Friday, June 26, 2009

Derivatives: The Devil's Handiwork

Floyd Norris' article, "Derivatives Tug of War Takes Shape" is a discouraging look at how hard the derivatives industry is fighting any kind of regulation, particularly having to be traded on an exchange where prices are transparent and companies will actually have to put up some collateral for the risks they take then fob off on some unsuspecting mark. It's all gambling on a massive scale.

“Simply put,” said Richard Bookstaber, one of the pioneers of financial engineering on Wall Street, “derivatives are the weapon of choice for gaming the system."

Mr. Bookstaber wrote one of the best books about the causes of the financial crisis, “A Demon of Our Own Design,” and did so before the crisis erupted. This month, his testimony to a Senate subcommittee provided a stark lesson in the uses to which derivatives have been put.

“Derivatives,” he testified, “provide a means for obtaining a leveraged position without explicit financing or capital outlay and for taking risk off-balance sheet, where it is not as readily observed and monitored.” They let institutions dodge taxes and accounting rules.

“Viewed in an uncharitable light,” he added, “derivatives and swaps can be thought of as vehicles for gambling; they are, after all, side bets on the market.”

And they were side bets that could destabilize the markets. Had American International Group been gambling in regulated markets, it would have been required to put up collateral when prices began to go against it. Instead, it was able to ignore the problem until its own collapse — and perhaps that of the financial system — was imminent.

As he put it, and as I saw in CNBC's show "House of Cards", the pirates use derivatives to transfer their risk to those who don't understand it. I was appalled listening to Alan Greenspan talking to the CNBC guy. He was basically saying there was nothing the Fed could do to stop the madness. You can't put the brakes on a bubble because that would destroy the economy and profitmaking. He's saying all this, that damned Ayn Rand suckup, while sitting in the midst of the wreckage. The profits were all phantom, except for those piled up by financial wizards who got paid upfront and left before everything crashed.

But the destruction spread far beyond the Wall Street borders and subprime mortgages. Right now we're looking at at least 11% unemployment by the end of 2009 (and it's gotta be more than that; I think it's already gone up 1.5% since April). And this is the official unemployment rate, which doesn't include the underemployed or those who have given up looking.

The sadness is that it will all be blamed on Obama and we'll get some horrible Republican in the White House in 2012.

Such a transfer of wealth from the not-rich to the rich.