Weekend Economists Boldly Go...Again! September 12-14, 2014

[Demeter]

3. Nomi Prins on the Credit Derivatives Systemic Risk Bomb

http://www.nakedcapitalism.com/2014/09/nomi-prins-credit-derivatives-systemic-risk-bomb.html

Yves here. Former Goldman managing director turned journalist Nomi Prins spoke on RT about unresolved systemic risk issues, most importantly, credit derivatives, which for the most part means credit default swaps. Prins stresses the interconnectedness problem, which was earlier identified by Richard Bookstaber in his book A Demon of Our Own Design as “tight coupling.” Processes can spiral out of control when they are so tightly connected that they move through a series of steps so rapidly that they cannot be interrupted. The systemic risk version of that problem is when a failure to perform on certain contracts leads to cascading defaults at other counterparties, quickly turning into an avalanche of failures.

It’s also worth noting that the CDS market is already under scrutiny for alleged price fixing. If these charges hold up, it could be another Libor-level scandal. From Reuters (hat tip Michael Crimmins):

A Manhattan federal judge said on Thursday that investors may pursue a lawsuit accusing 12 major banks of violating antitrust law by fixing prices and restraining competition in the roughly $21 trillion market for credit default swaps.

While dismissing part of the case, U.S. District Judge Denise Cote said investors may press claims that the defendants’ Sherman Act violations caused them to pay unfair prices on CDS trades from the autumn of 2008 through the end of 2013, even as improved liquidity should have driven costs down.

This RT segment starts with a short update on Scottish secession, focusing on the issue of whether Scotland creates its own currency. England says it can’t continue to use the pound. The discussion of systemic risk and credit derivatives starts at 3:20.