Woman Who Invented Credit Default Swaps is One of the Key Architects of Carbon Derivatives, Which Would Be at the Very CENTER of Cap and Trade → Washingtons Blog
Woman Who Invented Credit Default Swaps is One of the Key Architects of Carbon Derivatives, Which Would Be at the Very CENTER of Cap and Trade - Washingtons Blog

Monday, December 7, 2009

Woman Who Invented Credit Default Swaps is One of the Key Architects of Carbon Derivatives, Which Would Be at the Very CENTER of Cap and Trade

As I have previously shown, speculative derivatives (especially credit default swaps or "CDS") are a primary cause of the economic crisis. They were largely responsible for bringing down Bear Stearns, AIG (and see this), WaMu and other mammoth corporations.

According to top experts, risky derivatives were not only largely responsible for bringing down the American (and world) economy, but they still pose a substantial systemic risk:

  • Warren Buffett’s sidekick Charles T. Munger, has called the CDS prohibition the best solution, and said “it isn’t as though the economic world didn’t function quite well without it, and it isn’t as though what has happened has been so wonderfully desirable that we should logically want more of it”
  • Former Federal Reserve Chairman Alan Greenspan - after being one of their biggest cheerleaders - now says CDS are dangerous
  • Former SEC chairman Christopher Cox said "The virtually unregulated over-the-counter market in credit-default swaps has played a significant role in the credit crisis''
  • Newsweek called CDS "The Monster that Ate Wall Street"
  • President Obama said in a June 17 speech on his plans for finance industry regulatory reform that credit swaps and other derivatives “have threatened the entire financial system”
  • George Soros says the market is still unsafe, and that credit- default swaps are “toxic” and “a very dangerous derivative” because it’s easier and potentially more profitable for investors to bet against companies using them than through so-called short sales.
  • U.S. Congresswoman Maxine Waters introduced a bill in July that tried to ban credit-default swaps because she said they permitted speculation responsible for bringing the financial system to its knees.
  • Nobel prize-winning economist Myron Scholes - who developed much of the pricing structure used in CDS - said that over-the-counter CDS are so dangerous that they should be “blown up or burned”, and we should start fresh
  • A leading credit default swap expert (Satyajit Das) says that the new credit default swap regulations not only won't help stabilize the economy, they might actually help to destabilize it.
  • Senator Cantwell says that the new derivatives legislation is weaker than current regulation

Round Two: Carbon Derivatives

Now, Bloomberg notes that the carbon trading scheme will be largely centered around derivatives:

The banks are preparing to do with carbon what they’ve done before: design and market derivatives contracts that will help client companies hedge their price risk over the long term. They’re also ready to sell carbon-related financial products to outside investors.

[Blythe] Masters says banks must be allowed to lead the way if a mandatory carbon-trading system is going to help save the planet at the lowest possible cost. And derivatives related to carbon must be part of the mix, she says. Derivatives are securities whose value is derived from the value of an underlying commodity -- in this case, CO2 and other greenhouse gases...

Who is Blythe Masters?

She is the JP Morgan employee who invented credit default swaps, and is now heading JPM's carbon trading efforts. As Bloomberg notes (this and all remaining quotes are from the above-linked Bloomberg article):

Masters, 40, oversees the New York bank’s environmental businesses as the firm’s global head of commodities...

As a young London banker in the early 1990s, Masters was part of JPMorgan’s team developing ideas for transferring risk to third parties. She went on to manage credit risk for JPMorgan’s investment bank.

Among the credit derivatives that grew from the bank’s early efforts was the credit-default swap.
Some in congress are fighting against carbon derivatives:

“People are going to be cutting up carbon futures, and we’ll be in trouble,” says Maria Cantwell, a Democratic senator from Washington state. “You can’t stay ahead of the next tool they’re going to create.”

Cantwell, 51, proposed in November that U.S. state governments be given the right to ban unregulated financial products. “The derivatives market has done so much damage to our economy and is nothing more than a very-high-stakes casino -- except that casinos have to abide by regulations,” she wrote in a press release...

However, Congress may cave in to industry pressure to let carbon derivatives trade over-the-counter:

The House cap-and-trade bill bans OTC derivatives, requiring that all carbon trading be done on exchanges...The bankers say such a ban would be a mistake...The banks and companies may get their way on carbon derivatives in separate legislation now being worked out in Congress...

Financial experts are also opposed to cap and trade:

Even George Soros, the billionaire hedge fund operator, says money managers would find ways to manipulate cap-and-trade markets. “The system can be gamed,” Soros, 79, remarked at a London School of Economics seminar in July. “That’s why financial types like me like it -- because there are financial opportunities”...

Hedge fund manager Michael Masters, founder of Masters Capital Management LLC, based in St. Croix, U.S. Virgin Islands [and unrelated to Blythe Masters] says speculators will end up controlling U.S. carbon prices, and their participation could trigger the same type of boom-and-bust cycles that have buffeted other commodities...

The hedge fund manager says that banks will attempt to inflate the carbon market by recruiting investors from hedge funds and pension funds.

“Wall Street is going to sell it as an investment product to people that have nothing to do with carbon,” he says. “Then suddenly investment managers are dominating the asset class, and nothing is related to actual supply and demand. We have seen this movie before.”

Indeed, as I have previously pointed out, many environmentalists are opposed to cap and trade as well. For example:

Michelle Chan, a senior policy analyst in San Francisco for Friends of the Earth, isn’t convinced.

“Should we really create a new $2 trillion market when we haven’t yet finished the job of revamping and testing new financial regulation?” she asks. Chan says that, given their recent history, the banks’ ability to turn climate change into a new commodities market should be curbed...

“What we have just been woken up to in the credit crisis -- to a jarring and shocking degree -- is what happens in the real world,” she says...

Friends of the Earth’s Chan is working hard to prevent the banks from adding carbon to their repertoire. She titled a March FOE report “Subprime Carbon?” In testimony on Capitol Hill, she warned, “Wall Street won’t just be brokering in plain carbon derivatives -- they’ll get creative.”

How the Movie Ends

Yes, they'll get "creative", and we have seen this movie before ...an inadequately-regulated carbon derivatives boom will destabilize the economy and lead to another crash.

I have previously pointed out that CDS sellers - like the big sellers of other financial products - know that the government will bail them out if CDS crash again. So they have strong incentives to sell them and to recreate huge levels of leverage. Indeed, the same dynamic that led to the S&L crisis also led to last year's CDS crisis, and will lead to the next crisis as well. So - while CDS might be a particularly dangerous type of "weapon of mass destruction" (in Warren Buffet's words), the new carbon derivatives may very well become the new form of looting on the public's dime. If the government allows massive carbon derivatives trading with as little oversight as over the CDS market, taxpayers will end up spending many trillions bailing out the giant banks and propping up the economy when the carbon market bubble bursts.

And as I have previously pointed out: (1) the giant banks will make a killing on carbon trading, (2) while the leading scientist crusading against global warming says it won't work, and (3) there is a very high probability of massive fraud and insider trading in the carbon trading markets.


  1. Man. Great article. I have flooded this out as far as I can. Blogs, email groups, Reddit. etc. I hope we can educate enough people to do something in this world. Thanks for this excellent reporting. Peace bro.

  2. I cannot find a better place to say this, so I'll say it here.

    Yesterday a man was arrested for throwing tomatoes at Sarah Palin.

    I take strong objection to this.

    In our American Political Heritage is vast, varied, long and deep. -Noting this-, no one can deny it is entirely appropriate to throw tomatoes at political candidates, -all present, and past political candidates included.

    It is implied by our Vaudvillian heritage that we have the right to throw tomatoes at any and all public figures.

    Public people like Al Gore, David Letterman, Tom Cruise, Britney Spears, Tim Geithner, and Jim Lehrer should all be designated -OPEN-SEASON-.

    It certainly should be undeniably permissible to throw at said political candidates and moreso our political leaders, tomatoes, cabbages, eggs, feces of all types -and- even a dead carp.

    The historical precedent is clear.

    I consider this an expression of free speech, and -an extremely valuable expression of our free speech-.

    It should not be permissible to throw pitchforks at political candidates-

    -unless that is, -they deserve it.

  3. Simplicity is genius. He who creates the money owns everything. A fractional reserve fiat interest bearing money system is a ponzi scheme.
    End the Fed, allow the US government to create enough money to pay off the debt and rebuild America's infrastructure and watch the United States for America lead the world to prosperity again!
    The Colonies did it, the first century of the United States did it, England did it with the Tally system, and through out history flourishing civilizations did it! Time we did it again, it is due, it will be inevitable so let it happen now!

  4. I like shoes better. Better yet...boots

  5. Oh So Awesome! The Sun causes global warming, Wall Street is allowed to monetize the effects and when the market implodes or gets out of control- based on irrational exuberance and/or the SUN'S ACTIVITY American taxpayers get to PAY FOR IT ALL THROUGH THE TARP CDS CLIMATE MARKET BAILOUT!

    I so look forward to making financial employees lives the stuff of wonder with my hard work.

  6. Hopefully we'll open the paper someday, or turn on the internet or watch the news and find that all these traitors have been arrested and are in jail. That would make my heart sing.

  7. Oh my F***ing God!!! I used to work underneath this woman back in the day (albeit many many rungs underneath the ladder).

    Over two years I tried to understand what CDSs were according to the company line, never made sense until I realized it was all BS. Now Carbon trading? What a small world.

  8. The sun warms the earth, this is true. The problem is that greenhouse gases cause the retention of heat that would otherwise radiate into space, causing excessive warming. The principles are simple, but weather is not. People can't tell the difference between peaks and averages. One cold snap, it's "what global warming". Too bad they don't teach science and math in school anymore.
    Cap'n'trade is another way to do nothing while pretending to do something, and get rich in the process. How American!

  9. Important article. It is imortant to wake up people. Henry Ford said that if people would understand economics they would start a revolution.

    As long as the money elites can do what they want they WILL do what they want.

  10. AGW is at best dubious and corrupted science. At worst, the current excuse for the largest power grab in the history of humanity.

    They taught math and science when I went to school, and I am a scientist. I am one of the 10's of thousands of people who know that AGW is a crock. The real science is out there, and trust me, we WILL have another ice age - real science predicts it

  11. Carbon Tax is the way to go: industries will seek lower emission, or no emission, alternatives in order to pay less tax.
    The revenue collected can be returned to citizens to pay for home improvements like insulation, solar, etc and improving & expanding utilities like public transportation.
    Much easier to implement than cap & trade, once the big players (also the biggest contributors) do it others will soon follow. Any nay-sayers will get a Carbon Tariff imposed and they'll quickly change their minds.
    Phasing out coal by 2030 might not be a bad idea either.

  12. Life Insurance (other than pure term) is the same smoke and mirrors nonsense as CDS, et al

  13. The problem with Carbon Tax is that it puts $$$ in the hands of the govt and you trust them to "return it to citizens for insulation, etc." HAHAHAHAHA!!

    Cap and Trade puts $$ in the hands of businesses who are incented to lower carbon. Not a perfect system, and yes (gasp!) banks will make profits, but far better than a tax.

  14. Another form of graft and extortion which the public enables by tacit approval; dumb, dumb, dumb, dumb, dumb!

  15. As an Expat Wall St. lawyer, expertized in regulatory arbitage, toiled hard for my banking clients (i.e., ALL the usual suspects -- all of them) to maintain the regulatory status of OTC derivatives as "neither fish not foul , nor good red herring".

    THAT SAID, Cap & Trade ("C&T")is inevitable in U.S. -- the EU ETS has got it. Hate to say it, but C&T is the most "efficient" price discovery mechanism out there -- since the whole point (in my mind) is to "discovery" the cost /price of the carbon externalities. And yes the Banks will take a huge tithing -- if we got a problem , then shut donw the current market in Energy Derivatives. Carbon Trading will be an arbitrage position vis-a-vis ALREADY EXISTING gas/coal/power OTC derivatives -- in oil tradiong bus. when they trade oil vs. gasoline vs. kerosene etc., its called "crack trading" (someone go figure).


    Deep Thought

    Full disclosure : I'm with the Anthropogenic camp when it come to who/"what" caused the currnet global warming -- it ain't about sunspots, ladies and gents.

  16. I enjoyed reading your article as well as the other comments below; you are very accurate in your assessment of our current situation.
    My take on this subject is that our American culture has unfortunately developed a “something for nothing” attitude with many of us looking to cash in on our “lottery ticket” when it appears.
    All one has to do is look at the $1 trillion wagered in our US gambling industry (legal and illegal gambling) per year, one of the largest and fastest growing industry in the US, to better understand this concept.
    It doesn’t take a rocket scientist to understand that that our politician’s insatiable need for money to stay in power will always play to those that have it. Is it any wonder that gambling with all its allure would eventually find its way back into our financial system? I say back because it was banned decades ago through the passing the Glass-Steagall Act, a law passed by congress just after the Great Depression to help prevent another one from reoccurring. Among other things Glass-Steagall helped shut down “bucket shops”, gambling parlors that accommodated Wall Street betting on companies and also prohibited cross-ownership of banks, securities firms, and insurance companies.
    Through the passing of the “Commodities and Futures Modernization Act) of 2000, Pandora’s box was essentially opened by our politicians and the keys turned over to our financial institutions to create our new extension of the Las Vegas strip, the Wall Street Strip.
    Unfortunately this time Wall Street financial institutions used our homes to wager against. Then after creating and popping the real estate bubble, got bail out money, paid themselves back by cashing in the credit default swaps called in by their counter parties and in the process stole 10 years of real estate wealth from those who no longer could pay their mortgages due to lost jobs and the economy killed.

  17. Blythe Masters did not invent credit default swaps. My 6th grade teacher, Mr Edwards, taught us about this before she was born. Maybe she tweaked it to fit into current economic structure but the plan was there more than 40 years ago.

  18. The easiest way to bypass toxic CDO's and to rid yourselves of government and the more invasive private company control and to make a better future for your descendants is to take on renewable energy as soon as possible and adopt a sustainable economy.
    You then control your energy needs on site and if you have a return to community (remember S&L's before Reagan) banks you will control your finances locally. Instead of blaming everyone else start decentralising your needs. The Vampire?pyramid scheme masters hate this. Today with a 3Kw Solar system you could run a new electric car and your home needs and if you live with low consuming electrical goods you may have enough left over to sell to the power company. Take control of your futures not whinge about the big bogie man.

  19. Figures a woman started this nightmare

  20. Hey there;

    I just watched a report about Blythe Masters on The Keiser Report on the channel Russia Today, and the tactics this lady implemented into financial systems are of outright robbery!! Shame on her.

    Many thanks for your informative post.



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