaves a troublesome stigma and is also often associated with deep recessions. Pretending that no restructuring will be necessary doesn’t make the debt overhang disappear. For many, if not most, advanced countries, concerns about those debt burdens will shape policy choices for many years to come.

In this setting, monetary policy in the advanced economies is likely to remain “overburdened” for some time.

Complicating the situation is the fact that the debt overhang isn’t limited to the public sector, as it was immediately after World War II. There is now a high degree of leverage in the private sector, especially in the financial industry and households. In addition, the recent buildup in external leverage was greater than in past crises. This debt overhang and the financial fragility it creates are a common feature of most advanced economies, along with stubbornly high unemployment. Concerns that higher real interest rates and deflation will worsen an already precarious situation will probably impose added constraints on monetary policy.

-- Negative Real Interest Rates, 1945-1980 and Post-2008: One of the main goals of financial repression is to keep nominal interest rates lower than would otherwise prevail. This effect, other things being equal, reduces governments’ interest expenses for a given stock of debt and contributes to deficit reduction. However, when financial repression produces negative real interest rates and reduces or liquidates existing debts, it is a transfer from creditors (savers) to borrowers and, in some cases, governments.

This amounts to a tax that has interesting political- economy properties. Unlike income, consumption or sales taxes, the “repression” tax rate is determined by factors such as financial regulations and inflation performance, which are opaque -- if not invisible -- to the highly politicized realm of fiscal policy. Given that deficit reduction usually involves highly unpopular spending cuts and/or tax increases, the “stealthier” financial-repression tax may be a more politically palatable

12--Youth unemployment is Europe(shocking), zero hedge


13--- Beware of Housing Market Cheerleading, naked capitalism

Excerpt: ...housing inventory is completely divorced from market reality. .... the metrics surrounding housing market price discovery are temporarily suspended until the shadow inventory is accounted for and disappears....Every day in foreclosure court bank lawyers argue in favor of never-ending delays...

Countless homes here in FL are in REO status with no literally no sign of being for sale; no MLS listing, no sign on the front lawn .. nothing. Except for court records, and the lousy job property maintenance companies do maintaining the houses, you’d never know they’re waiting to be sold. Even the NY Times ran an article, “When Living In Limbo Avoids Living on the Street,” noting banks sometimes ask borrowers to stay put after a foreclosure, to live for free, in exchange for maintaining the property and paying the utility bills. Banks even pay the house insurance....

Sellers “waiting for a better market” remind me of my time in Silicon Valley during the dot-com days when people thought their already hyper-inflated stocks would go up higher, only to see their dot-com riches crash and burn. If you want to sell your house anytime soon then sell it now, while the price declines are being artificially dampened by inventory management.

Pump and dump promotion is an ancient problem; promoters pump up the value of an obscure inexpensive stock, sell at the peak, then leave those who received a “hot stock tip” holding the bag as the penny-stock craters. The only difference between traditional pump-and-dump promoters and current housing price cheerleaders are nicer offices, better clothing, and more zeros.

14---CAUSE, EFFECT & THE FALLACY OF A RETURN TO NORMALCY, The Burning Platform

Excerpt: The “fantastic” automaker recovery is being driven by 0% financing for seven years peddled to subprime (aka deadbeats) borrowers for mammoth SUVs and pickup trucks that get 15 mpg as gas prices surge past $4.00 a gallon. What could possibly go wrong in that scenario?...

The 135% increase in retail sales over two decades may have been slightly enhanced by the 213% increase in consumer credit outstanding. Consumer revolving credit rose from $800 billion to the current level of $2.5 trillion over the last two decades...

Total consumer credit outstanding peaked at $2.58 trillion in July 2008. Today it stands at $2.50 trillion. Revolving credit card debt peaked at $972 billion in September 2008 and subsequently declined to $790 billion by April 2011. It now stands at $801 billion, as living well beyond our means has resumed its appeal. Meanwhile, non-revolving credit for automobiles, boats, student loans, and mobile homes peaked at $1.61 trillion in July 2008 and “crashed” all the way down to $1.58 trillion in May 2010. Once Bennie fired up the printing presses, the government car companies decided to make subprime auto loans again and the Federal government started doling out student loans like a pez dispenser, all was well in the non-revolving consumer loan world. The debt outstanding has soared to $1.7 trillion, a full $90 billion above the pre-crash peak. So, after three and a half years of “austerity” and supposed deleveraging, consumer debt outstanding has fallen by 3%....

Real disposable personal income has fallen by 5% since the peak in 2008 as Bernanke’s Wall Street bailout zero interest rate policy has caused prices for everything except our houses to surge. The people carrying most of the credit card debt are the least able to pay it off. These are the same people who have swelled the food stamp rolls from 28 million in 2008 to 46.5 million today. ...

CNBC bubble headed arrogant bimbo might sarcastically ask, “If the American consumer isn’t deleveraging, than how did revolving credit card debt drop by $182 billion over three years?” Rather than do the minimal research needed to find the answer, they would rather parrot the company/government line. The chart below, compiled from Federal Reserve data, provides the answer. The Wall Street banks have written off $193.3 billion of bad debt since 2008. Now for some basic math, that will probably be over the head of most Wall Street analysts and CNBC parrots. If you start with $972 billion of credit card debt... If you start with $972 billion of credit card debt and you write-off $200 billion (assuming another $7 billion in the 4th Quarter of 2011) and your ending balance is $801 billion, how much debt did the American consumer pay down? It’s a trick question. The American consumer ADDED $29 billion of credit card debt since 2008 to go along with the $90 billion of auto and student loan debt ADDED onto their aching backs...

Can you think of a better business model than being a Wall Street bank? You hand out 500 million credit cards to 118 million households, even though 60 million of the households make less than $50,000. You then create derivatives where you package billions of subprime credit card debt and convince clueless dupes to buy this toxic debt as if it was AAA credit. When the entire Ponzi scheme implodes, you write-off $200 billion of bad debt and have the American taxpayer pick up the tab by having your Ben puppet at the Federal Reserve seize $450 billion of interest income from senior citizens and re-gift it to you through his zero interest rate policy. You then borrow from the Federal Reserve at 0% and charge an average interest rate of 15% on the $800 billion of credit card debt outstanding, generating $120 billion of interest and charging an additional $22 billion of late fees...

With 40% of all credit card users carrying a revolving balance averaging $16,000, they are incurring interest charges of $2,400 per year. Some of the best financial analysts in the blogosphere have been misled by the propaganda spewed by the Wall Street media shills at Bloomberg and CNBC. The following chart, which includes mortgage and home equity debt, gives the false impression households are sensibly deleveraging, as household debt as a percentage of disposable personal income has fallen from 115% in June 2009 to 101% today. As I’ve detailed ad nauseam, $200 billion of the $1.2 trillion of “household deleveraging” was credit card write-offs. The vast majority of the remaining $1 trillion of “deleveraging” could possibly be related to the 5 million completed foreclosures since 2009. Of course, this pales in comparison to the unbelievably foolhardy mortgage equity withdrawal of $3 trillion between 2003 and 2008 by the 1% wannabes. Bloomberg might be a tad disingenuous by excluding the $1 trillion of student loan from their little chart. If student loan debt is included, household debt outstanding surges to $11.5 trillion....

Disposable personal income in the 2nd quarter of 2008 reached $11.2 trillion. It has risen by $500 billion, to $11.7 trillion by the end of 2011. Coincidentally, government social transfers have risen by $400 billion over this same time frame, a 20% increase. Excluding government transfers, disposable personal income has risen by a dreadful 1.1%. For the benefit of the slow witted in the mainstream media, every penny of the social welfare transfers has been borrowed. Only a government bureaucrat could believe that borrowing money from the Chinese, handing it out to unemployed Americans and calling it personal income is proof of deleveraging and austerity...

Household debt as a percentage of wages in 2008 was 185%. Today, after the banks have written off $1.2 trillion of debt, this figure stands at 169%. Meanwhile, total credit market debt in our entire system now stands at an all-time high of $54 trillion, up $3 trillion from 2007. It stands at 360% of GDP. In 1992, total credit market debt of $15.2 trillion equaled 240% of GDP ($6.3 trillion). Was it a sign of a rational balanced economic system that total credit market debt grew by 355% in the last two decades while GDP grew by only 238%? I think it is pretty clear the last two decades have not been normal or built upon a sustainable foundation. In the three decades prior to 1990 household debt as a percentage of disposable personal income stayed in a steady range between 60% and 80%. The current level of 101% is abnormal. In order to achieve a sustainable normal level of 80% will require an additional $2 trillion of debt destruction. No one is prepared for this inevitable end result. The impact of this “real” deleveraging will devastate our consumer dependent society....

We’re Not in Kansas Anymore Toto

“We tell ourselves we’re in an economic recovery, meaning we expect to return to a prior economic state, namely, a turbo-charged “consumer” economy fueled by easy credit and cheap energy. Fuggeddabowdit. That part of our history is over. We’ve entered a contraction that will seem permanent until we reach an economic re-set point that comports with what the planet can actually provide for us. That re-set point is lower than we would like to imagine. Our reality-based assignment is the intelligent management of contraction. We don’t want this assignment. We’d prefer to think that things are still going in the other direction, the direction of more, more, more. But they’re not. Whether we like it or not, they’re going in the direction of less, less, less. Granted, this is not an easy thing to contend with, but it is the hand that circumstance has dealt us. Nobody else is to blame for it.” – Jim Kunstler

The historic spending spree of the last two decades was simply the result of easy to access debt peddled by Wall Street and propagated by the easy money policies of Alan Greenspan and Ben Bernanke. The chickens came home to roost in 2008, but the Wizard of Debt – Bernanke – has attempted to keep the flying monkeys at bay with his QE1, QE2, Operation Twist, and ZIRP. As the economy goes down for the count again in 2012, he will be revealed as a doddering old fool behind the curtain.

“If we understand the mechanism and motives of the group mind, it is now possible to control and regiment the masses according to our will without them knowing it.” – Edward Bernays

15--Credit default swaps are insurance products. It’s time we regulated them as such, Wa Post

Excerpt: The biggest underwriter of default swaps was AIG, the world’s largest insurer. Without that reserve-requirement limitation, it was free to underwrite as many swaps as it could print. And that was just what it did: AIG’s Financial Products unit underwrote more than $3 trillion worth of derivatives, with precisely zero dollars reserved for paying any potential claim.

Though this may sound utterly absurd today, circa 2005 it was considered brilliant financial engineering. Consider this quote from Tom Savage, the president of AIG FP: “The models suggested that the risk was so remote that the fees were almost free money. Just put it on your books and enjoy.”

Ahhh, free money — how could that dream ever go wrong?

As it turns out, quite easily. Underwriting swaps was enormously lucrative — so long as you don’t count that unpleasant crashing and burning into insolvency at the end.

Oh, and that massive $185 billion AIG government bailout. Aside from those tiny hiccups, there was some good money to be made.

It was more than just AIG. While the radical deregulation wrought by the CFMA led to AIG’s self-directed collapse, it also helped steer two of the largest securitizers of mortgages — Bear Stearns and Lehman Brothers — into insolvency. Perhaps they were lulled into complacency, believing (wrongly) that they were hedged against losses. The CFMA led to their demise, and it was indirectly responsible for the collapse of Citigroup, Bank of America and Fannie and Freddie. It also was a significant factor in the near-death experiences of Goldman Sachs, Morgan Stanley and quite a few others.

Despite the CFMA’s horrific fatality toll, it has never been overturned. Parts of it were modified by Dodd-Frank regulations, but not the insurance exemptions. Today, these swaps are cleared through exchanges or clearinghouses — but they are still exempt from all insurance regulatory oversight. Which is bizarre, because they are little more than thinly disguised insurance products, with the CFMA kicker that there is no reserve requirement....

Why does it matter if swaps are not insurance? In a word, reserves. That is the key difference between insurance and swaps. State insurance regulators actually require reserves from insurers — a lot of reserves — to ensure payments can be made in the event any payable event occurs. The swaps industry does not require reserves. Not even one penny against billions in potential losses.

I think you can see why this matters so much. Swaps are a lot less profitable as an insurance product than they are as a trading vehicle. That is the primary issue that we all should be concerned about. It is exactly how AIG blew itself up. There is nothing that prevents the marketplace from doing it again. We could very well see a repeat unless this gets resolved. Indeed, the odds heavily favor such an event occurring, unless we collectively do something to stop it.

Credit-default swaps are insurance products. It is well past time we regulated them as such.

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