Page 22 - Oil and Energy January 2013

ÓÓ U " &ENERGY
they’re not going to just roll over when it
takes a hit, but that it will pursue reform as
far as necessary to implement the statute.
The CFTC has the better position limits
argument, and while the appellate court to
which the appeal is taken is still controlled
by judges appointed by a Republican
president who are hostile to regulation,
I think the CFTC has a respectable chance
of success on appeal. By the way, there are
four pending vacancies on that appellate
court. President Obama has not yet filled
one of the vacancies. I hope Obama and
the Senate Democrats can get judges more
sympathetic to financial reform regula-
tion on the court, but I think the position
limits ruling was so wrong that even in a
conservative court there is a good change
the CFTC will prevail.
F <1 You have said that there is a lack of
understanding about what caused the
financial collapse. What were the principal
preconditions and causes of the collapse?
D>1 Basically, the collapse was caused
by the use of financial instruments to bet
that subprime mortgages would be paid by
borrowers. Even a casual observer of the
economy knows that the exact opposite
happened. Mortgages were defaulted upon.
When you state that proposition as harshly
as that, it’s clear that whomever bet the
mortgages would be paid had a bad end of
that bet.
What the American public don’t fully
comprehend is how those bets were placed
through naked credit default swaps: i.e.,
those who shorted the subprime market
did not have any relationship to subprime
mortgages other than they bet that they
would fail, much as someone bets that a
horse will lose a race. What people do not
understand is that those who bet the mort-
gages would be paid were not required to
have any capital reserves in case they lost
their bets. So, you had AIG, as only one
example, which bet hundreds of billions
of dollars that subprime mortgages would
be paid, but had no money to pay off their
losing bets.
Moreover, since AIG’s counterpar-
ties could repeatedly bet that a subprime
mortgage would not be paid (sometimes
there were nine bets on each mortgage),
the betting escalated exponentially the
consequences of mortgage defaults. What
would have been a single default if there
were no betting became a default multi-
plied nine times by the gamblers. When
the casino could not pay off its losing bets,
the American taxpayer was required to do
it dollar for dollar. The biggest winner in
the AIG bailout was Goldman Sachs, which
had bet with AIG that billions of dollars in
subprime mortgages would not be paid.
Taxpayer money that “rescued” AIG went
out the back door of AIG and into the
pockets of Goldman, for example.
The odds were completely masked by
the fact that the investments representing
the quality of subprime mortgages were
given Triple A ratings. People betting that
the mortgages would be paid thought they
were betting on something that would
stand up because it received the credit
rating “gold standard”. But, actually it
was an investment that was self evidently
weak. You could bet nine times against the
payment of a mortgage, and you did not
have to own it. It was just like going to a
football game and betting on the game with
nine different bookies.
Because of the Triple A rating, people
who bet thatmortgages would be paid didn’t
know they were betting on a Little League
team beating the New York Yankees. The
people who bet that mortgages would be
paid had no capital in reserve to pay off
their losing bets, and to avoid the failure of
all the casinos (or what were called world-
wide banks), the American taxpayer had
to back up casino bets around the world.
I don’t think people understand it was not
just the defaults on mortgages that caused
the meltdown but the effect of betting on
nine times their value and when there was
a default, it was nine times greater than the
value of the actual defaulting mortgages.
Dodd-Frank does fix that by not letting
banks make those bets for their own
book. The Volcker rule prevents that, and
Dodd-Frank otherwise makes those bets
transparent, so people can see the absurdity
of the bet, and to be involved in the betting
you have to have the capital in reserve and
show how you can collateralize the bets.
If that were in effect in 2008, we probably
would not have had the meltdown. And we
would not have had the Great Recession.
People don’t know why a capital hole
was blown into the economy. It was blown
in by reckless and feckless betting. If the big
banks won the bets, they kept the winnings.
If they lost the bets, they expected (and still
expect) the American taxpayer to cover
their losses to avoid a financial calamity.
If the American people understood that,
they would be much more supportive of the
regulation of Wall Street.
In terms of commodity prices that are
far in excess of what supply and demand
would dictate, again that situation is
caused by betting. This time it is betting on
upward direction of commodity prices that
misrepresents the value of the commodi-
ties. The commodity futures market for oil
and heating oil is supposed to be premised
on supply and demand fundamentals, with
producers hedging against consumers with
both sides seeking to lock in a future price
that is favorable. The tension between the
price needs of the producers and consumers
derives a price that is supply-and-demand
driven, but that’s not what happens when
the market is 80 percent speculative or non-
commercial as it is today.
Speculators mostly are betting that
prices will go up, so you have a false demand
signal that doesn’t comport with actual
supply and demand. It is distorting the
price discovery mechanisms of the futures
markets, andwe have a speculative premium
being added to the cost of everything from
bread to gasoline, all derived from upward
betting on the price of those commodities.
If that betting was stopped, the supply and
Q&A: Michael Greenberger
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