The US Navy ignores this, simply because nuclear carriers are impressive, and because they employ large numbers of sailors; which in turn increases the size of the Navy and hence makes plenty of room for well-paid, high-ranking officers and also lots of profits for shipbuilders. Stealth arsenal ships would do the same or better, with much less expense on men and machinery – which is precisely why the idea has been repeatedly shelved.

There is an analogy with the financial and corporate system here. Large units ought to be more efficient because of economies of scale, but just about never are. Why? Because large organisations make for bureaucracy, empire-building and various forms of cheating and embezzlement. Of course, there is a minimum effective size for a power plant or steel mill – but how big does a bank have to be?

Of course anyone would rather be the CEO of Bank of America than the manager of some local branch – but who benefits society in general more?

Thx for the props. As an on-and-off, long-time lurker of BC, I have enjoyed and appreciated your work. Makes the compliment all the more meaningful.

L3

For Congress & Wall Street

[start quote]

Here’s one big part of the answer. First, the alert reader will notice that Ben Stein said many times that the amount of money at risk in the subprime meltdown was just not enough to sink an economy of this size. And I was right…to a point. The amount of subprime that defaulted was at most – after recovery in liquidation – about $250 billion. A huge sum but not enough to torpedo the US economy.

The crisis occurred (to greatly oversimplify) because the financial system allowed entities to place bets on whether or not those mortgages would ever be paid. You didn’t have to own a mortgage to make the bets. These bets, called Credit Default Swaps, are complex. But in a nutshell, they allow someone to profit immensely – staggeringly – if large numbers of subprime mortgages are not paid off and go into default.

The profit can be wildly out of proportion to the real amount of defaults, because speculators can push down the price of instruments tied to the subprime mortgages far beyond what the real rates of loss have been. As I said, the profits here can be beyond imagining. (In fact, they can be so large that one might well wonder if the whole subprime fiasco was not set up just to allow speculators to profit wildly on its collapse…)

These Credit Default Swaps have been written (as insurance is written) as private contracts. There is nil government regulation of them. Who writes these policies? Banks. Investment banks. Insurance companies. They now owe the buyers of these Credit Default Swaps on junk mortgage debt trillions of dollars. It is this liability that is the bottomless pit of liability for the financial institutions of America.

Because these giant financial companies never dreamed that the subprime mortgage securities could fall as far as they did, they did not enter a potential liability for these CDS policies anywhere near their true liability – which again, is virtually bottomless. They do not have a countervailing asset to pay off the liability.

[end quote]

Re: Delphi
Just because CDSs exceeded the value of its bonds tenfold doesn’t mean losses increased tenfold. Total losses were limited to the losses on the bonds. The CDSs just spread that risk around.

There are only two ways CDSs are used: hedging and speculation. If the losses were hedged, the losses moved from the lenders to the buyers of the CDSs. No increase in loss, just a transfer of losses from one party to another. If the losses were speculative, they were fully offset by speculative gains. No increase in loss, just a transfer of wealth from one group of rich people to another group of rich people. Doesn’t keep me up at night.

So, I still fail to see the problem. In fact, CDSs might be a net positive (losses shared by many instead of a few). But maybe I’m missing something…

L3

The size of the market has soared well above the value of the underlying debt that they are supposed to insure (reaching about USD 62 trillion at the end of 2007). This has become clear since 2005, when Delphi, the auto parts maker, went bankrupt: the CDS on Delphi’s debt in the market exceeded the value of its bonds tenfold.