Economics of Contempt

Sadly, Tanta is no longer around to shred the idiocy that Gretchen Morgenson produces. That's too bad, because Morgenson's column on credit default swaps yesterday was a doozy. It's hard to know what to say about a column that's so detached from reality. It's sad that people will read this column and believe that it's true. Felix Salmon covered most of Morgenson's nonsense pretty well, so I'll only add a couple things. Morgenson starts with this:

Any honest assessment [of the financial crisis] must include the role that credit-default swaps have played in this mess: it’s the elephant in the room, the $30 trillion market that people do not want to talk about.

The CDS market is "the elephant in the room"? Clearly Morgenson is impressed by big numbers, so here's one for her: the market for interest rate swaps is a $356 trillion market! Just look at the relative size of the OTC derivative markets: Of course, interest rate swaps aren't going to bring down the financial system, and the $356 trillion number doesn't reflect the true risk of interest rate swaps. But credit default swaps also won't bring down the financial system, and the $30 trillion number also doesn't reflect the true risk in the CDS market. And since claiming the $30 trillion number represents the risk in the CDS market would be tantamount to lying to her readers, Morgenson included this:

While the amount of credit insurance outstanding is around $30 trillion, Robert Arvanitis, chief executive of Risk Finance Advisors in Westport, Conn., says he believes fully half that amount isn’t problematic because it consists of winning and losing stakes that offset each other.

That's an extremely conservative estimate, to say the least. Most people in the CDS market estimate that the true risk in the CDS market is about 1/10th of gross notional outstanding. Consider that roughly 90% of CDS trades in the DTCC warehouse are dealer-to-dealer, and that the dealer banks generally run matched books: Netting out all the outstanding CDS trades would probably reduce the notional outstanding to about $5-$7 trillion (the 10-to-1 ratio is probably accurate, but I'm accounting for the contracts that aren't in the DTCC warehouse). Morgenson also pushes two proposals for how to "fix" the CDS market, both of which are too stupid to even merit discussion. Suffice to say that one of the proposals is from Chris Whalen, who, as I noted the other day, appears to be totally bat-shit crazy.