Forum Post: Hard Evidence: Bailed-Out Banks Take More Risk
Posted 12 years ago on Nov. 12, 2011, 1:46 p.m. EST by MonetizingDiscontent
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Hard Evidence: Bailed-Out Banks Take More Risk
http://financeaddict.com/2011/11/hard-evidence-bailed-out-banks-take-more-risk/
Politicians, Treasury Secretaries, etc. would have you believe that “moral hazard” is something we should only worry about in the abstract, in the future, when they’ve moved on to another job. But now a study confirms with hard facts: moral hazard–it lives.
Researchers have asked for some time whether and how bailouts might affect banks’ risk-taking. Would they run wild, aware of the high likelihood of being bailed out again if they ran into trouble? Or would they ease off precisely because they’d now be assured of lower financing costs and long-term survival, and therefore would want to avoid doing anything that might cause regulators to take that valuable banking license away? More daring or more discipline?
Each of these camps had its underpinnings yet the question was a difficult one to study. Why? Because, generally speaking, the developed Western countries didn’t really do bank bail-outs. [Insert smirk here.]
But then came 2008 and its bailout-palooza. And so, thanks to hundreds of billions of taxpayer dollars and an alphabet-soup of bank welfare programs, this question can now benefit from the availability of real-life, empirical data. (Cloud, silver lining and all that.)
Continue Reading The Rest Here:
http://financeaddict.com/2011/11/hard-evidence-bailed-out-banks-take-more-risk/
Key Lesson From Iceland Crisis: “Let Banks Fail”
http://www.washingtonsblog.com/2011/11/key-lesson-from-iceland-crisis-let-banks-fail.html
What Iceland Teaches Us: “Let Banks Fail”
Agence France-Presse notes:
http://news.yahoo.com/key-lesson-iceland-crisis-let-banks-fail-003849604.html "...Three years after Iceland’s banks collapsed and the country teetered on the brink, its economy is recovering, proof that governments should let failing lenders go bust and protect taxpayers, analysts say."
Do we want bailed out banks to loan money to the undeserving working class or not? If yes, then by definition they will be taking on more risk so we will be able to call them greedy and creating bubbles to screw the working class. If not, then we can all call them greedy and unwilling to help the working class. Either way we win and we do not have to face the fact that the working class was undeserving of loans in the first place, but went overboard and overextended, which is what created a bubble and crashed the economy. The fault will all be that of the banks. If they loan money they are greedy. If they don't, they are greedy. Viva la Resistance. We. Are. The 99%.
(TylerDurden of ZeroHedge) "We are being throttled by the Big Lie: we're told that if the predatory financial system implodes, we'll all be ruined. The opposite is true: the only way to save our economy is to let the corrupt, pathological and flawed financial system implode."
http://www.zerohedge.com/news/guest-post-collapse-our-corrupt-predatory-pathological-financial-system-necessary-and-positive
The Collapse of Our Corrupt, Predatory, Pathological Financial System Is Necessary and Positive (a Guest Post on ZeroHedge)
(Submitted by Charles Hugh Smith from Of Two Minds)
I was recently challenged by a contributor to write something positive, and so I decided to write about the single most positive outcome of the current financial crisis in Europe: the complete collapse of the corrupt, predatory, pathological global banking sector and its dealers, the central banks. Exploring why this is so reveals the insurmountable internal conflicts in our current financial system, and also illuminates the systemic political propaganda which is deployed daily to prop up a parasitic, corrupting, pathologically destructive financial system.
Our first stop is modern finance itself. Modern financial "products" and "instruments" are often highly complex and abstract, but the entire edifice can be distilled down to this: the system is based on the assumption that all risk can be hedged, and the difference between the initial position's yield/gain (i..e. placement of capital at risk for a gain) and the cost of hedging the risk of the wager to zero can be skimmed from the system risk-free.
That is the entire system in a nutshell, and we can immediately see the advantages of this system over traditional Capitalism, where risk can be hedged but never to zero, and the return is correlated to the risk taken on.
In modern finance, high-risk "investments" (wagers) with high returns can be taken on without worry because any and all risk can be hedged to zero, even in super high-risk wagers.
And since even high-risk positions can be seamlessly hedged to zero, then there is no reason not to borrow money to increase the size of your wagers: since you can't lose, then why not? Wagering in risk-free skimming with borrowed or leveraged money is simply rational.
Put these together and we see how a system based on risk-free skimming eventually leverages itself to the point that the slightest disruption can bring down the entire over-leveraged, over-extended system.
Why is this so? Every hedge has a counterparty who is supposed to pay off if the initial wager blows up. A system based on risk-free hedging is ultimately a self-organizing system which maximizes return by increasing bet sizes, leveraging/borrowing to near infinity and hedging every hedge as well as every wager.
This creates long chains of hedges and counterparties. Here's an example based on an asset we all understand, a house. Let's say someone buys a house for $1,000 down, something that was common in the housing bubble. That $1,000 is leveraged up to buy a $200,000 house via a $200,000 mortgage.
The "owner" of the house then buys a hedge to protect himself from the house losing value, so the risk is reduced to zero: if the value rises, the owner reaps the gain and if it declines, then he collects the payoff of the hedge from the counterparty, for example, a Wall Street investment firm.
The counterparty calculated the risk of real estate declining and then priced the hedge accordingly. There is some small risk that the loss will exceed the cost of the hedge, so the issuer of that hedge bundles similar bets and then buys a hedge or "insurance" from another player, who makes the same calculations of risk and return.
Meanwhile, the mortgage has been tranched (sliced into principal and interest and into various pools of risk) and bundled with other "low-risk" mortgages and sold to investors, who also buy a hedge against any loss in the tranch, for example, a credit default swap (CDS) which pays out if a borrower defaults. Those hedges are sold or "insured" with another hedges.
All of this debt and all of these hedges are based on a mere $1,000 of actual capital. The players who originated each hedge are similarly leveraged, because since risk can be lowered to zero, who needs capital?
So what happens when one counterparty (issuer of a hedge) somewhere in the chain runs into trouble? The entire chain collapses. With razor-thin capital to cover any losses, then each link in the chain dissolves into insolvency if their counterparty fails to pay off.
This is how we get hundreds of trillions of dollars in "notational" derivatives: every hedged is hedged with another "instrument," "products" are bundled and insured, and so on. The system is based on the principle that risk can be reduced to zero, and so there is no need for capital...
Continue Reading the rest of this article At:
http://www.oftwominds.com/blognov11/collapse-of-corrupt11-11.html
http://www.zerohedge.com/news/guest-post-collapse-our-corrupt-predatory-pathological-financial-system-necessary-and-positive