Inventor of Credit Default Swaps is a Key Architect of Carbon Derivatives

[6.8SPC_DUMP]

Woman Who Invented Credit Default Swaps is One of the Key Architects of Carbon Derivatives, Which Would Be at the Very CENTER of Cap and Trade

I have written hundreds of articles documenting that unregulated, speculative derivatives (especially credit default swaps) are a primary cause of the economic crisis.

And I have pointed out that (1) the giant banks will make a killing on carbon trading, (2) while the leading scientist crusading against global warming says it won't work, and (3) there is a very high probability of massive fraud and insider trading in the carbon trading markets.

Now, Bloomberg notes that the carbon trading scheme will be centered around derivatives:

The banks are preparing to do with carbon what they’ve done before: design and market derivatives contracts that will help client companies hedge their price risk over the long term. They’re also ready to sell carbon-related financial products to outside investors.

[Blythe] Masters says banks must be allowed to lead the way if a mandatory carbon-trading system is going to help save the planet at the lowest possible cost. And derivatives related to carbon must be part of the mix, she says. Derivatives are securities whose value is derived from the value of an underlying commodity -- in this case, CO2 and other greenhouse gases...

Who is Blythe Masters?

She is the JP Morgan employee who invented credit default swaps, and is now heading JPM's carbon trading efforts. As Bloomberg notes (this and all remaining quotes are from the above-linked Bloomberg article):

Masters, 40, oversees the New York bank’s environmental businesses as the firm’s global head of commodities...

As a young London banker in the early 1990s, Masters was part of JPMorgan’s team developing ideas for transferring risk to third parties. She went on to manage credit risk for JPMorgan’s investment bank.

Among the credit derivatives that grew from the bank’s early efforts was the credit-default swap.

Some in congress are fighting against carbon derivatives:

“People are going to be cutting up carbon futures, and we’ll be in trouble,” says Maria Cantwell, a Democratic senator from Washington state. “You can’t stay ahead of the next tool they’re going to create.”

Cantwell, 51, proposed in November that U.S. state governments be given the right to ban unregulated financial products. “The derivatives market has done so much damage to our economy and is nothing more than a very-high-stakes casino -- except that casinos have to abide by regulations,” she wrote in a press release...

However, Congress may cave in to industry pressure to let carbon derivatives trade over-the-counter:

The House cap-and-trade bill bans OTC derivatives, requiring that all carbon trading be done on exchanges...The bankers say such a ban would be a mistake...The banks and companies may get their way on carbon derivatives in separate legislation now being worked out in Congress...

Financial experts are also opposed to cap and trade:

Even George Soros, the billionaire hedge fund operator, says money managers would find ways to manipulate cap-and-trade markets. “The system can be gamed,” Soros, 79, remarked at a London School of Economics seminar in July. “That’s why financial types like me like it -- because there are financial opportunities”...

Hedge fund manager Michael Masters, founder of Masters Capital Management LLC, based in St. Croix, U.S. Virgin Islands [and unrelated to Blythe Masters] says speculators will end up controlling U.S. carbon prices, and their participation could trigger the same type of boom-and-bust cycles that have buffeted other commodities...

The hedge fund manager says that banks will attempt to inflate the carbon market by recruiting investors from hedge funds and pension funds.

“Wall Street is going to sell it as an investment product to people that have nothing to do with carbon,” he says. “Then suddenly investment managers are dominating the asset class, and nothing is related to actual supply and demand. We have seen this movie before.”

Indeed, as I have previously pointed out, many environmentalists are opposed to cap and trade as well. For example:

Michelle Chan, a senior policy analyst in San Francisco for Friends of the Earth, isn’t convinced.

“Should we really create a new $2 trillion market when we haven’t yet finished the job of revamping and testing new financial regulation?” she asks. Chan says that, given their recent history, the banks’ ability to turn climate change into a new commodities market should be curbed...

“What we have just been woken up to in the credit crisis -- to a jarring and shocking degree -- is what happens in the real world,” she says...

Friends of the Earth’s Chan is working hard to prevent the banks from adding carbon to their repertoire. She titled a March FOE report “Subprime Carbon?” In testimony on Capitol Hill, she warned, “Wall Street won’t just be brokering in plain carbon derivatives -- they’ll get creative.”

Yes, they'll get creative, and we have seen this movie before ...an inadequately-regulated carbon derivatives boom will destabilize the economy and lead to another crash.

[Roguish Lawyer]

What a bunch of ignorant crap.

[6.8SPC_DUMP]

Originally Posted by Roguish Lawyer

What a bunch of ignorant crap.

Want to elaborate?

[Pete]

I'm amazed that this information is out there and the MSM does not beat their drums.

Like Algore racking up millions in a business that makes money off trading carbon credits.

[Dad]

6.8--I think you are absolutely right that Wall St will find some way to profit from this and invent another way to suck money out of productive uses. It is in their soul and there is no moral hazard or political will to rein in their excesses.

[SkiBumCFO]

"6.8--I think you are absolutely right that Wall St will find some way to profit from this and invent another way to suck money out of productive uses. It is in their soul and there is no moral hazard or political will to rein in their excesses. "

Hey Dad - i know it may sound strange but there are a few of us QPs that spent a lot of time on Wall Street (or the London equivalent) and I think our souls are pretty intact. I would also argue that in a capitilist society Investment Bankers are critical - not really non productive (though my wife might disagree). A problem we will never be able to overcome is that it is impossible for a govt regulatory authority to completely understand and monitor Financial Derivatives. Congress didn't even bother to try but that's another matter. They are way too complex and you cant take a moderately paid govt regulator and ask him to figure out what a highly compensated MIT phd has designed. This stuff will happen as long as we live in a capitalist democracy and i gotta tell you there aint no better way to live even if we do have a little bit of volatility in our lives.

Best regards

[Dad]

9

[steel71]

Al Gore won't make millions because he's gonna make billions off his global warming fear mongering act. Instead of being a prostitute for the elite, finally he'll join their ranks..

Al Gore: world's first carbon billionaire?
http://latimesblogs.latimes.com/wash...llionaire.html

http://www.nytimes.com/2009/11/03/bu...nt/03gore.html


Al Gore invests millions to make billions in cap-and-trade software

http://www.canadafreepress.com/index.php/article/11607

[nmap]

So...can we get put options...sold short on margin...on ETNs....based on futures...which are connected with carbon derivatives...

Seriously, I would think it would be a fairly good way to speculate on whether the overall global economy was expanding (more carbon, hence more expensive derivatives) or contracting (less carbon, hence cheaper derivatives).

[Roguish Lawyer]

Originally Posted by 6.8SPC_DUMP

Want to elaborate?

Not at great length, but people who blame derivatives, swaps and other financial instruments for the collapse of the economy typically don't even know what these things are. Generally speaking, people should be free to enter into whatever transactions they want to, subject to traditional common law restrictions like prohibitions on fraud.

Complex financial instruments are not boogeymen. They are just contracts entered into by big boys and girls. Discussions like the one you posted are irrational and a danger to our liberty IMO.

[Roguish Lawyer]

I should add that making money is as American as apple pie, and anyone who has a problem with that should move to Cuba.

[PedOncoDoc]

Originally Posted by Roguish Lawyer

I should add that making money is as American as apple pie, and anyone who has a problem with that should move to Cuba.

They may not have to if the current administration keeps at it...

[CSB]

OK, here it is in nutshell.

Suppose I run a taxicab company. I know I need 20,000 gallons of 87 octane gasoline throughout the next year. I am damned uncertain what the price will be. I've got to set the meters on my cabs (and get approval from the city cab commission) for a fixed rate structure that I can't quickly change. The price might stay at $2.50 a gallon (where it is now), or it might drop to $2.25 (happy days for me), or it might climb to $3.95 a gallon (a sure road to bankruptcy). So what do I do to "hedge" or minimize my risk?

I can buy a "derivative" contract from an investment bank. I pay perhaps $2,000 up front, and receive from them this promise: "If the price of gasoline drops, we pay you nothing. If the price of gasoline stays the same, or climbs to $3.50 a gallon, we pay you nothing. But if the price of gasoline climbs to $3.51 or above, we will pay you $10,000 to help you cover the extra cost of the more expensive gasoline." My $2,000 fee to the bank is a known cost that I can budget, and incorporate into the rates I set on my cab meters and get approved by the city cab commission.

Assuming the bank is legitimate, and has the assets to pay the $10,000 when needed, no worries.

Here's the problem: THERE IS NO REQUIREMENT IN THE LAW THAT THE PURCHASER OF A DERIVATIVE CONTRACT HAVE A STAKE IN THE OUTCOME. AND THERE IS NO REQUIREMENT IN THE LAW THAT THE BANK SET ASIDE ANY RESERVE (LIKE AN INSURANCE COMPANY WOULD) TO PAY OFF THE DERIVATIVE CONTRACTS THEY WRITE.

In other words, a derivative contract is just like a Las Vegas bet. Actually, it's worse than a Vegas bet, since in Vegas the gaming commission requires the casinos to keep a sufficient reserve to pay off losing bets. Wall Street imposes no such obligation.

I don't actually have to have a taxi cab company to buy a derivative contract, I can be the owner of a brick factory, or even an unemployed drifter who got tired of betting on the ponies and decided for something a little different.

It is gambling, pure and simple. And the contracts can be bought and sold without regard to whether or not the purchaser has taxi cabs, or a fleet of lawn mowers, or any other real need to hedge against the rise in price of gasoline. It's just a bet, that may pay off if the price goes up.

And "carbon offsets" are going to be the same paper scam in which someone who owns a tree farm will be allowed to sell promises not to harvest a certain acerage of trees. Those trees -- which may or may not have ever been cut down -- would then "offset" someone elses coal fired power plant. Watch as the "offsets" get further and further from reality, just like the derivatives have become totally disconnected from the actual "insurable interest" that they are supposed to be protecting.

[nmap]

Originally Posted by CSB

Here's the problem: THERE IS NO REQUIREMENT IN THE LAW THAT THE PURCHASER OF A DERIVATIVE CONTRACT HAVE A STAKE IN THE OUTCOME. AND THERE IS NO REQUIREMENT IN THE LAW THAT THE BANK SET ASIDE ANY RESERVE (LIKE AN INSURANCE COMPANY WOULD) TO PAY OFF THE DERIVATIVE CONTRACTS THEY WRITE.

I'm not sure that speculation - gambling, if you prefer - is such a bad thing. If I wish to speculate on gasoline, then I match my wits against whoever is on the other side of the trade. It is a classic case of the luckiest (or best) player winning.

However - the lack of reserves to perform under the contract is a problem. In stock or commodity speculation, the parties have to put up adequate money to cover the trade. Should prices move against them, more margin is required. So long as those involved are responsible for losses, all is well. But when the taxpayers or other innocent parties share in the losses (but not the profits), there is a problem.

I have another issue...or perhaps, just a concern...about derivatives. I am not at all sure these represent contracts between fully informed participants. The prospectus for a CDO is, as I understand it, on the order of 200 pages. In addition, there is the issue of ratings.

Credit rating agencies did not properly manage their conflicts of interests when assigning ratings to structured products such as mortgage-backed securities, a report by the Securities and Exchange Commission said on Tuesday. LINK

This troubles me. If a large pension fund is told that Moody's and S&P have rated a security as AAA, they might not question the implicit assumptions within 200 pages of text. Let us consider the table at the top of page 5 of the linked discussion of CDO^2. LINK It shows a default probability of 1%, referencing the underlying CDOs. I am not at all sure that the average (or even above average) pension fund manager fully understands the implications - nor would he (she) understand what might happen if the probability was a bit higher. (By the way - I don't understand those implications either. I suspect quite a lot of study would be necessary.)

There is another problem with carbon derivatives as a specific issue. I have to wonder just how vulnerable they are to governments world-wide concealing truth, falsifying facts, or making sudden, unexpected changes. If the market has lots of players with inadequate reserves, a sudden dislocation could trigger a new financial crisis.

I would like to see some assurance of adequate reserves, transparency, a regulated exchange with publicly reported pricing, and contract standardization. While such speculators may be big boys and girls, the present bailout environment seems to present us with the risk of sharing their pain - or, perhaps, even accepting all of their losses.

[Roguish Lawyer]

Counterparty credit risk is an ordinary consideration for parties entering into these transactions. It can be and typically is hedged. Pension money is subject to ERISA and, to my knowledge, can't be invested in these instruments. The government should mind its own business.