Saturday, June 2, 2018

"Pope says credit default swaps are unethical"

Following up on the disturbing post immediately below.
Over the years we've had some thoughts on CDS's and the regulation thereof, links after the jump.

From the Financial Times, May 17
‘Gambling on the failure of others . . . is unacceptable from the ethical point of view’

The Vatican singled out credit default swaps for criticism in a sweeping commentary on the financial system, comparing the derivatives to “a ticking time bomb” and saying they encourage betting on the “ruin” of others.

 In a position paper published on Thursday, the Vatican castigated the CDS market for its role in the 2008 financial crisis, and in particular for the bundling and re-bundling of CDS into bonds.

 “It is obvious that the uncertainty surrounding these products . . . makes them continuously less acceptable from the perspective of ethics respectful of the truth and the common good, because it transforms them into a ticking time bomb ready sooner or later to explode, poisoning the health of the markets,” said the statement....MORE
If interested here's the Vatican press office with:
“‘Oeconomicae et pecuniariae quaestiones’. Considerations for an ethical discernment regarding some aspects of the present economic-financial system” of the Congregation for the Doctrine of the Faith and the Dicastery for Promoting Integral Human Development, 17.05.2018
Regarding default swaps, if the purchaser doesn't own the underlying instrument they are, straight up, gambling.
And the problem Wall Street has is that gambling is usually regulated at the state level and state's usually say that unless they can get a cut of the action gambling is illegal.
What's a poor financier to do?

Supremacy Clause! 

If Wall Street can convince Federal legislators to pass laws saying certain types of gambling (those favored by Wall Street) are actually legal, then the doctrine of preemption which derives from Article VI of the Constitution ("supreme law of the land") kicks in and all those pesky state laws against gambling and bucket shops are just the wheezings of the unenlightened mob.

And thus AIG became Goldman's favorite counterparty. And underlying. And chump.

Financial Reform: Enforce New York's 1908 Bucket Shop Law and trash the 2,319 Page Dodd-Frank Bill
It's Time to Regulate Credit Default Swaps Using State Gambling Laws
Are Derivatives Contracts Nothing More than Unenforceable Gambling Debts?
...Here's the U.S, Senate testimony of Eric Dinallo, then-Superintendent of the New York State Insurance Department on October 14, 2008 (8 page PDF).
...I have argued that these naked credit default swaps should not be called swaps because
there is no transfer or swap of risk. Instead, risk is created by the transaction. Indeed, you
have no risk on the outcome of the day’s third race at Belmont until you place a bet on
horse number five to win....

...“Bucket shops” arose in the late nineteenth century. Customers “bought” securities or
commodities on these unauthorized exchanges, but in reality the bucket shop was simply
booking the customer’s order without executing on an exchange. In fact, they were
simply throwing the trade ticket in the bucket, which is where the name comes from, and
tearing it up when an opposite trade came in. The bucket shop would agree to take the
other side of the customer’s “bet” on the performance of the security or commodity.
Bucket shops sometimes survived for a time by balancing their books, but were wiped
out by extreme bull or bear markets. When their books failed, the bucketeers simply
closed up shop and left town, leaving the “investors” holding worthless tickets....
Finally, the very readable "Partners in Crime: The Telegraph Industry, Finance Capitalism, and Organized Gambling, 1870-1920".