Friday, October 24, 2008

New Idea: Shutting Down the Multiplication of Risk, For a Time


The last proposal was for a forced unwind of synthetic CDO contracts.

I've already talked about the need for regulators to forestall, as much as possible, further blows to the system (not just throw rescue lines of capital injections).

In the prior writings, this involved isolating individual credits, that potentially have destabilizing "resonances" throughout the system because of CDS contracts. (Not all will, that is why the regulators need to have enough data to know which ones do...).

We can also propose emergency regulatory authority to overtly manipulate the collateral for the reference indexes that have driven an orgy of spread risk speculation, including credit risk, levered throughout the system, synthetically or otherwise.

  1. Pro bono publico, the government throws a guarantee around the issues/companies in the index, neutralizing prospective default risk. Hopefully, there is not too much residual risk related to any "events" that the government cannot "re-insure", but that's not a 'show stopper'. (Yes, there is a 'free rider' boost for the cash bond holders - who the hell cares, at this point?).

  2. Through a series of moves, the issues are retired, default free, the instruments that rely on them are unwound, fiat, and the system deleverages, until it has the capacity to try again, with "better models" and more capital (probably more than enough, by then, but let's not digress).

n.b. This effort is designed to target the structured products that appear to be looming large, still, for a controlled systemic unwind. I'm unconvinced that the regular trading of credit, by responsible parties (i.e. risk-managed entities that are willing to disclose their net exposures), is something that ought to halt.

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