How Should Economic Policies Address Conflicts of Interest?

[rcgldr]

There are two main issues I'm interested in for this thread, and how far should regulations have to go to control these issues?

1. The conflict where an individual is in a position to make decisions that benefit the individual at the risk or detriment of the company or other employees. Examples would be the individuals involved in the sub-prime crisis. An extreme example would be Film Recovery Systems http://americanfraud.com/filmrecoverysystems.aspx , although that case eventually ended in prosecutions of those in charge. A more common example would be a manager of a group deliberately understating the true cost of a program that manager is in charge of in order to convince a company to start up or continue with that program.

2. The conflict where a coporation makes decisions that benefit the corporation at the risk or detriment to the country, society in general, or a local population. An example would be Enron's actions with California's electricity generating plants (deliberately shutting them down to increase prices). Pollution would be another example. More common examples would be campaign donations and lobbyist to get policies in place that benefit the donors to the detriment of society in general. Another example would be outsourcing jobs or manufacturing where quality standards are lower and/or reduced or non-existant regulations, then importing lower quality products back into the USA (for example GlaxoSmithKline's Cidra plant, which was eventually shut down).

 

[WhoWee]

I'm not certain of the focus of this thread? However, in the US, the tail often wags the dog. The ruling of a single isolated court case - can ultimately restrict the rights of 300,000,000 people.

 

[cobalt124]

On point two, regulation should aim to stop them when it directly affects people, although I'm not too sure about the campaign/lobbying example, that seems woolly. The first one I'm not too sure about, it would probably be case by case and depend on whether it's "because the needs of the many outweigh the needs of the one" or "because the needs of the one outweigh the needs of the many". Live long and prosper \\ //.

 

[rcgldr]

I was a bit tired when I posted this, and some of my examples are poor ones in terms of being regulated, but the basic idea is the trade off between attempting to protect society from harm and over regulation.

 

[Proton Soup]

well, i think deregulation has been the bigger tragedy lately. especially with cases like Enron and the housing bubble.

i feel like a good bit of the problem is this artificial idea of the non-violent nature of white collar crime. sure, white collar criminals don't mug you on the street while you're going out to dinner. but they rob food, shelter, education, and medical care from you and your children. their actions rob you of your future to the betterment of their own, stealing years off your lives to extend their and theirs. what isn't violent about that?

 

[mheslep]

well, i think deregulation has been the bigger tragedy lately. especially with cases like Enron and the housing bubble.

With respect to the housing bubble and subprime crisis, what leads you to cite deregulation?

 

[WhoWee]

well, i think deregulation has been the bigger tragedy lately. especially with cases like Enron and the housing bubble.

I'm not sure I'm convinced that deregulation caused the housing bubble - weren't mandates part of the problem?

Without going too far with that discussion, I think it's important to measure the response to each crisis we face - and the unintended consequences. After Enron - we got the Sarbanes-Oxley Act 2002.
http://fl1.findlaw.com/news.findlaw.com/cnn/docs/gwbush/sarbanesoxley072302.pdf

This legislation was written with the best of intentions, but it has placed a significant (and disproportionate) burden on small to mid-sized companies.

Now, the legislation being discussed regarding a housing fix includes a proposed requirement for "safe mortgages" of 30% downpayment - what will this do to housing starts and re-sale values?
http://video.foxbusiness.com/v/4484183/30-mortgage-downpayment/

 

[mheslep]

There are two main issues I'm interested in for this thread, and how far should regulations have to go to control these issues?

1. The conflict where an individual is in a position to make decisions that benefit the individual at the risk or detriment of the company or other employees. Examples would be the individuals involved in the sub-prime crisis. An extreme example would be Film Recovery Systems http://americanfraud.com/filmrecoverysystems.aspx , although that case eventually ended in prosecutions of those in charge. A more common example would be a manager of a group deliberately understating the true cost of a program that manager is in charge of in order to convince a company to start up or continue with that program.

That's a large question. These might help:
http://ocw.mit.edu/courses/economic...lation-of-industry-spring-2003/lecture-notes/
http://ocw.mit.edu/courses/economics/14-41-public-economics-fall-2004/study-materials/

2. The conflict where a coporation makes decisions that benefit the corporation at the risk or detriment to the country, society in general, or a local population. An example would be Enron's actions with California's electricity generating plants (deliberately shutting them down to increase prices). Pollution would be another example. More common examples would be campaign donations and lobbyist to get policies in place that benefit the donors to the detriment of society in general. Another example would be outsourcing jobs or manufacturing where quality standards are lower and/or reduced or non-existant regulations, then importing lower quality products back into the USA (for example GlaxoSmithKline's Cidra plant, which was eventually shut down).

In particular:
http://ocw.mit.edu/courses/economics/14-23-government-regulation-of-industry-spring-2003/lecture-notes/1423class16.pdf"

 

[Proton Soup]

With respect to the housing bubble and subprime crisis, what leads you to cite deregulation?

http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#Credit_default_swaps
http://en.wikipedia.org/wiki/Credit_default_swap

maybe unregulated is more correct?

 

[Proton Soup]

I'm not sure I'm convinced that deregulation caused the housing bubble - weren't mandates part of the problem?

Without going too far with that discussion, I think it's important to measure the response to each crisis we face - and the unintended consequences. After Enron - we got the Sarbanes-Oxley Act 2002.
http://fl1.findlaw.com/news.findlaw.com/cnn/docs/gwbush/sarbanesoxley072302.pdf

This legislation was written with the best of intentions, but it has placed a significant (and disproportionate) burden on small to mid-sized companies.

Now, the legislation being discussed regarding a housing fix includes a proposed requirement for "safe mortgages" of 30% downpayment - what will this do to housing starts and re-sale values?
http://video.foxbusiness.com/v/4484183/30-mortgage-downpayment/

i think the real problem was lack of accountability in the lending system. items like unregulated credit default swaps remove accountability. with accountability removed in the form of an insurance policy (way underpriced apparently), you don't care how close to the edge a borrower is. if he defaults, it's not your problem. so you do everything you can to get him into a house. more house than he can afford. and with so much money available to buy houses, sellers hold out for more, driving the prices up.

mandates may have contributed, but if there had been more accountability in the lending process, then you would have also seen a different kind of construction boom, with smaller, more affordable houses being built, and lower prices on homes in general.s

 

[mheslep]

http://en.wikipedia.org/wiki/Subprime_mortgage_crisis#Credit_default_swaps
http://en.wikipedia.org/wiki/Credit_default_swap

maybe unregulated is more correct?

CDS's were certainly in the mix. The question is were they the cause? That is, if you saw your small children Fannie and Freddie running wildly about with scissors, tripping on the inevitable toy and thus poking out an eye, would the wise move be to blame and ban the toy?

Historically, the US has existed some 200 years with no CDS regulation, yet until now managed to escape any nationwide housing finance collapses. Why now? I see the difference between then and now mainly as large government involvement in the housing and financial markets, both through manipulative lend-to-who-we-tell-you-to regulation, by the government essentially taking over $trillions of the US market financing via Fannie Mae and Freddie Mac, and setting bad precedents for too big to fail by bailing out hedge funds like the http://en.wikipedia.org/wiki/Long-Term_Capital_Management"

 

[Proton Soup]

CDS's were certainly in the mix. The question is were they the cause? That is, if you saw your small children Fannie and Freddie running wildly about with scissors, tripping on the inevitable toy and thus poking out an eye, would the wise move be to blame and ban the toy?

Historically, the US has existed some 200 years with no CDS regulation, yet until now managed to escape any nationwide housing finance collapses. Why now? I see the difference between then and now mainly as large government involvement in the housing and financial markets, both through manipulative lend-to-who-we-tell-you-to regulation, by the government essentially taking over $trillions of the US market financing via Fannie Mae and Freddie Mac, and setting bad precedents for too big to fail by bailing out hedge funds like the http://en.wikipedia.org/wiki/Long-Term_Capital_Management"

are you sure about that?
http://money.usnews.com/money/perso...ing-todays-housing-crisis-with-the-1930s.html

considering the argument against a single cause, and working towards a more multifactorial explanation, i would also suggest to you that there was racist, predatory behavior going on towards these naive first-time home buyers.

 

[WhoWee]

i would also suggest to you that there was racist, predatory behavior going on towards these naive first-time home buyers.

Care to elaborate - about the "racist, predatory behavior"?

 

[rcgldr]

Historically, the US has existed some 200 years with no CDS regulation.

States could have outlawed derivatives as a form of illegal gambling, but congress passed laws in 1992 and 2000 to preempt any state gambling laws from banning them.

http://en.wikipedia.org/wiki/Commodity_Futures_Modernization_Act_of_2000

In the case of AIG, this is probably an example of the individuals making money by selling CDS, to the detriment of AIG, which unlike a common bookie, wasn't balancing it's bets. The individuals involved didn't care, because they wouldn't be the ones having to pay out any money when defaults occurred, and many ended up getting bonuses with federal bailout money.

 

[Proton Soup]

Care to elaborate - about the "racist, predatory behavior"?

no, i don't

 

[chiro]

There are two main issues I'm interested in for this thread, and how far should regulations have to go to control these issues?

There is always talk about the need for government intervention into all forms of economic and business activity, and personally I think there will always be a need for this.

The so called free market system looks good in theory but it has problems. In a nutshell human beings are far from optimal in creating enterprises that put societies needs over those of shareholders. Because of this, in the interest of societies needs, it is important to stop potential catastrophes from forming. Let's look at some examples:

1) Antitrust

I think its pretty clear to most people that giant monolith corporations have huge potential to do damage. One way is anti-competitive conduct where lowered prices force competition out of the market leaving the option of raising prices when there is no competition.

This kind of activity does in no way benefit society in the long term: businesses collapse, people get fired, people lose money and stop spending money and things get bad. Some theorists may disagree, but there are many examples, especially in america where this has and is happening.

2) Shareholder Interest

The idea of a corporation being classified as a type of "person" to me is absolutely ridiculous, but the idea that corporations place the highest priority on serving its shareholders is again not a wise choice.

Its not so much that the shareholders be a priority, but that the priority is so high. This basically creates incentives that are short-term that only serve self-interest to raise stock prices and make shareholders, the board, and of course the executives happy since their currency is basically some kind of stock option agreement.

But look at what is happening in america: you consume so much and you don't make anything. The corporations have outsourced all the labor and technology to places like china and your business model is basically create in china, ship to america, and raise the price significantly and keep the profit.

This short term thinking is creating problems for competition for good made in america because you can't pay people less than a dollar an hour to work. The only place in america that you can do that is in the prison systems, and as despicable as that sounds, its one of the rewards of privatization of prison systems that the owners get.

So as a result of all of this, the country has become a service economy where all of the manufacturing, technology and even in some cases research h as gone overseas and the only people that benefit are the executives and shareholders.

To me the idea of having regulation is to preserve the interests of society at large and not the few, but unfortunately it seems that nowadays people in general are getting screwed big time. The fact that you can have accounting standards that enron used just baffles me.

To me there's a simple way to check if something needs to be regulated and that is basically if some area that has a wide social impact is or has the potential to impact them negatively beyond their control (ie majority of society do not have a choice) then regulation needs to exist to fix that.

You could extend that statement to include anything that causes a negative effect for society that they may be able to control but I personally think that if people do have a choice to avoid something negative due to fair and anti-competitive competition, then as such society has a choice which is made purely by them and is not something that has been forced upon them.

 

[mheslep]

are you sure about that?
http://money.usnews.com/money/perso...ing-todays-housing-crisis-with-the-1930s.html

Ok, I should have been more specific - price collapses caused by housing speculation and / or the lack of financial regulation. The depression era house price collapse was brought on by the collapse of the money supply (caused mainly by the Federal Reserve), not the collapse of a housing bubble fueled by 3% down loans to those with no ability to pay.
http://graphics8.nytimes.com/images/2006/08/26/weekinreview/27leon_graph2.large.gif

 

[mheslep]

States could have outlawed derivatives as a form of illegal gambling, but congress passed laws in 1992 and 2000 to preempt any state gambling laws from banning them.

http://en.wikipedia.org/wiki/Commodity_Futures_Modernization_Act_of_2000

In the case of AIG, this is probably an example of the individuals making money by selling CDS, to the detriment of AIG, which unlike a common bookie, wasn't balancing it's bets. The individuals involved didn't care, because they wouldn't be the ones having to pay out any money when defaults occurred, and many ended up getting bonuses with federal bailout money.

For all I know the states might label attempt to label any financial transaction gambling absent federal preemption, but the legalities aside I want to address an important difference I see here between such financial dealing and what we might see in Las Vegas at the tables; it is this: when one places a bet in Vegas or buys a lottery ticket, the wager creates a risk that did not exist before. CDS's, or commodities securities like Corn futures and their derivatives do not create a create a new risk: they move an existing risk elsewhere, such as the risk that a given loan will default, or that the corn crop will go bad. So to my mind loan derivatives are not gambling, whatever the legal interpretation might be.

 

[chiro]

For all I know the states might label attempt to label any financial transaction gambling absent federal preemption, but the legalities aside I want to address an important difference I see here between such financial dealing and what we might see in Las Vegas at the tables; it is this: when one places a bet in Vegas or buys a lottery ticket, the wager creates a risk that did not exist before. CDS's, or commodities securities like Corn futures and their derivatives do not create a create a new risk: they move an existing risk elsewhere, such as the risk that a given loan will default, or that the corn crop will go bad. So to my mind loan derivatives are not gambling, whatever the legal interpretation might be.

The derivatives are a form of gambling but that doesn't make it necessarily bad.

Any form of insurance is gambling. We have car insurance, home insurance, life insurance and so on and I doubt that most people (even the uninsured) would say that these are 'bad' things.

You also have insurance like say a farmer hedging against a bad year such as a drought or something along those lines. I'd bet that most people would see this as a good thing to and put it in the same category as say life insurance.

The major underlying theme with the above is that they serve a social purpose: we have car insurance to protect someone going bankrupt in the case of light accidents, we have life insurance to protect a wife and her kids from a catastrophe like being responsible for a mortgage in the case of a death where the family has only one provider (ie the husband).

Theres even a public form of insurance called unemployment insurance (I think in the states its called social security).

Clearly there are some forms of "gambling" or insurance that would be seen as things that benefit more people than other forms of insurance.

The thing is, and its a big one, is that it is illegal to obtain a claim to insurance in the instance of fraud. That is you can't get the wife can't get life insurance if she killed the husband, or joe blow can't get fire insurance if he torched the house.

However that sort of thing actually happened with the housing crisis: financial entities were advising people to get into mortgage backed securities while simultaneously betting against them with insurance products. Its like buying multiple fire insurance policies and then torching the house.

The above is a clear case of fraud and I'm surprised at least in the states that the majority of people aren't outraged. Iceland has basically put the banks in their place at least.

If the insurance policy is well designed legally, then fraud like this would be legally identified and the insurance policy would be void.

I guarantee if anyone that wasn't a corporation above the law did this, they would go to jail.

 

[rcgldr]

For all I know the states might label attempt to label any financial transaction gambling absent federal preemption, but the legalities aside I want to address an important difference I see here between such financial dealing and what we might see in Las Vegas at the tables; it is this: when one places a bet in Vegas or buys a lottery ticket, the wager creates a risk that did not exist before. CDS's, or commodities securities like Corn futures and their derivatives do not create a create a new risk: they move an existing risk elsewhere, such as the risk that a given loan will default, or that the corn crop will go bad. So to my mind loan derivatives are not gambling, whatever the legal interpretation might be.

I don't see the difference. When a person buys a CDS, it creates a risk for the person paying for the CDS and creates a risk for the person selling the CDS, in terms of the amount of money involved betting for and against the outcome of an event. Unlike insurance, a person can wager for or against the outcome of an event even if the person has no stake in that event, other than the CDS. The analogy would be a sports bet on a football game at Vegas. The gambler has no personal stake in the outcome of the game other than his wager. Derivatives are side bets that can be made by people that are otherwise uninvolved with the event.

Clearly AIG created a risk by selling CDS with AIG betting that defaults would not happen, and worse yet, not having sufficient reserves to cover the bets it was making, requiring the Feds to bail out AIG.

In the case of a CDS, sometimes the number of CDS in a market can effect the outcome of financial events. You have to wonder if some of the people that pushed for GM to go bankrupt, were holding derivatives betting that GM would go bankrupt.

 

[cobalt124]

There are the life threatening ones where legislation should go as far as is necessary to minimise risk to lives, there can be no debate:

http://en.wikipedia.org/wiki/Bhopal_disaster

This happened in 1984 and it's still in the courts and proper and enforced regulations could have prevented 8000-15000 deaths.

well, i think deregulation has been the bigger tragedy lately. especially with cases like Enron and the housing bubble.

i feel like a good bit of the problem is this artificial idea of the non-violent nature of white collar crime. sure, white collar criminals don't mug you on the street while you're going out to dinner. but they rob food, shelter, education, and medical care from you and your children. their actions rob you of your future to the betterment of their own, stealing years off your lives to extend their and theirs. what isn't violent about that?

Agree with this in regards to Enron. Just because it's not easily seen, that seems to make it OK. It's not. Whilst not as drastic as the previous example, I feel legislation should stop this, and if that meant shareholders or profits or the economy suffer, then so be it. In the long term, it would be worth it to bring these uncaring, greedy people to account. All too often it goes the other way and economic considerations come first.

I guess the main issue is (including "derivatives gambling" here), that people are (IMO) playing a game with other peoples lives, they are certainly not interested in knowing or caring about the consequences of their actions, so again I would notch up legislation to near max to stop them. Also, insist that someone is accountable, not a corporation, a person you can punish properly.

 

[mheslep]

I don't see the difference. When a person buys a CDS, it creates a risk for the person paying for the CDS and creates a risk for the person selling the CDS, in terms of the amount of money involved betting for and against the outcome of an event. Unlike insurance, ...

You may indeed be right in the case of naked CDS; I'll have to look more at that. We know a CDS can be bought to act as a hedge by the lender, i.e. indeed as insurance, to lay off the risk of the loan to the buyer of the CDS. In any case, there has to be a loan executed somewhere, i.e. risk has to be created first, before a CDS can be created after the fact.

 

[WhoWee]

You have to wonder if some of the people that pushed for GM to go bankrupt, were holding derivatives betting that GM would go bankrupt.

Who might that be - unions(?) - what are you suggesting?

 

[mheslep]

You have to wonder if some of the people that pushed for GM to go bankrupt, were holding derivatives betting that GM would go bankrupt.

I'm not sure how one could push for the GM bankruptcy, aside from encouraging them to build bad cars and too many of them. You mean I assume then by asserting political influence - to have the government refrain from bailing them out? I'm not sure there was anyway out of the bankruptcy: traditional Chap 11 with no gov. help, or the softlanding business-as-usual bankruptcy that occurred with gov. help. Either way GM common stock was wiped out, some (most?) GM debt defaulted.

 

[WhoWee]

I'm not sure how one could push for the GM bankruptcy, aside from encouraging them to build bad cars and too many of them. You mean I assume then by asserting political influence - to have the government refrain from bailing them out? I'm not sure there was anyway out of the bankruptcy: traditional Chap 11 with no gov. help, or the softlanding business-as-usual bankruptcy that occurred with gov. help. Either way GM common stock was wiped out, some (most?) GM debt defaulted.

The only clear winners were the unions - certainly not the car dealers or bondholders.

 

[nismaratwork]

The only clear winners were the unions - certainly not the car dealers or bondholders.

Correction: The OLD union ****ers. The new kids have to work at half the pay... really they work so much like organized crime, sometimes it's almost as though they're related... oooooooooooohhhhhh.

 

[mheslep]

There are the life threatening ones where legislation should go as far as is necessary to minimise risk to lives, there can be no debate:

http://en.wikipedia.org/wiki/Bhopal_disaster

This happened in 1984 and it's still in the courts and proper and enforced regulations could have prevented 8000-15000 deaths.

Maybe. It is also true that if the company and industry had exhibited 'proper and enforced' safety regulations the tragedy itself might have been prevented. The above contains an unwarranted assumption: that somehow the oversight of fallible people by other fallible people, who happen to work for the government (perhaps just before/after joining/leaving the target of regulation), are somehow guaranteed to render business safe. I don't argue here for elimination of all government regulation, but I do argue that i) regulation is no panacea and may not improve safety even if enforced as created by some political process, and ii) it is guaranteed to impose additional costs on business operations, which may in itself hinder the safety of others.

 

[nismaratwork]

Maybe. It is also true that if the company and industry had exhibited 'proper and enforced' safety regulations the tragedy itself might have been prevented. The above contains an unwarranted assumption: that somehow the oversight of fallible people by other fallible people, who happen to work for the government (perhaps just before/after joining/leaving the target of regulation), are somehow guaranteed to render business safe. I don't argue here for elimination of all government regulation, but I do argue that i) regulation is no panacea and may not improve safety even if enforced as created by some political process, and ii) it is guaranteed to impose additional costs on business operations, which may in itself hinder the safety of others.

Panacea or not, like our court system, it's just the best we have to work with right now. Just roll it back to Clinton era regulation, and go after corruption the way republicans want to. I'm sorry, but deregulation has been a pretty ugly thing for the most part, in my opinion. You're not offering any workable alternative, and the notion that conservatives would forge a new system of anything is oxymoronic; you would now by definition be 'progressive'.

Hell, can you REALLY say that the lack of proper funding for the FDA isn't a shame on us all? We shouldn't have to be concerned about our food supply being blatantly unregulated, and supplements being this magical niche for snake oil.

 

[Proton Soup]

Hell, can you REALLY say that the lack of proper funding for the FDA isn't a shame on us all? We shouldn't have to be concerned about our food supply being blatantly unregulated, and supplements being this magical niche for snake oil.

it's not so much about funding, but about freedom. it comes down to DSHEA.
http://en.wikipedia.org/wiki/DSHEA#United_States

you could think of it as allowing the sale of placebos, if you like. not unlike your friendly physician handing out paxil.

 

[rcgldr]

You may indeed be right in the case of naked CDS; I'll have to look more at that. We know a CDS can be bought to act as a hedge by the lender, i.e. indeed as insurance, to lay off the risk of the loan to the buyer of the CDS. In any case, there has to be a loan executed somewhere, i.e. risk has to be created first, before a CDS can be created after the fact.

If a lender wanted insurance to hedge loans, the lender is able to buy forms of insurance, but insurance is regulated and requires reserves, while CDS aren't regulated and don't require reserves, so the CDS's end up being cheaper for the lender. In addition, anyone wanting to place a bet on the default rate of a loan pool can buy CDS's, even though they have no involvement with the lender or the properties used for those loans. There were a few very successful investment funds that did exactly that (bet that sub-prime home loan pools would default). Since AIG didn't have the reserves to pay out on the CDS when loans defaulted, the CDS purchasers should have taken the hit, since the purchasers knew the risk up front when buying CDS, but apparently it seems that at least some companies were expecting the feds to bail out AIG.

CDS are just a form of deravitive, a side bet placed on the outcome of some finanancial event, but without any actual ties to the financial event. Unlike stocks that represent ownership of a company, or bonds that represent loans made to a company, derivatives are just side bets, a legalized form of gambling. This becomes apparent when congress passed laws in 1992 and 2000 to preempt states from banning such transactions as illegal forms of gambling.

... an unwarranted assumption: that somehow the oversight of fallible people by other fallible people, who happen to work for the government (perhaps just before/after joining/leaving the target of regulation), are somehow guaranteed to render business safe. I don't argue here for elimination of all government regulation, but I do argue that i) regulation is no panacea and may not improve safety even if enforced as created by some political process, and ii) it is guaranteed to impose additional costs on business operations, which may in itself hinder the safety of others.

Regulation can't guarantee 100% safety, but it increases the odds and helps prevent criminal behavior such as this:

http://americanfraud.com/filmrecoverysystems.aspx

 

[nismaratwork]

it's not so much about funding, but about freedom. it comes down to DSHEA.
http://en.wikipedia.org/wiki/DSHEA#United_States

you could think of it as allowing the sale of placebos, if you like. not unlike your friendly physician handing out paxil.

Proton, I find it hard to believe you don't have more issues with supplements as they're marketed and regulated in the US. The fact is that people are meant to be protected from snake oil... really, it's a basic function of government in my view. I'd add that these powders, gels, pills, and drinks aren't placebo... that would be BETTER!... these are unregulated, and tested only by the private sector... which doesn't seem to be enough.

There are real drugs in these placebos, just not effective as advertised, and without full knowledge of the interaction.

 

[nismaratwork]

If a lender wanted insurance to hedge loans, the lender is able to buy forms of insurance, but insurance is regulated and requires reserves, while CDS aren't regulated and don't require reserves, so the CDS's end up being cheaper for the lender. In addition, anyone wanting to place a bet on the default rate of a loan pool can buy CDS's, even though they have no involvement with the lender or the properties used for those loans. There were a few very successful investment funds that did exactly that (bet that sub-prime home loan pools would default). Since AIG didn't have the reserves to pay out on the CDS when loans defaulted, the CDS purchasers should have taken the hit, since the purchasers knew the risk up front when buying CDS, but apparently it seems that at least some companies were expecting the feds to bail out AIG.

CDS are just a form of deravitive, a side bet placed on the outcome of some finanancial event, but without any actual ties to the financial event. Unlike stocks that represent ownership of a company, or bonds that represent loans made to a company, derivatives are just side bets, a legalized form of gambling. This becomes apparent when congress passed laws in 1992 and 2000 to preempt states from banning such transactions as illegal forms of gambling.

Regulation can't guarantee 100% safety, but it increases the odds and helps prevent criminal behavior such as this:

http://americanfraud.com/filmrecoverysystems.aspx

Hell, corrupt as it is, the gaming industry in Nevada is still better than the criminal alternative we're familiar with in the relatively recent past (for the consumer at least). That bit of regulation, the loss of a gaming or liquor license, doesn't make it smooth sailing, but it keeps casinos tricky rather criminal.

 

[WhoWee]

If a lender wanted insurance to hedge loans, the lender is able to buy forms of insurance, but insurance is regulated and requires reserves, while CDS aren't regulated and don't require reserves, so the CDS's end up being cheaper for the lender. In addition, anyone wanting to place a bet on the default rate of a loan pool can buy CDS's, even though they have no involvement with the lender or the properties used for those loans. There were a few very successful investment funds that did exactly that (bet that sub-prime home loan pools would default). Since AIG didn't have the reserves to pay out on the CDS when loans defaulted, the CDS purchasers should have taken the hit, since the purchasers knew the risk up front when buying CDS, but apparently it seems that at least some companies were expecting the feds to bail out AIG.

CDS are just a form of deravitive, a side bet placed on the outcome of some finanancial event, but without any actual ties to the financial event. Unlike stocks that represent ownership of a company, or bonds that represent loans made to a company, derivatives are just side bets, a legalized form of gambling. This becomes apparent when congress passed laws in 1992 and 2000 to preempt states from banning such transactions as illegal forms of gambling.

Regulation can't guarantee 100% safety, but it increases the odds and helps prevent criminal behavior such as this:

http://americanfraud.com/filmrecoverysystems.aspx

Let's not forget the transactions (and trading operations) were not all US based.

 

[cobalt124]

The following is a pale shadow of the articulate response that PF decided to chew up and throw away.

The above contains an unwarranted assumption: that somehow the oversight of fallible people by other fallible people...are somehow guaranteed to render business safe.

I don't expect guaranteed safety, just a robust system that fallible people can operate within. It can be done. Look at the scrutiny given to Iraq by U.N. weapons inspectors searching for WMD's. I think something along these lines should be applied to companies so that fallibility is minimised, criminal activity not tolerated, and regulations are adhered to. They cannot be trusted to police themselves, or to operate responsibly. Ideally there should be a change in corporate culture (i.e. it is accepted) rather than it being enforced by government.

it is guaranteed to impose additional costs on business operations, which may in itself hinder the safety of others.

This hints at one of the problems with current corporate culture, that additional costs may hinder safety. There should be no connection here. Better that additional costs may make us rethink whether the operation is morally or financially viable, for example. The influence of money on corporate culture needs to be reduced.

Panacea or not, like our court system, it's just the best we have to work with right now. Just roll it back to Clinton era regulation, and go after corruption the way republicans want to.

What is needed is a shift in emphasis towards a system where corruption is not tolerated, and away from a system that runs down the field after corruption after it has bolted from the stable.

deregulation has been a pretty ugly thing for the most part, in my opinion.

I suspect, but I don't know, that the primary reason for deregulation is to free up companies to allow them to make more money, and any other reason (good or bad) to do so is given less weight.

Hell, can you REALLY say that the lack of proper funding for the FDA isn't a shame on us all? We shouldn't have to be concerned about our food supply being blatantly unregulated, and supplements being this magical niche for snake oil.

It would be a disgrace. It reminds me of the whole GM thing, where being right and making money took precedence over earning the peoples trust.

Apologies, multiquote went belly up on me.

Proton Soup Quote:
"it's not so much about funding, but about freedom. it comes down to DSHEA.
http://en.wikipedia.org/wiki/DSHEA#United_States

you could think of it as allowing the sale of placebos, if you like. not unlike your friendly physician handing out paxil."

Freedom is an issue in this. More regulation implies less freedom.

rcgldr Quote:
"Regulation can't guarantee 100% safety, but it increases the odds and helps prevent criminal behavior such as this:

http://americanfraud.com/filmrecoverysystems.aspx"

It isn't just an issue of fallibility and rule dodging, there are criminals in this. That increases the need for regulation.

 

[mheslep]

If a lender wanted insurance to hedge loans, the lender is able to buy forms of insurance,

Yes

but insurance is regulated and requires reserves, while CDS aren't regulated and don't require reserves, so the CDS's end up being cheaper for the lender.

Which means that, without access to the cheaper CDS in the current form, lenders are less likely to hedge their loans, concentrating risk, or less likely to lend, making credit harder to obtain, etc, etc.

In addition, anyone wanting to place a bet on the default rate of a loan pool can buy CDS's, even though they have no involvement with the lender or the properties used for those loans.

Yes, the so called naked CDS, though obviously lenders with first hand involvement in the loan can also buy a CDS.

There were a few very successful investment funds that did exactly that (bet that sub-prime home loan pools would default). Since AIG didn't have the reserves to pay out on the CDS when loans defaulted, the CDS purchasers should have taken the hit, since the purchasers knew the risk up front when buying CDS, but apparently it seems that at least some companies were expecting the feds to bail out AIG.

With the government created Fannie and Freddie creating the mortgage security market investors had good reason to believe everyone would be bailed out, as most of them were.

CDS are just a form of deravitive, a side bet placed on the outcome of some finanancial event,

Yes, as are http://en.wikipedia.org/wiki/Derivative_(finance)#Examples"

but without any actual ties to the financial event.

Possible, but no not necessarily true.

Unlike stocks that represent ownership of a company, or bonds that represent loans made to a company, derivatives are just side bets, a legalized form of gambling.

In some cases, maybe so. Certainly not if the lender buys a CDS. But given no CDS can occur without first creating risk via a loan, it is not clear to me, yet, that this is so.

This becomes apparent when congress passed laws in 1992 and 2000 to preempt states from banning such transactions as illegal forms of gambling.

Because the states wanted to regulate as gambling something formerly unregulated doesn't mean that it is such. They may just have wanted to collect fees from regulation.

Regulation can't guarantee 100% safety,

Agreed.

but it increases the odds and helps prevent criminal behavior such as this:

An assertion. http://en.wikipedia.org/wiki/Post_hoc_ergo_propter_hoc"
And more than that, there is excellent evidence that in some cases the opposite is true, that regulation causes harm, even fatal harm. The US FDA has killed thousands by keeping drugs off the market or making them vastly more expensive in its quest to prevent the release of the possible bad drug.