Sunday, April 18, 2010
“Who Would Not Want the Transparency [for Derivatives]? The Only Parties that Benefit from a Lack of Transparency are Wall Street Dealers.”
There is a huge fight going on right now over whether or not derivatives will be made more transparent.
While this is being portrayed as a partisan battle, it is really a battle between the big banks and everyone else. Indeed, the guy in charge of regulating derivatives - Gary Gensler - says that the only opponents to transparency are the big Wall Street derivatives dealers.
As the Financial Times wrote last month:
The cry of "draining liquidity" is, of course, a thinly-disguised cover for the big derivatives dealers' real concern - reducing profits (and - remember - we are in an insolvency crisis, not a liquidity crisis).
“Who would not want the transparency [for derivatives] that you have in the stock market?” said Gary Gensler, chairman of the Commodity Futures and Trade Commission, and one of the regulators in the US who has become a strong advocate of big reforms. “The only parties that benefit from a lack of transparency are Wall Street dealers.”
Theo Lubke, head of markets infrastructure division at the Federal Reserve Bank of New York, which has been spearheading regulatory efforts to improve information and the structure of derivatives markets, said that recent uncertainty around the trading in Greek CDS had highlighted the importance of greater transparency. “The lack of good knowledge by regulators [about OTC derivatives] is not a tenable long-term equilibrium,” he added.The big derivatives dealers – which include the largest Wall Street banks Mr Gensler referred to – say requirements to publish trading volumes and prices for the privately-traded derivatives markets in a similar way to stock markets could drain liquidity from large parts of derivatives, and result in price information which is inaccurate or misleading.
And the "inaccurate or misleading" price argument is also a smoke screen.
Specifically, as I pointed out last October:
Leading derivatives trader and expert Satiyajit Das wrote a must-read article pointing out the falsity of the justifications used by both buyers and sellers of credit default swaps and other complex forms of "financial innovation":While all of the focus is on the battle over derivatives legislation, the truth is that legislation is only a small part of what is really going on.The unpalatable reality that very few, self interested industry participants are prepared to admit is that much of what passed for financial innovation was specifically designed to conceal risk, obfuscate investors and reduce transparency. The process was entirely deliberate. Efficiency and transparency are not consistent with the high profit margins that are much sought after on Wall Street. Financial products need to be opaque and priced inefficiently to produce excessive profits or economic rents.
Das is not alone. The top derivatives experts all say (except those who work for the too-big-to-fail banks) that CDS are incredibly dangerous, don't provide much benefit to the consumer or the economy as a whole, and must be reined in.
The Bloomberg article goes on to give the real reason that the TBTFs and their many lapdogs in Congress don't want CDS regulated:
The change [in Obama's proposed regulation being championed by McMahon and Frank, which even the guy who formerly blocked regulation is now saying is too weak] could protect billions of dollars in profit for the dealers. When securities or derivatives are traded on exchanges -- where investors can see real-time prices, rather than indicative prices sent by e-mail in the over-the-counter market -- it can shrink the amount that dealers make on each trade, known as the spread.
“Having more discretion for the dealers in the regulations gives an extra benefit to them by staying away from narrower spreads,” said Darrell Duffie, a finance professor at Stanford University in California.
The top five U.S. commercial banks, including JPMorgan, Goldman Sachs and Bank of America Corp., were on track through the second quarter to earn more than $35 billion this year trading unregulated derivative contracts, according to a review of company filings with the Federal Reserve and people familiar with the banks’ income sources.
The banks are arguing that an exchange or trading-system mandate that publicizes large trades could make it too expensive or impossible to execute customer orders and hedge those trades at the same time, according to the people familiar. Publicized large orders may dry up the willingness of dealers and investors to buy or sell contracts, they said...
Not mandating exchange or other types of electronic trading “will probably prevent spreads from dropping like a rock,” said Kevin McPartland, a senior analyst in New York at Tabb Group, a financial-market research and advisory firm...
In other words, beneath all of the fancy arguments from the TFTFs and their mouthpieces in Congress, the real reason that they don't want CDS regulated is because it will narrow the spreads, and they will make a little less money. In addition, transparency would reduce the market, because investors would see CDS as the snake oil that they are (outside of some very narrow, specific uses).
The TBTFs couldn't care less that a huge, unregulated CDS market will destabilize the economy and lead to crises in the future.
Why should they? As Nobel prize-winning economist George Akerlof predicted in 1993, the financial giants would use CDS until the system crashed, knowing that the taxpayers would bail them out when the crash happened.
They know the same thing will happen tomorrow . . .The bottom line is that we are now in a system where gains are privatized and losses are socialized (and see this). The debate over CDS is really one part of the larger debate as to whether that system will continue or not.
As I pointed out last Thursday, no matter what legislation is or is not passed, derivatives will never be transparent until the giant banks are broken up.