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Category Archives: Economics

Many people believe that in 1985-87, when Negative Gearing was abolished in Australia by the Hawke/Keating government, that rents rose, and rose dramatically.  This is certainly the assertion of the Turnbull government as part of its 2016 Federal Election campaign strategy in which the spectre of massive rent rises coupled with a  dramatic fall in housing prices is daily utilized as a scare campaign.

In fact, during that period 1985-1987, while rents did rise in Sydney and Perth as NG was abolished, they fell in Adelaide, Hobart and Brisbane and remained steady in Melbourne. In other words there was no relationship between the abolition of Negative Gearing (NG) and rental prices in that period.

The predominant reason that rents increased in Sydney and Perth during that time was tight rental vacancy rates. Sydney, in particular had very low vacancy rates (less than 1%).

If the abolition of Negative Gearing leads inevitably to rent increases it should have done so in all cities during 1985-1987.

It did not.

This alone is enough to disprove that abolition of Negative Gearing has a dramatic influence on rents.

Even the recent (March 2016) BIS Shrapnel report which modelled a particular set of assumptions about Negative Gearing and which has been used by the Turnbull Government to forecast general economic disaster should Negative Gearing be abolished, agrees that rents did not rise during 1985-1987. It says

neither rents nor dwelling prices displayed any notable change of behaviour or deviation from trend during 1985-87 [when negative gearing was abolished]

The CEO of the Commonwealth Bank, Ian Narev, whose bank owns a $400 Billion property portfolio says that Negative Gearing is only a minor influence on housing prices. He said:

I can tell you having a $400 billion home loan book – your assumptions on unemployment and what’s happening in global interest rates will dwarf whatever assumptions you’ve got on the modelling about the impact of negative gearing by a factor of…I can’t tell you the number but it’s a big number.

It would appear that the BIS Sharpnel model is drivel.

Macrobusiness characterises the BIS Sharpnel modelling outcome as hoplessly inconsistent on its own terms:

 [BIS Sharpnel say] restricting negative gearing to newly constructed dwellings would somehow crash dwelling construction, raise rents, and destroy employment, the Budget and the economy? Even in its own terms this makes no sense. How does a sagging economy and rising unemployment lead to a rental cost spike?

One should also note that the NG scenario that BIS modelled is significantly different from the actual policy that the ALP has proposed, though Prime Minister Turnbull and Treasurer Morrison used the BIS Sharpnel scenario to criticise the ALP’s NG proposals.

So Why, Then, Was Negative Gearing Restored In 1987 ?

We are thus left to answer the question: So if Negative Gearing has a negligible effect on housing prices and rents, why then did the Hawke/Keating government resume Negative Gearing in 1987 ? My assessment is that they caved in to political pressure, possibly due to the upcoming NSW State Election being fought in a climate of rental stress and declining construction activity.

The Cabinet Submission prepared by Keating in 1987 said, in general agreement with Ian Narev above, that

Evidence suggests local factors rather than tax measures dominate in metropolitan rental markets

But the submission nevertheless stated an expectation that Negative Gearing would re-stimulate the construction sector, which had dropped off over the prior 18 months, during the time that Neg Gearing had been abolished. Keating’s submission said

restoring negative gearing could be expected to provide some stimulus to construction in the medium term

This ‘expectation’ of Keating’s is nowhere backed by evidence in his submission.

As we have already noted, the actual available evidence (listed in detail in the submission) points to ‘local factors’ driving rents. Not Negative Gearing..

My contention is that Keating was feeling political heat and just wanted to be seen to be doing something to assist the Building Construction sector and ease rents. But he knew re-establishing Negative Gearing wouldn’t help much, if at all.

The failure of Negative Gearing In Australia to provide its stated aims of stimulating Housing Construction and reducing rents is well-established by the prominent Australian economist Saul Eslake.

An Expensive And Failed Policy

In 2013 Eslake noted that 92% of housing investors buy established dwellings, so NG has not significantly improved housing supply. All it does is assist investors to buy established homes, this bidding up prices on the existing housing stock.

Eslake also notes that in the decade 2001-2011 Australian Housing Stock grew at a rate less than the population growth. Negative Gearing has simply been ineffective at increasing housing supply to any significant extent, if at all.

In fact, by rewarding speculative investment in Housing,  The National Housing Supply Council, of which Eslake is a member calculates that NG has assisted in the suppression of  investment in new housing during 2001 and 2011, such that the national housing stock was 228,000 dwellings less than would otherwise have been under historical rates of housing formation.

In summary then

  • Abolition of Negative Gearing did not increase rents between 1985 and 1987
  • Negative Gearing does not stimulate housing construction
  • Negative Gearing is a very minor factor in housing prices
  • Negative Gearing does not reduce rents
  • The March 2016 BIS Sharpnel report is based on a faulty and self-contradictory model of Negative Gearing effects.

 

 

 

 

 

 

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I think its because they want a budget surplus. Yes, the vision is that small. Please prove me wrong. (Hang on I just did: here)

Data in this post largely plagiarized from Political economist Dr Remy Davison from Monash University speaking on The World Today

The Australian Motor Vehicle Industry and associated components manufacturers provide 50,000 jobs. The level of subsidy Australians provide is relatively low by international standards. The US government just subsided its own car industry to the point of partial nationalization. ALL national governments heavily subsidize their Motor Vehicle Industry: China, Japan, South Korea, Germany and France.

The level of subsidy may well be $48,000 per year, per job as Treasurer Hockey says, but that’s $25 per head annually which is what the current assistance of $500 million amounts to.

The Motor vehicle Industry produces a $23 Billion dollar gross value add to Australia’s economy and is a $3.6 Billion dollar export industry.

Sorry. I am not seeing the urge or logic here. Where is the over-spend ? Isn’t it obvious that the asset has value ?

Australian banks are subsidized at least 4 times as much as the Motor Vehicle Industry at least $100 per person per year.

The Mining Industry receives $4 billion a year in subsidy. That’s about $200 per year per head or 8 times as much as the Motor Vehicle Industry.

The Australian car industry spends over $600 million per year on R&D. That will stop if the Motor Vehicle Industry dies.

Wasn’t Abbott and his team hysterical when Rudd announced the end of Fringe Benefit Tax concessions on Company Cars during the 2013 election campaign? Wasn’t that going to decimate the car industry ? The same one they are now willing to let die as a costly festering Stone Age heap of useless slag ?

Here’s a quote from the Coalition’s election material on Rudd’s FBT changes:

The Coalition does not support Labor’s $1.8 billion hit on the car industry.

Tony Credlin-Abbott said that Rudd’s FBT cancellation was

a disaster for a motor industry which is already under pressure

and that the FBT concessional support should be maintained to support the industry.

Today it seems the Coalition is happy to see the Industry gone altogether. No, not true. They sincerely want it to survive, but without one cent of government assistance. Which happens nowhere in the world. Its a fantasy.

As Ian Credlin-McFarlane-Credlin, our current Federal Industry Minister said just six weeks ago

every vehicle in the world was subsidised, either directly or in kind, be it through tariffs, currency manipulation or other means…All countries subsidise. Most subsidise much more than we do…If you don’t subsidise the industry, it won’t be there. I accept that argument. I’m not sure that my colleagues do yet.

What drives the Coalition fantasy of a subsidy-free Motor vehicle Industry ? A small headline saving on the 2014 budget spreadsheet ? One which would be dwarfed by the ensuing loss in economic value add ?

Surely not.

Something Worth Subsidizing

So what does the Coalition think is worth subsidizing ? Well, hospitals in marginal electorates. In 2010 Abbott offered Andrew Wilkie $1 bn to re-build Hobart Hospital in exchange for Wilkie’s support in a minority government. The promise was unfunded.

So 50,000 jobs in the Motor Industry is not worth a $500 million subsidy.
1 job in the Federal Parliament, the PMship for Mr. Tony Abbott, is worth a $1 bn subsidy.
Taxpayers should feel…informed.

PS

Actually, back on Hockster’s per job figure I’ve just calculated it. That’s a subsidy of $10,000 per job. Not $48,000 as per Hockster, who must be using direct jobs in direct car manufacturing alone even though he knows the direct manufacturing jobs support the entire component industry. Sneaky old Hockster.

One Million Unemployed

The Liberal/National Party Coalition in Australia has two great indictments on the former ALP Treasurer and Prime Minister, Paul Keating. The first is ‘17% Interest Rates’ and the second is ‘One Million Unemployed’. Here’s Peter Costello long-term Lib. Treasurer in 2007 stringing the insults together into his party-preferred summary of Keating’s anti-achievements

I love seeing Paul Keating out on the media. And I would say: Paul, keep it going, remind people of what it is like under a Labor Government. And you saw all of the old vitriol coming out and it reminds people of a million unemployed, 17 per cent interest rates, a budget deficit of $10 billion, Commonwealth debt at $96 billion

Interview with Virginia Trioli 702 ABC, Sydney Friday, 26 October 2007

Was Keating clueless on Employment ? Could he have done better ? What do he do wrong ?

Keating The Chiropractor

The high profile Blogger and academic John Quiggin scores Keating low on Employment, claiming Keating had no focussed Employment Policy apart from a brief period following the 1993 election with the program Working Nation and even that ran for only a short time before being overtaken by other priorities.

See Quiggin in his article from 2000 ‘Unemployment: Still Hoping For A Miracle ?’

The main reason for pessimism is the fact that unemployment is at the bottom of the policy agenda, just as it has been for all but a few years in the past two decades. In the absence of a serious policy response, we are reduced to ‘hoping for a miracle’. (p.3)

The Working Nation program, […] was introduced by the Labor government
in 1994, cut back in 1995, and slashed by the incoming Liberal–National coalition
government in 1996…(p.19)

Quiggin regards Keating as a technocratic, neo-liberal economist, who aimed merely to calibrate the economy so that it would function efficiently, thereby producing Employment as a natural by-product of health. If true that would make Keating’s approach to the economy rather like that of a Chiropractor, attempting to maximize the efficiency of the body’s nervous system and waiting for natural feedbacks to produce a vigorous equilibrium.

Mega An’ Me

I decided to find out more about what Keating did on Employment and started by borrowing ‘The Longest Decade’ by George Megalogenis from the local library. Lo and Behold, Chapter 1 summarized Keating’s Economic Project as Treasurer/Prime Minister and gave me an outline of what Keating did and its effects on the broad economy.

I enjoyed the chapter so much I have decided to blog The Longest Decade as a series of posts called ‘Mega An’ Me’…maybe.

Mega Loves Paul

From Chapter 1, I would say Mega loves Paul (Keating). He makes it pretty clear that he regards Keating as having done the hard work of reform and that Howard was the beneficiary of Keating’s brave reforms. Mega says:

“[Keating’s] interest rates begat another recession…[but Keating] wanted praise for ending the speculative orgy of the 1980’s. At first we thought he was crazy […] but history has validated […] Keating […] The decade that followed his recession (which began in November 1990) expired on 24 November 2007 [with the defeat of the Howard Government]”

The catch for Keating is that the longest decade still belongs to Howard.
– The Longest Decade, pp.9-10

Mega claims, I feel a little blithely, that most people did not feel any pain in Keating’s recession.

Neither number [17% interest rates or one million unemployed] happens to be mainstream.[…] In NSW only one out of 24 workers were retrenched… Three out of four households were on a fixed interest rate of 13.5%, the ceiling that applied before April 1986…Also the banks shielded the remainder by extending the term of the loan, so repayments did not rise…

Longest Decade, pp.12-13

…but there has to be some reason for that ALP vote in 1996 shrinking to post-Great Depression lows. People were feeling it. Pretty much only the rusted-ons stayed attached to the ALP in 1996.

As it is, Keating and Mega are supported in their views by Ian McFarlane, Reserve Bank Governor from 1996. Mega quotes McFarlane addressing the Australian Business Economists Annual Conference in 2005 as Governor Of The Reserve Bank, where McFarlane stated Keating’s recession should be regarded as a ‘policy triumph’ as it delivered Australia ‘a low-inflation, stable growth eceonomy’.

Is VIC There ?

Mega traces the pain of Keating’s recession squarely to Victoria. He notes that three-quarters of the job losses of the recession were sufferred in that State due to the reduction of tariffs on the automotive and other manufacturing industries. In Mega’s view those job losses were the price that Victoria had to pay for being ‘dragged into the global economy’ pp.18-19

One might also apply those comments to South Australia, another state that had Manufacturing Industry job losses at that time.

Mega supports his case (only VIC and SA suffered) by presenting results from the 1996 election that show the ALP losing 9 seats in Victoria, but picking up 5 seats in NSW and Qld combined. He could also have mentioned that the ALP was almost obliterated in SA, being reduced to only 2 seats out of 12.

Keating’s Interest Rates

Keating portrays his 17% interest rates as necessary evil required to finally conquer the inflation monster that had risen in the middle of every boom. Wage inflation was being controlled through the Accord, but Asset inflation notably house prices but running at 15% with the help of the newly deregulated financial sector. Keating pumped interest rates until they trumped asset inflation (Longest Decade pp.13-15)

Keating’s interest rates deepened the recession but they were the tool employed to kill inflation which allowed The Longest Decade of stable growth and therefore deserve to be lauded as a policy triumph.

So Was Keating Clueless On Employment ?

I’ll go with ‘Probably Not’. Mega and Keating spin a very plausible yarn on tariffs and the task of destroying inflation but Quiggin speaks in other articles of ‘paths not taken’ on employment policy. I would like to hear some of those other voices.

Mega also makes the point that the international economy was not vibrant in the early 1990’s which gives PJK some further excuses.

But the Coalition are shameless to criticise Keating for his reforms, since they voted for all of them. Have they ever explained what magic wand they would have waved over Victoria to prevent job losses in a manufacturing sector denied its tarrif barriers ?

Note to self: I do not really understand why it is necessary to destroy asset inflation unless maybe to forestall wage demands to cover said inflation.

Loose Ends

There are some other strands of this story to be covered such as Keating’s ‘jobless recovery’ inlcuding the changing technological profile of work and jobs which meant that lost blue-collar jobs could not be immediately replaced. Having peeked ahead I know these topics will be covered in due course.

Last night I attended the public lecture at the Sydney Institute entited ‘The World Financial Crisis How Did It Happen’. Speakers were Mark Johnson, former chairman Macquarie Bank, Timo Henckel, Research Fellow, Centre for Applied Macroeconomic Analysis, ANU and Dr. John Edwards, Chief Economist HSBC and formerly Economic Advisor to Paul Keating.

Mark Johnson
Mark Johnson spoke first, and most entertainingly. He started his speech by approvingly quoting US Federal Reserve Chairman Ben Bernanke who summed up the crisis by saying (to paraphrase) that the trigger was

‘the turn of the US housing cycle in 2006 with its associated cascading delinquency in sub-prime mortgages which was then itself triggered the collapse of the mountain of associated instruments and securities such as Mortgage Backed Securities, Collateral Debt Obligations and Credit Default Swaps all of which were funded by debt (borrowing). The securities were made to look more attractive than they really were due to improper US Underwriting standards and poor regulation of the financial industry.’

Johnson discussed how the US Credit Boom was funded by Global Current Account Imbalances i.e. The US borrowed while China (especially), Japan, Germany and OPEC loaned to the US by the purchase of US Government Securities (e.g Treasury Bonds). Successive US Administrations deliberately ran deficits as a response to challenges such as the Asian Financial Crisis, Y2K Bug, 9-11 and the DotCom bust.

Johnson said that Alan Greenspan and the US policy-makers had an over-confident ideological, (I would say quasi-religious) belief in the ‘Doctrine Of Efficient Markets’ i.e. that markets do not require regulation and automatically self-correct (NB Doctrine – see I told you it was a religious system) and so tolerated the growth of an unregulated ‘shadow banking sector’ which revelled in the cheap credit churned out by Washington, produced the weird securities mentioned above (MBS, CDO, CDS) and created the horrendous varieties of sub-prime mortgage which fuelled the melt-down.

Conventionally regulated banks were far from innocent however, also producing and trading in these instruments but moving them to ‘off-balance sheet vehicles’.

Such regulation that did exist was outmoded, confused (conflicting Federal-State laws) and politicized. The Financial sector lobbied for and got a repeal of the Glass-Steagall Act of 1933 which prevented Commercial Banks behaving like Investment Banks and vice-versa. After repeal of Glass-Steagall ‘everybody got into everybody ele’s business’ and the borrowing to deal in the ‘opaque’ MBS, CDO and CDS securities ran amok.

Greenspan later said that he watched the system collapse in ‘shocked disbelief’ so convinced was he that ‘free’ financial markets would self-correct. It is a brutal thing to see one’s most confident opinions shredded by reality.

US Rating agencies comprehensively failed the public and the world during this time. There were 37,000 AAA issues on the NYSE during 2007 most of which are now rated as Junk.

Opacity and the Liquidity Crisis

The meaning of ‘opaque’ in relation to the MBS and CDO securities is that third-parties cannot tell what they are composed of. Sub-Prime mortgages were bundles with good mortgages into MBS parcels which were then sold, combined with other MBS parcels -re-sold, sliced and diced some more and then re-sold again. The end result was a ‘mortgage porridge’ where no-one can tell which specific mortgages are where, or how many sub-prime mortgages you hold.

The opacity of MBS was of crucial importance because when the sub-primes started failing, lenders suddenly became very interested in knowing how many sub-prime mortgages say Bear Sterns, had parcelled up in their MBS. The answer was ‘We don’t know’ and so the lenders wouldn’t lend. This is where the ‘Liquidity Crisis’ came in and inter-bank lending dried up.

Timo Henckel

Timo Henckel took the podium and said that he essentially concurred with Mark Johnson’s view of the origins of the Global Financial Crisis, describing it as a ‘perfect storm’, a confluence of many factors, some of which taken by themselves were innocent or good in an isolated context.

He was specifically critical of the Ratings Agencies who, he said, acted as both ‘referee and player’ in the financial markets, pointing to their conflicts of interest. Dr. Henckel also pointed to outdated Accounting Rules as a contributer to the crisis as well grossly insufficient liquidity requirements, which the US Security and Exchange commission lowered to 33 to 1 (itself stupidly insufficient). According to the balance sheet of Lehmann Brithers their leverage ratio was 40 or 50 to one but their real position would have been far worse than that.

Dr. Henckel specifically mentioned the Community Reinvestment Act as amended in 1995 which he said (to paraphrase) ‘encouraged a loosening of lending standards, thus fuelling the sub-prime mortgage sector..’ I followed up on this point during question time.

Dr. Henckel’s most interesting points were those regarding the modelling of Financial Markets. As mentioned above, Greenspan and the policy-makers, indeed the consensus amongst economists today (prior to the crisis) was that Financial Markets were not different to any other market and function most efficiently when deregulated.

Henckel described the work of the economist, Hyman Minsky, who said that Financial Markets are a special case, characterised by very large ‘Information Assymetry’ which means that they are intrinsically unstable i.e volatile. In order to correctly regulate financial markets the correct model of their operation must be understood. The work of Minsky is now enjoying a renaissance. 🙂

John Edwards

John Edwards took a different perspective to the previous speakers. Instead of trying to assemble the fullest explanation possible, he tried to concentrate on the essential components.

For example, he said that Global Current Account deficit imbalances were not an essential factor in the explanation because interest rates could plausibly have been lower even if the whole world was not loaning to the USA to support their deficits.

Edwards was very critical of Greenspan and the regulators. He described the regulators as ‘irresponsibly negligent’. He noted that in inquiries into the crisis three seperate US Agencies claimed jurisdiction over regulation of Credit Default Swaps (CDS).

Edwards fingered the sub-prime mortgages as an indispensible part of the explanation, Greenspan (poor economic policy) and poor regulation. He noted that the adjustable-rate sub-prime mortgages products being peddled during the US Housing Bubble 1998-2006 could only be serviced in a phase of rising housing prices. As soon as that stops, defaults are inevitable.

On their own, however, sub-prime delinquencies would merely have decimated the US Housing Market as the bubble burst in 2006. What turned the whole show into a Global Crisis was the link between sub-prime mortgages and MBS/CDO securities. The collapse in these securites is what made Lehmann Brothers insolvent with cascading effects that now affect the entire world.

Edwards muted Henckel’s appraisal of the role of the Community ReInvestment Act, noting that it did not require or reward sub-prime loans. He may have also said, but did not, that the CRA actually mandates normal, prudential oversight but leaves the specifics of how loans should be structured to the expertise of the banks themselves.

Question Time

I directed a question to Dr. Henckel:
“Many people have fingered the CRA as the trigger to the crisis saying that the CRA caused large numbers of sub-prime loans to be held by poor (ethnic) minorities who then defaulted. I have read data that said that 60% of sub-prime loan defaults were held by middle-class and affluent borrowers. Is this true and how did they end up holding sub-prime loans ?”

Dr. Henckel replied:
“I would like to see that data. It does not correspond to data that I have.”

At the conclusion of the evening I handed Dr. Henckel a copy of my source which is the article The Community Reinvestment Act and the Recent Mortgage Crisis by US Federal Reserve Governor Randall S. Kroszner, December 3, 2008 .

Our analysis of the loan data found that about 60 percent of higher-priced loan originations went to middle- or higher-income borrowers or neighborhoods. Such borrowers are not the populations targeted by the CRA…Putting together these facts provides a striking result: Only 6 percent of all the higher-priced loans were extended by CRA-covered lenders to lower-income borrowers or neighborhoods in their CRA assessment areas…

In correspondence with Dr. Henckel, he said that he had misunderstood my question at the time and noted that ‘the sub-prime mortgage sector was concentrated in four states – Arizona, California, Florida and Michigan and indeed the majority of sub-prime mortgage holders there were white households.’

When I asked my question, the Sydney Institute audience let out a discontented murmur. I don’t think they were comfortable with the concept that the middle-class or affluent have contributed to this enormous problem. They were quite comfortable with the concept that poor minorities could have.

A Visit To The Institute

It was a good evening and very good value for $10 as a non-member. The talk was held on Level 61 of Governor Phillip Tower just behind Circular Quay, so there were panoramic views of the Harbour and the Botanic Gardens. Really stunning.

I would say there would have been about 200 people there, maybe more. We sat in rows in a big seminar room. Average age would have been maybe late 40’s or ealy 50’s. I went by myself but talked to a few people. Three worked in the Financial Industry, one was a retired man who has been a Sydeny Institute member for 3-4 years. He said the quality and number of speakers has been continually increasing. I didn’t notice any politico-celebs or IPA Members (I scanned the guest list) in the audience.

The line-up of speakers for this year is very good: Julia Gillard, Julie Bishop, Wayne Swan, Helen Coonan, Maxine McKew: and they have people with a leftist viewpoint e.g. Helen O’Neill (Refugee Advocate). Gerard Henderson should be congratulated for assembling a range of speakers that do not necessarily accord with his conservative viewpoint.

It went for two hours (80 mins talk, 40 mins questions) though the schedule for was 60 mins talk, 60 mins questions. Never mind, the speakers were very interesting. Gerard Henderson gave a very brief intro. and didn’t waste any time. No party pies or quiches afterwards (rats) but light refreshments are promised at future talks (see the Sydney Institute website).

So it makes for an good evening. I would recommend it. Come prepared with a good question and look enthusiastic and you’ll probably get a chance to ask it.

I am considering the following one for Senator Coonan, ‘Do you, like John Howard, consider the ABC to be the enemy of the Australian people’. Strewth. They’ll throw me out!

Example Of Sub-Prime Contagion
Here is an example of how Sub-Prime mortgages triggered failures in other securities.

The linked article describes how ‘Commercial Paper’ issued by investment and asset management companies e.g. Ottimo Funding, an affiliate of Aladdin Capital Management, an investment manager in Stamford, Connecticut was linked to sub-prime mortgages and hence how defaults in the latter flowed on to defaults in Commercial Paper.

Commercial Paper is a fancy term for an IOU. They were bought by pension funds, insurance companies, hedge funds and short-term money market funds. Commercial Paper became increasingly backed by sub-prime mortgages. In August 2007 more than one-third of all US Commercial Paper was backed by various forms of consumer debt such as residential mortgages, credit card receivables, car loans and other bonds.

The funds generated by Commercial Paper backed by sub-prime mortgages were used to buy…more sub-prime mortgages!

As sub-prime mortgages defaulted, the companies issuing Commercial Paper could not repay their debts to the Pension Funds etc. who became likewise compromised.

Blimey – its a house of cards!

Credit Default Swaps

Wikipedia has a good page on these. These operate like a form of Insurance where you pay a premium over time and get a payoff if a specified event occurs e.g. Lehmann Brothers go bankrupt or Sub-Prime Mortgage Parcel #1005 gets downgraded to Junk

You do not actually have to own any of the security (e..g Mortgage Parcel #1005) to be able to buy a CDS on it, so you can make money out of things you don’t own. Consequently the majority of the CDS market is a huge casino disconnected from the actual buying and selling of stock or bonds.

The role of CDS in the Financial meltdown was that

1) They introduced Systemic Risk into the Financial system which contributed to the ‘Liquidity Crisis’
2) They were responsible for the collapse of AIG

As Wikipedia explains on Systemic Risk, CDS and Liquidity:

imagine if a hypothetical mutual fund had bought some Washington Mutual corporate bonds in 2005 and decided to hedge their exposure by buying CDS protection from Lehman Brothers. After Lehman’s default, this protection was no longer active, and Washington Mutual’s sudden default only days later would have led to a massive loss on the bonds, a loss that should have been insured by the CDS. There was also fear that Lehman Brothers and AIG’s inability to pay out on CDS contracts would lead to the unraveling of complex interlinked chain of CDS transactions between financial institutions…

Some commentators have noted that because the total CDS exposure of a bank is not public knowledge, the fear that one could face large losses or possibly even default themselves was a contributing factor to the massive decrease in lending liquidity during September/October 2008.

Many thanks to Dr. Henckel for taking the time to enter into correspondence on his talk.