<em>Shadow Elite</em>: The "Secretive" Bankers Who Love Derivatives and Hate the Free Market

Banks keeping competitors out and price information to themselves are using tactics designed to maximize profits, but there's nothing free market about those tactics. It's up to the government to "free" the market, but so far it's failed.
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Surely if you asked the bankers at the center of the Sunday New York Times investigation -- "A Secretive Banking Elite Rules Trading in Derivatives" -- if they hate the free market, they would be aghast. But we oppose onerous taxation! We support fair and vigorous competition! Look, The Complete Ayn Rand is on my Kindle!

But words are not deeds. In practice, Wall Street's top players defy the very ideals of capitalism they claim to espouse, and that's the real outrage the Times exposes.

Reporter Louise Story examined how "nine members of an elite Wall Street society," described by critics as the "derivatives dealers club," gather each month, attempting "to block other banks from entering the [derivatives] market, and ... also trying to thwart efforts to make full information on prices and fees freely available."

This banking elite dominates by privatizing information, thwarting access to the inner-circle of decision-making, and exerting influence with public officials, which is the modus operandi of the most agile players of the shadow elite era. This MO was something Janine saw up close as a social anthropologist in Eastern Europe as the Cold War drew to a close. After Communism collapsed, the informal networks that amassed and guarded vital information didn't collapse with it, but rather rose up to configure, and sometimes even to become the new system.

This is not unlike what we are seeing in the financial markets. The new derivatives clearinghouses were borne of the 2008 calamity -- as regulators pushed banks to set up a more centralized way to track this dizzyingly complex, enormous, opaque and hugely profitable market.

But rather than open the system up to competition, the same old crowd of powerful banks are, of course, eager to seize control. They'd like to keep as many derivatives out of the clearinghouses as possible, because any move towards a more transparent (free) market -- with better price information -- could slam their profits. One proponent of electronic trading told the Times that customers might have paid tens of billions of dollars in "economic rent the dealers enjoy from a market that is so opaque." (While likely true, that proponent does have a clear financial interest in making that assertion.) And the Chairman of the Commodity Futures Trading Commission adds that the cost trickles down to "all Americans."

For the portion of the market that does end up in the clearinghouses, bankers will still seemingly have enormous discretion over how derivatives are cleared, and what competitors they will allow in. As Story notes, "Under the Dodd-Frank bill, the clearinghouses were given broad authority," to set up and manage their own "risk committees" where the rules are made. And the bankers' Republican friends are helpfully trying to expand the banks' self-regulating power. We all know how well that worked in the past.

Critics of the Times piece (and there are quite a few) say that it is to be expected that the big banks would try to keep smaller competitors out, because they add too much risk if they do not have enough capital to contribute. Point taken. But one would have to be naive -- or on a beach with no wifi for the last 2 years -- to assume that the banks are primarily worried about the structural integrity of anything. If recent history is any indication, these groups are obviously interested in maximizing profit. Keeping competitors out and price information to themselves are tactics designed to maximize profits, but there's nothing free market about those tactics. That's why it's disheartening to see that the government, even in a period of supposed reform, shows little inclination or ability to really "free" the market -- by insisting on price and information transparency and full and fair competition. The bankers have too many powerful friends they've long been supporting.

The Times mentions similarities between the derivatives market and the Nasdaq market of the 1990's:

Back then, the Justice Department discovered that Nasdaq market makers were secretly colluding to protect their own profits. Following that scandal, reforms and electronic trading systems cut Nasdaq stock trading costs to 1/20th of their former level -- an enormous savings for investors.

The idea that this could happen again -- in the case of derivatives -- is the bank's big fear; and an investor's great hope. It's a capitalist's great hope, too.

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