Wall Street’s gambling problem

Steve Titterud’s comment on my Roubini post yesterday gets at the aspect of the financial crisis that I’ve found most surprising–please pardon the naivete–as I’ve worked the economy beat since last fall: “We are financing the losses in a craps game!” He’s talking about AIG bailout money, but the murky world of derivatives is crammed to the gills with contracts that amount to no more or less than gambling on the performance of assets owned by others. Remember the phrase “casino capitalism,” which enjoyed a brief vogue a few years back? We didn’t know the half of it.

Pure speculators aren’t the only problem. For a lot of investors, credit default swap positions can mean you’re actually better off seeing your investment go belly up. As Bloomberg reported a few days ago:

Amusement-park operator Six Flags Inc. and automaker Ford Motor Co. may be pushed toward bankruptcy by bondholders trying to profit from credit-default swaps that protect against losses on their high-yield debt….

Investors who bet on the collapse of a company are pitting themselves against traditional debt holders at a time when Moody’s Investors Service projects defaults will more than triple this year to the worst level since the Great Depression. The clash may stall restructuring efforts to prevent bankruptcies, as basis traders may be less inclined to participate in distressed debt exchanges, said Matthew Eagan, an investment manager at Boston-based Loomis Sayles & Co., with $7 billion in high-yield assets.

“Before, you really had to worry mostly about where you were in the” company’s capital structure, he said. “Now, you have to consider the possibility that you might have this large holder of CDS incentivized to see it go into bankruptcy. It’s something that’s going to come up more and more.”

Casino capitalism indeed. Isn’t there supposed to be an underpriced buffet where the suckers who get fleeced can at least score a decent meal? Or is that what charity foodshelves are for?

Comments (1)

  1. Submitted by Glenn Mesaros on 03/11/2009 - 06:19 pm.

    The book, “Deception and Abuse at the Fed”, by Robert Auerbach, is an excellent primer for congressmen who want to start a new “Pecora Commission” this year to investigate the piracy and debauchery of Wall Street and the Federal Reserve System. While it chronicles Cong. Henry Gonzalez decades long struggle against the Federal Reserve, there are three key pages in the middle of the book about former NY Governor Eliot Spitzer.

    In 1998, Citibank formed Citigroup, which included investment and commercial banking operations. Since this was illegal, they drafted Clinton Treasury Secretary Robert Rubin to create the “Financial Services Moderization Act”, which passed with Clinton’s endorsement in December, 1999. This bill reversed the Glass Steagell Act of 1933, which had formed the bedrock of the post Depression financial system: it outlawed the linkage of commercial and investment banking.
    The bill sponsors were “Gramm-Leach-Bliley”, and their bill even specifically forbade states from regulating “bucket shops”, the common name for betting operations, i.e. Derivatives, which had been banned after the 1907 Panic. Fed Chairman Alan Greespan set up a special office nearby the Banking committee which created the new legislation to “be available” for consultation.

    Shortly after 2000, the refurbished gambling den now known as Citigroup hired Robert Rubin as a key Director. Meanwhile NY Attorney General Eliot Sptizer prosecuted various banks for the new swindles created under the auspices of the aforesaid legislation. He fined them a large amount of money in a late 2002 settlement.
    Spitzer ran on this record to become Governor of New York State. Recently, he was destroyed in a sex scandal. The book directly quotes his contention that repeal of Glass Steagell is the cause of the Wall Street financial speculation and piracy.

    The Larouche Homeowners and Bank Protection Act would outlaw derivatives, and reorganize the banking system without honoring “debts from crap games”.

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