In 1988, Muriel Siebert testified before the subcommittee on Telecommunications and Finance, in the wake of the 1987 market crash. The major problem with the market, she said, was derivatives. "Program trades and index arbitrage end up bringing the volatility and rampant speculation of the futures pits to the floor of the Big Board. Futures have become the tail wagging the dog."
In 1998, she was back before Congress after the Long Term Capital Management debacle. "Simply stated, regulation has not kept up with advancements in technology and new financial products." She went on to describe the products that made the LTCM implosion possible: derivatives.
In 2002, she testified before the Senate Subcommitte on Investigations; her topic: the lessons of Enron. "The current market crisis has parts of its genesis in the derivatives arena, that murky corner of the securities industry where futures, options, swaps, warrants and convertibles are the vehicles of choice. Yet, despite its size, the derivative market is largely opaque and unregulated, a fertile field for those looking to create the latest legal loophole."
She went on to ask what could be learned from these experiences about regulation. "We should note that regulatory responses to the first two downturns did nothing to stop the third. And I'm afraid nothing can prevent the next debacle unless we address the core problems, which are the lack of management accountability and the lack of transparency of these new financial tools. This financial engineering permitted the illusion of economic activity."
And now we learn in the Washington Post that Brooksley E. Born pushed for the regulation of derivatives, only to be resisted by Greenspan, Rubin and Levitt. Her failure to persuade them is explained by Rubin in typically patronizing terms: she was too strident. (This is how men always describe women they disagree with.) Instead we got Greenspan's favored course of self-regulation which, we now know, is no regulation at all.
For decades, women have warned us about the dangers we faced in financial markets. And for decades, they were ignored, excluded and patronized. What makes anyone believe that Paulson, Bernanke, Greenspan, Rubin and their ilk have any capacity, will or talent to change the environment they engineered so poorly in the first place? Won't they do what they and their cronies have always done - defend the system their own creations? We need a new guard, who know the system but didn't build it. Don't let anyone tell you they're not out there. They've been there for years.
Most egregious have been OTC credit default derivatives. They were declared not to be futures contracts, not to be gambling, not to have any reserve requirements,. not required to be disclosed, and not bound by laws of any state governments.
What these things are is this: a bet between A and B about C. B pays A. A will pay B if C defaults. B can sell his right be paid by A to someone else. A can sell his obligation to pay B if C defaults to someone else. NO ONE KEEPS TRACK OF ALL THESE CONTRACTS.
All these contracts do indeed exist, but they are not traded in public markets. The whole world is obliged to accept the risks from these contracts, without knowing anything about them.
$62 trillion of credit WORLDWIDE is now "guaranteed" by credit default contracts -- more than the GDP of the whole world -- more than the capital of all the banks and insurance firms in the entire world -- more than all the savings of all the corporations and all the people in the world.
I wrote an article about the 1987 crash that I sent to Muriel Siebert. My article didn't get published by Barrons, or anyone else, but Muriel Siebert used some of my words in her testimony to Congress. Some of her testimony was then used by the Comptroller of the Currency to describe reserve requirements for Banks here in the US. Both the Basel Accords and the Comptroller of the Currency use some of my phrasing, not that I've obtained a job in compliance anywhere. (I'm a Wharton CPA and former stockbroker working as as a tour guide here in NYC.)
I wrote then that the crash was precipitated by market participants engaging in regulatory arbitrage rather than actual risk arbitrage. Profits were made going back and forth among the differing margin requirements for stocks and futures (50% versus 5%). Risk was reduced most of the time for users of portfolio insurance, but that risk did not disappear. It was transferred to all the other market participants when the insureds traded in the public markets. Everybody who was not using portfolio insurance was forced to absorb potential losses from those who did.
Since changes in the law in 1999 under the direction of Phil Gramm and lax enforcement by W's administration, such arbitrage has only increased.
There are so many smart, wise, creative thinkers in every field. Hopefully, under an Obama administration these folks (including strident women!) will take the lead and leave the scheming evil ones in the dust.
I'm far from an economist, but in recent months I've been reading all I can on the subject; recently I've come to two conclusions about what future regulations should address:
1) Glass-Stengall needs to brought back from the dead; mortgage banks and investment banks need to be separate entities, and investment banks need to be restricted from using mortgages as an investment source.
2) As stated in this article, derivatives are a big problem; they need to be a) banned completely, or b) heavily regulated, and must be individually traceable and defined by a supportable initial value.
America is a MOCK of a democracy. Here's your proof!
The simple answers to all these questions happens to be that it is much better to go along with whatever the current brand of "bushwa" happens to be than to stand on principle, that is if you know what is good for your career. I think we all know this.