Posted on 09/22/2007 7:02:06 AM PDT by shrinkermd
...When it comes to Fannie Mae and Freddie Mac, the presumed government backing is called an “implicit guarantee.” On Wall Street, it has many names — ex-post insurance, a Greenspan put, or now, a Bernanke put. Whatever you call it, its existence demands that markets be subject to adequate rules and oversight.
That’s clearly not the case at present. Hedge funds and private equity firms, which are allowed to operate largely in secret, need to be subject to more official scrutiny so that the Federal Reserve and the Treasury have a grasp of their activities before big problems occur and so that investors affected by their actions can better assess the risks they’re taking. Regulators must develop and coordinate a system for staying on top of the overlapping instruments and transactions that fuel market activity.
Currently, regulators can’t even decide if the derivatives at the heart of so much of today’s instability are securities, which would fall under the purview of the securities’ regulators, or futures contracts, the purview of commodities’ regulators.
It is possible to strike a balance between monitoring markets and protecting proprietary information, between fostering innovation and curbing excessive risk-taking that all Americans end up on the hook for. Mr. Bernanke and Mr. Paulson should be leading the way. If they won’t, Congress and the next administration have their work cut out for them.
(Excerpt) Read more at nytimes.com ...
The editorial outlines the problem. Thus far no one has even suggested, let alone debated, a solution.
I certainly reject more regulation and bureaucracy as any part of a solution. I also reject the notion of essentially being blackmailed due to the magnitude of the irrationality.
The reality is, that removing the gov’t implied backing probably makes the most sense. Then it is just private contracts between individual parties.
Don`t cha` just love hedge funds. Slicksters create them , make millions whether the fund itself grows or not and then they retire at age 35 with millions in their back acoount.
Solution: bigger government????
Friedrich Hayek was right. These defacto insurance policies constitute nothing but subsidy - and just like for all other subsidies, bailouts, and other supposed "necessities", these glorified taxpayer-funded handouts need to be eradicated. To use the failure and expense invoked by these policies to further regulate industry is precisely what Hayek envisioned - letting the government promote, nay, empower failure, and then using that failure to argue that the government needs a stronger hand (any guesses on the next phase of the cycle?).
Problem: Without a government there is no way to enforce contracts. Think Somalia vs. US.
Problem: Without oversight you have no way of knowing what financial contracts are fraudulent or impossibly risky. Think OTC derivatives vs. NY Stock Exhange.
I don’t know who to scold the most, the editorial incompetents at the NYT or those people on FR who think they have a clue what these markets are. I hold the NYT to a higher level on this issue, because they have the ability to lie and scare the public.
Financial derivatives are mostly business to business balance sheet transactions. Not income statement transactions. Most financial derivatives are not sold to the public. For example, if I am an importer of a certain type of raw material to make a manufactured good, and that material is projected to rise in value next year, I might buy a derivative product that would lock in the cost of purchasing that material next year. The other side of that transaction is likely to be the producer of the material. How is that risky to this economy???
Other types of derivatives include interest rate swaps. Bank One might decide to ‘swap’ its fixed rate loans to another bank in exchange for some of their variable rate loans. Financial institutions do this all the time to better match their assets to their liabilities. This reduces risk to the economy. If you don’t believe that, go back and look at the history of the S&L industry, which blew up over time because they had huge inventories of fixed rate mortgages, which they had to finance with rapidly growing deposit rates (remember how rates spiked in the early 1980’s). Since they couldn’t match their assets and liabilities, they reapidly lost money. It was in this environment that the GSE’s in real estate evolved to take the risk of this off the books of the banking sector.
Another major derivative is currency futures, which mostly are used to reduce the risk of large currency movements. Importers and exporters buy huge amounts of these to ensure ‘price stability’ in the cost of the currency part of the transaction. If we have learned nothing in the last year of currency fluctuation, it is the desirability of ‘hedging’ that risk.
Don’t kid yourself, the reason why the NYT’s and their fellow travelers are raising this issue is to try to gain regulatory control over a rapidly growing economic market that they can tap into for more social control.
As to the issue of implied guarantees: yes, there are definitely times when these implied guarantees are taken too far. But that is the classic economic story of taking a few steps backwards in order to take many steps forward. Sometimes I feel that some readers of this website would prefer to experience the Great Depression again because it would validate their economic purity of free markets. The whole reason for these types of derivative markets, as well as certain levels of regulation, is to try to smooth these economic cycles out. It is hard to fathom arguing that the economic policies of the last 25 years, combined with the growth of information systems and management approaches has not been accomplished.
If you want to see how life looked before some of the better regulation take a look at the investment markets of the 1920’2 before the advent of the Securities Acts of 1934, 1939 and 1940, when people invested blindly without any insight into whether a company existed, no uptick rules on short selling existed, etc.
As for Soros, et al: It is true that Soros in particular made a fortune in trading derivatives. As toxic as I found his politics, he accomplished his profits legitimately. The book he wrote, The Alchemy of Finance, is a very well written guide to trading and investing. That doesn’t mean I am not rooting for his financial demise (hopefully he will spend all his money and still not get electoral success!).
Pinch buried his Leftist lead, shrinker. Go back and read it again.
Derivatives are so complicated, even the hedge funds and investment firms that create them with all their brilliant quant jocks get it wrong sometimes. Look at the recent billions and billions lost by various firms such as Bear Stearns and Goldman Sachs.
It’s somewhat worrysome and clearly a few individuals haave the leveraged ability to cause a global financial crisis. But does anyone think the government can regulate this any better other than free market incentives? Noone wants to lose money.
Derivatives are just contracts. In my opinion, we don't need any more regulatory scrutiny of a contract dealing with a security or a set of securities than we do of any other type of contract between private parties.
Assume that you write a contract with your neighbor that gives him the option to buy a piece of land from you at a certain price for any time over the next year. Should you be forced to call in some "land sale regulators" to check over the terms of that option?
Or let's say that you want to buy the option to buy 10 head of cattle from a local farmer at a fixed price over the next year. Should that option also have go through the local "beeves-on-the-hoof options regulator" to be scrutinized for regulatory compliance prior to the agreement being signed?
Then why should we have regulators looking at every contract for every swap of interest rates on holdings of yen and dollars?
I don't want to burden you, but the fourth largest bank in the UK just became a government ward. The very informative Telegraph article is HERE.
How did this large, well run bank go broke on sub-prime loans from the US?
I must say suspicion is also rampant on some ethical and responsible financial Web Sites. See Jim Sinclair below: The following are some important notes in response to the following article:
Think positive and hope for the best, but know you are now prepared for the worst. This is a $20 trillion dollar problem that lacks any functional final solution."Have some cash at home. Have some one ounce gold coins at home. All investments should be taken in certificate form if are positive you will not misplace them as replacing certificates can be a disaster. No investment you have should have the anything to do with over the counter derivatives. Would you believe that GE is a major derivative dealer? Think twice about any Internet financial service from banks to brokers. Since you must have a broker, select a small traditional human broker with no over the counter directives on their books, in their safe or on the Internet. Ask for a letter confirming that before opening your account. When you make a trade get certificates. For sales, deliver the certificates and make the trade. Park spare cash in Canadian National, not Provincial, T Bills. This has been my advice to you since 1999.
I copied and pasted this missive not because I believe it to be true, but to indicate, if these people are ignorant, the problem is they are influential in the gold and other commodity markets.
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