The Fed in the CDS Business? When oh When Does it End?
At this point, I can no longer rightfully get up in arms over Federal Reserve intervention in flailing markets. It's not the anomaly of bygone days, it has become the standard by which our economy limps along and my therapist and I have been working on my anger issue surrounding this but until then, I've pretty much accepted that the Fed is happy to stick as many spare fingers as it's got in every leak along the way and that's just how it is.
Outrage? Oh please, I'm tired of this.
Exotic financial instruments known as credit default swaps played a central role in the crisis that brought the U.S. economy to its knees last year. Ricardo Caballero and Pablo Kurlat, two M.I.T. economists, have an audacious response: The Federal Reserve itself should get into the credit default swap business to prevent the next crisis.
Their proposal will be debated today at the Fed’s annual Jackson Hole, Wyo., symposium by the world’s leading central bankers and economists. Harvard’s Kenneth Rogoff, former chief International Monetary Fund economist, will present a critique.
A credit default swap is an insurance policy for financial storms. A firm selling a swap — a hedge fund, an insurance company, a big bank — promises the buyer that it will be repaid if an underlying debt defaults.
Use of these instruments soared during the credit boom earlier this decade. Many investors and banks went beyond using them as insurance protection against defaults and instead used them to make bets on the ups and downs of firms and markets. Many sellers of the protection also gravely misjudged the risk they were insuring. When American International Group Inc.’s financial services unit fell deep into the hole on mortgage-related CDS promises, it collapsed and helped sink the global financial system.
The two professors say the underlying idea — selling insurance against extreme financial risk — should be in the Fed’s arsenal to manage financial crises.
“Insurance is an effective and cheap tool during a panic,” they say in their Jackson Hole paper. The Fed did provide an ad-hoc form of insurance during the crisis -– guarantees to Citigroup Inc. and Bank of America Corp. on the value of more than $400 billion in assets they held. More broadly, the Fed provided insurance to the whole financial system when officials there vowed to do “whatever it takes” to stabilize markets last fall and extended their safety net beyond banks to AIG. The professors say the bank guarantee program should be formalized in instruments called tradable insurance credits which could be triggered by banks and even hedge funds if another crisis erupts.
Wait. Wait just one fucking minute. This suggestion is real? They aren't kidding?
I'm dumbfounded. Or maybe numb. I haven't decided yet but will be sure to let you know when I figure it out. This Jackson Hole gig is starting to sound like a damn party!!