1 Boring Old Man

Obama Pushes Broad Rules for Oversight of Derivatives
New York Times
By STEPHEN LABATON and JACKIE CALMES
May 13, 2009

In its first detailed effort to overhaul financial regulation, the Obama administration on Wednesday sought new authority over the complex financial instruments, known as derivatives, that were a major cause of the financial crisis and have gone largely unregulated for decades.

The administration asked Congress to move quickly on legislation that would allow federal oversight of many kinds of exotic instruments, including credit default swaps, the insurance contracts that caused the near-collapse of the American International Group.

The Treasury secretary, Timothy F. Geithner, said the measure should require swaps and other types of derivatives to be traded on exchanges and backed by capital reserves, much like the capital cushions that banks must set aside in case a borrower defaults on a loan. Taken together, the rules would likely make it more expensive for issuers, dealers and buyers alike to participate in the derivatives markets. The proposal will probably force many types of derivatives into the open, reducing the role of the so-called shadow banking system that has arisen around them.

“This financial crisis was caused in large part by significant gaps in the oversight of the markets,” Mr. Geithner said in a briefing. He said the proposal was intended to make the trading of derivatives more transparent and give regulators the ability to limit the amount of derivatives that any company can sell, or that any institution can hold…

_{Wendy Graham, Phil Graham, and friends…}

It’s hard to imagine that they didn’t know what they were doing. She opened the door in the last days of her tenure at the FCTC, right before going on the Board of Enron. He poked his legislative part through Congress when Clinton was almost out of office avoiding any Congressional debate.

If Derivatives remains a meaningless term to you, there are a few articles that offer clarification. This one in the Village Voice is the first one that made any sense to me:

What Cooked the World’s Economy?
It wasn’t your overdue mortgage
By James Lieber
January 28, 2009

I think some of the terms used in this world must’ve been chosen to make what they were actually doing more opaque: Derivatives, "Complex" or "Exotic" Financial Instruments.  What is the difference between some legitimate investment, or a reasonable Insurance Policy, and these new financial toys?  In the Stock Market, one buys and sells actual Stock Certificates, paper representations that are directly "secured" by some incremental ownership in the enterprise named on the certificate. In the Derivatives World, there’s no connection to ownership. One is "placing side bets." Likewise, in the Commodities Market, somewhere down the line, there’s some actual object involved. So if you’re trading Onion Futures, real onions are involved. In the Derivative world, what’s being bought and sold are bets on the price of onions. In an Insurance Office, you insure your car. In the Derivative world, you can buy Insurance on somebody else’s car. So Derivative means "derived from." What you can buy is not limited by ownership, it’s only limited by what someone is willing to sell you. So, theoretically, in that world, I can buy auto insurance on the worst driver in North America [with no ownership in his car], and collect when he crashes [with no need to spend the money on getting anything fixed].

What fool would sell you such a Derivative? Apparently, there are plenty of such fools. In the housing market which was on a steady march upward, there were more than enough fools. In the past, people who defaulted on loans lost their houses which were then resold. The intrinsic value was maintained. That worked so long as the market value of houses either stayed the same or rose. It was a good bet. But the problem became a cycle. The availability of easy money, easy loans, drove the housing market to vastly falsely inflated values, way above any intrinsic value. The house value no longer assured that the loan could be retrieved. So, the Derivative Market destroyed "real value." At some inevitable point, the "sure bet" of the credit default swaps [insurance on these shaky, overvalued mortgages] became the worst bet in the world. It was like selling life insurance without factoring in the fact that , sooner or later, people actually die.

The clever names used to describe this market no longer hide the fact that it’s just a Casino, a betting parlor, where gamblers are drawn in by the lure of fast money. Problem is, it was your money. Retirement Plans, Foundations, any place money accumulated was being managed in this off-the-radar world. It was like sending our savings to Las Vegas to be managed by it’s denizens. Well, nobody insures gamblers against loss on the BlackJack tables. But that’s what happened. When the gamblers hit a losing streak, they cashed in their policies – and you ended up paying it off.

The Republicans and the financial industry are going to fight this kind of regulation. Why not? It’s their way of passing on the risk that is intrinsic to their world. It’s beyond ironic that the industry that specializes in risk management found a way to avoid dealing with it altogether. Effective regulation will either legitimize this market or destroy it. Either option is fine with me…