Michael Lewis' The Big Short: Diabolical Castles in the Sky

Voiding Credit Default Swaps

In a book stuffed with scathing insights and blockbuster revelations, here's perhaps the biggest one (courtesy of Michael Lewis, writing in The Big Short):

The reason Citigroup (amongst others) is considered "Too Big Too Fail" isn't because it holds over $1 trillion in ordinary Americans' savings in their vaults.

It's not because inflicting billions of dollars of losses on Citigroup's creditors and shareholders would jeopardize other financial institutions -- and by extension, the U.S. financial system and economy (domestic and global).

And it's not even because the U.S. would then have to step up and make good on its guaranties of hundreds of billions of Citigroup's crappy mortgages and other collateral.

The Real Reason Citigroup is TBTF

No, the real reason that Citigroup is considered to be TBTF is that it may be the object of billions -- maybe trillions -- in Wall Street bets, just like the housing market was before:

Citigroup's failure . . . would trigger the payoff of a massive bet of unknown dimensions: from people who had sold credit default swaps on it to those who had bought them. This is yet another consequence of turning Wall Street partnerships into public corporations: It turns them into objects of speculation. It [is] no longer the social and economic relevance of a bank that renders it too big too fail, but the number of side bets that have been made upon it.

--Michael Lewis, The Big Short (p. 263)

What to Do

If Lewis is right -- and I have no reason to think he isn't -- the appropriate policy response couldn't be more obvious, or necessary.

Step One: the federal government should void all such credit default swaps, immediately.

Aren't those private contracts?

So what?

So were millions of contracts (presumably unwritten) making human beings owners of other human beings.

What do you think happened to all those contracts on January 2, 1863? (the day after The Emancipation Proclamation).

Step Two. Break up the monster banks that ushered in this toxic, dysfunctional and highly combustible state of affairs (cue Warren Buffett's line about "financial weapons of mass destruction").

Step Three. Hold their leaders accountable for their epic greed, negligence and corruption* (vs. giving them, collectively, ongoing billions in bonuses).

No, that hasn't happened yet.

In fact, it hasn't even started.

*Let the courts figure out the proper weighting; mine would be 50% greed, 30% corruption, 20% negligence.