If Banks MUST keep their CDSs here's a way to remove the risk of another housing bubble

[Bill USA]

31. the point is the large banks aren't interested in CDSs used properly as hedges of risk. What really

interests them is using CDSs improperly - to magnify profits by taking on more risk which CDSs magically make disappear (until AIG collapses).

This is precisely the thinking on the part of banks which created the Credit Catastrophe - 2008.

If we could count on bankers to use CDSs only as hedges of risk there would be nothing to worry about. But bankers are people. And it is a common weakness of humans to think they can 'pull off' what others before them always thought they could pull off - assume lots of risk - make your score - and then get out. But people never 'get out'. They want to hit the 'table' or the market for one more 'score'. Ergo, the Credit Catastrophe of 2008. I'm not saying bankers are different. I'm saying they are people, a portion of whom always think they can gamble - take on excessive risk - and win - time and time again. This is a human weakness and that's why we need regulations and close monitoring of what is going on.

Change the subject - what I want to do is make the possibility of using CDOs (of high risk - read: subprime - mortgages) untenable. If you remove the ability to 'play with' subprime, high risk mortgages by reckless securitizations of them (which using CDSs makes possible - "Not to worry, if the CDO tranche I'm selling you goes south - this CDS will save your ass. Ya see - more return without the risk! What a deal!"

[font size="3"]
How Wall Street Defanged Dodd-Frank[/font]
(emphases my own)
http://www.thenation.com/article/174113/how-wall-street-defanged-dodd-frank?page=full

Battalions of regulatory lawyers burrowed deep in the federal bureaucracy to foil reform.



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[font size="3"]Perhaps no part of Dodd-Frank matters more than the CFTC’s battle to implement derivatives reform. Certainly the big banks wouldn’t argue that point: no product peddled by Wall Street has proved as lucrative in recent years, especially for the country’s most elite firms. Just five banks—Goldman Sachs, JPMorgan Chase, Citigroup, Morgan Stanley and Bank of America—account for more than a 95 percent share of a derivatives market that has been generating an estimated $40 billion to $50 billion in annual revenues.[/font] Because derivatives have been traded on dark (i.e., unregulated) markets, this “oligarchy” of five, says Darrell Duffie, a finance professor at Stanford’s Graduate School of Business and the author of How Big Banks Fail and What to Do About It, has been able to charge exorbitant rates to the wide range of businesses and government entities that buy them—profit margins that are sure to plummet if Dodd-Frank is fully implemented, Duffie says. That alone would justify the huge sums spent on lobbying to gut Dodd-Frank, a reflection of the banks’ unflinching resolve to protect the billions of dollars in derivatives profits they book every year. “If you look at the energy and ferocity and the dollars the financial sector put on the table, it was overwhelmingly directed at derivatives,” says Michael Barr, the former Treasury official.

This is why derivatives—and by extension, the CFTC—should matter to the rest of us as well, at least if we want to reduce the odds that the banks will again blow up the global economy anytime soon. It was derivatives, after all—all those credit default swaps, collateralized debt obligations and other exotic financial instruments that most of us would learn about in newspaper infographics offered only after the fact—that were the main culprit in the collapse of insurance giant AIG. They were also the main problem in the failures of Lehman Brothers and Bear Stearns, and nearly took down the other big banks as well.

Price manipulations of basic commodities such as oil and grains through derivatives are another target of Dodd-Frank, which instructs the CTFC to create “position limits”—caps on the portion of a market that financial speculators can own. The need for this check on financial speculators has never been clearer than in recent years, given the wild fluctuations in the price of oil in 2008, when a barrel of crude rose to $145 before whipsawing back to $37 in early 2009, and a spike in the price of wheat and other basic grains that caused rioting around the world.

The push to regulate a new breed of ever more complex derivatives goes back to the 1990s. The catalyst was the central role these instruments played in the financial collapse of Orange County, California, which in 1994 became the largest municipal entity ever to declare bankruptcy. Those in favor of derivatives reform would find their champion in Brooksley Born, who headed the CFTC under Bill Clinton. Think of most derivatives as a bet on the price of something going up or down—an interest rate, say, or mortgage defaults. Her agency was already in the business of regulating the futures markets for commodities such as corn and soybeans, Born argued, so why not add this new breed of financial derivatives to the CFTC’s portfolio? But this was in the Clinton era, when Democrats worked overtime to win the affections of Wall Street, and Wall Street knew that transparency would only spoil a good thing. Clinton’s top economic advisers, including Treasury Secretary Robert Rubin and Lawrence Summers, the deputy who would take his place in 1999, overruled Born and worked with Congress to pass what became the Commodity Futures Modernization Act of 2000, which had the effect of deregulating much of the derivatives market along with basic commodities like oil. Just eight years lat
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