Originally published 03/24/09 in the New York Observer
We frequently identify the shaping forces of human affairs as “isms”: communism, fascism, capitalism, mercantilism, socialism and so on. In looking over the wreckage-strewn landscape of global finance, however, it seems to me that words ending in “ity” should have their turn at bat. “Rapacity” and “duplicity” are too easy, too obvious. “Timidity” works, but my inner jury is still out on Geithner, so I’m going to let it pass. The three little “ity” words that spring foremost to mind are stupidity, obesity and nudity. Let’s look at these in no particular order.
Obesity occurs in financial institutions—look at Citigroup—as much as in teenagers, brought on by junk finance rather than junk food; there’s as much water-bloat on our balance sheets as in our waistlines. The artery-clogging qualities of junk finance can be as threatening to our overall health as a nation as those of junk food. Mayor Bloomberg should have required the securities firms he has courted so assiduously with stay-in-Manhattan subsidies to post trans-fat warnings on their deal documents.
Whether we’re speaking of Wall Street or Main Street, fast food is rapidly prepared and even more rapidly consumed. Gobble gobble, slurp, slurp—the way teenagers blow through Value Meals, but then, Wall Street has always displayed a penchant for adolescent behavior. For confirmation, you need only have visited any of Manhattan’s reigning steakhouses during the pre-bust boom; no place on earth is as vile at the height of a traders’ bull market than one of those places that dishes up 20-ounce porterhouses slathered in Black-Scholes testosterone, where the behavior of the crowd at the bar, the louts with street voices, big cigars and bumpers of $50 per glass Barolo, perfectly fits what John Dos Passos wrote about Veblen: “… the last grabbing urges of the profit system taking on, as he put it, the systematized delusions of dementia praecox.” (The Big Money, 1936)
Next: stupidity. Here we need only look at the uproar over the AIG bonuses. To be sure, this is an issue that’s a specific proxy for a widespread, generalized, confused anger, but in a situation like this, more than mere catharsis is called for. Emotional distractedness never solved anything. What you end up with is this idiotic movement toward one-size-fits-all compensation controls in a situation that calls for careful case-by-case analysis.
This is a situation that involves two enablers and one enablee: the press and the Congress being the parties of the first part, and the public/electorate the party of the second. Anyone who has ever observed the average citizen at a fast-food counter, a supermarket checkout point or boarding an airliner knows that, as a people, we don’t have an instinctive or intuitive grasp of process. We need instruction and protection: The former is the job of the press, the latter of the Congress. Both have failed miserably. The media suddenly rediscovered the bonus “scandal”—which was known about last fall, as Michael Kinsley has pointed out—and whipped up a froth that has drowned out the real horror show: the AIG “pass-through,” whereby billions of bailout money has ended up in the hands of Goldman, Sachs, foreign banks and assorted other derivatives counterparties. As for the Congress … well, five minutes of TV exposure to Nancy Pelosi tells all that need be said.
Of course, solutions confected under intense, emotional PSI seldom work, which brings me to “nudity,” as in “naked,” as in naked derivatives and naked short sales. Start with the latter. In the good old days, if you didn’t like a stock and wished to short it, you had to fulfill two requirements: Your short sale had to be made on an “uptick,” at a price higher than the last previous recorded sale, and you had to deliver the shares sold short, which could be borrowed for a small fee.
That ceased to be the case quite a while back. The “uptick” rule was revoked. The requirement to deliver just seems to have vanished. What this leads to, as a Bloomberg report puts it, are “… unlimited sell orders, overwhelming buyers and driving down prices.” There seems to be clear evidence, in the form of unsettled short sales where the seller failed to deliver the stock, that this is what happened to Bear Stearns and Lehman Brothers, even as those firms writhed in their death agonies, and it’s probably what herded Merrill Lynch into the embrace of Bank of America. What this also accentuates is the folly of the various Paulson working groups in trying to devise crisis solutions under the gun of a market in which they must have known this was taking place.
The way I work out the nudity in the derivatives market is this: The amount of debt notionally covered by credit default swaps (CDS) comes to three to four times the amount of debt actually ever issued. How can this be? Simple. The global CDS book breaks down into two categories: insurance, and bets.
Insurance is easy. I own $1 million of X’s debt. I want to sleep easy, so—for a modest monthly premium—AIG sells me insurance, promising to pay off any shortfall if X can’t come up with principal and interest when due. There’s the easy part. But then the ironclad precept that Wall Street steers by kicked in: As more people try to get in on the game, the game itself degenerates, the players start to reach. In this case, the players started to buy protection on debt they didn’t own; basically, all they were doing was betting that Bear or Lehman or whoever would fail, would default or be downgraded, whatever. AIG was happy to book these bets, so enticing was the vigorish. The result? A naked global CDS book that probably runs to $30 trillion.
Normally, when a bookie loses big, he skips town. He doesn’t go to City Hall pleading that the Steelers didn’t cover and he’s tap city and the municipal coffers need to be hit up to make him whole. Yet that’s what happened at AIG. And, by gum, City Hall seems ready to pay.
I don’t think that should happen. I think naked transactions—short or CDS—should be left out of any bailout. Legitimate bets, such as Buffett’s been making on future levels of stock prices and indices, can be left on the books. But for the most part, I don’t think We the Taxpayers should be obligated to strip down to cover someone else’s nudity. We’re up to our hocks in naked emperors as it is.