U.S. Chamber Of Commerce President Mocks Demonstrators For Having Insufficient Knowledge Of Complicated Financial Instruments
Over at ThinkProgess, Lee Fang relates the reaction U.S. Chamber of Commerce President Tom Donohue gave at being told about a small demonstration that had formed outside a St. Louis event where he was speaking.
As you might expect, he didn't think much of the protesters! Nor did he have many kind words for the similar crowds that have sprung up in Wisconsin, as he criticized public sector workers for their "out of control" pensions and "over bloated" compensation.
But this, to me, is the best part. Per CBS' St. Louis affiliate:
While Donohue was inside calling for more deregulation, demonstrator Johnathan McFarland was outside calling for more regulations on business and banking, "We came to where we are at right now, because of the lack of government regulation and we need to put safeguards on things like derivatives."
When a reporter informed U.S. Chamber of Commerce President and CEO Tom Donohue that protestors were planning to demonstrate against his visit to St. Louis, he questioned their intelligence.
"Do you think they even know what a derivative is?" Donohue said.
Oh, my. Well, I'll be honest with you, derivatives are a complicated thing to understand. And it's been made more complicated with the rise of ornate, synthetic derivatives that have taken the derivatives market well beyond old-school agricultural futures. Synthetic derivatives, credit-default swaps, collateralized debt obligations...these are things that happened to the lives of ordinary people while they were putting out fires and running the Department of Motor Vehicles and teaching children about fractions.
I can imagine most ordinary people do not have an understanding about these instruments. (Previously, with the help of Julie Satow, I took a stab at explaining part of this complicated puzzle.) But the difference between Tom Donohue and myself is that I do not have contempt for people who lack an understanding of this material.
What makes his line hysterical to me, of course, is that there's ample evidence -- you know, in the form of a massive financial crisis -- that the people tasked with understanding derivatives didn't know much about them, either.
If you've got the desire to learn more, I recommend purchasing John Lanchester's book I.O.U.: Why Everyone Owes Everyone And No One Can Pay, one of the best books about the financial crisis because it's written for ordinary people, for whom Lanchester also has no contempt. Here is a relevant selection:
In an ideal world, one populated by vegetarians, Esperanto speakers, and fluffy bunny wabbits, derivatives would be used for one thing only: to reduce risk. Because they are bought "on margin" -- that is, not for the full cost of the underlying asset but for the advance premium...they offer a cheap and flexible form of insurance against things going wrong. Imagine, for instance, that you are convinced that the stock market will go up by 50 percent in the next year. You know it in your waters -- so much so that you borrow $100,000 and use it to buy shares. If the market goes up, you'll be pleased with yourself; but if you're wrong and the market plunges, you'll be badly out of pocket -- unless you take out some insurance. So you buy a $10,000 option to sell shares at a lower price than you paid for them. That money is wasted if your shares go up -- but you wont' care much because your main position is in serious profit. But if shares go down, you have some insurance -- you can cash in the option to sell shares at the lower price and eliminate most of your losses. This is called "hedging": you have used an option to hedge your main risk.
Alas, we don't live in that kinder, gentler world. In reality, the power of derivatives has a way of proving irresistible for those people who aren't just sure that the market is going up, but who are beyond sure, are supersure, are possessed of absolute knowledge. Financial experts are often possessed of this kind of certainty. In that event, it is very tempting indeed to buy an option that increases your level of risk, in the certainty that this will increase your level of reward. In the above example, instead of hedging the position with an option to sell, you could magnify it with options to buy, which will be worth a lot if you're right - sorry, when you're right. When you're right and the market goes up by half, your $10,000 option will be worth $50,000 (that's the $50,000 by which the shares have gone up). In fact, instead of buying $100,000 of shares and a $10,000 option to buy, why not instead buy $100,000 worth of options? This is called leverage: you have leveraged your $100,000 to buy $1,000,000 worth of exposure to the market. That way, when you get your price rise, you have just made $500,000, and all with borrowed money.
In fact, why not skip the option and instead buy some futures, which are cheaper (because riskier) - let's say half the price? These futures, at $5,000 each, oblige you to buy 20 lots of the shares for $100,000 each in a year's time. Hooray! You're rich! Unless the market, instead of doubling, halves, and you are saddled with an obligation to buy $2 million worth of shares that are now worth only $1 million. You've just borrowed $100,000 and through the power of modern financial instruments used it to lose $1 million. Whoops.
It might seem unlikely that anyone would do anything that stupid, but in practice it happens all the time.
And, circa fall of 2008, this stupidity occurred on a massive scale, and if you might recall, you folks paid a pretty penny to put things right.
So, yeah, y'all might be too stupid, in Tom Donohue's estimation, to understand the complexities of the financial markets, but when the sage geniuses who supposedly do nearly destroy the economy and send a pile of untold wealth straight to money heaven, paying to patch over the collossal cock-up becomes your responsibility.
Were you thanked for this, by the way? I guess the "thanks" comes when the remaining holes in the economy are filled by your pensions!
By the way, there's this woman named Elizabeth Warren who is putting together something called the Consumer Financial Protection Board. Her modest goals and desires include changing the way banks do business so that credit card agreements aren't filled with "tricks and traps" that come buried in obtuse language designed to confuse people.
So, it's important to remember the ignorance of ordinary people who Tom Donohue mocks is precisely the state in which he hopes ordinary people persist.