Thursday, October 09, 2008

The quadrillion dollar derivative market and how one woman tried unsuccessfully to regulate it

The Times had a great article about how a lady chairing the Commodity Futures Trading Commission (CFTC) ten years ago was thwarted by the all knowing Mr. Greenspan in her attempts at bringing greater regulatory authority over options, swaps and futures (derivative instruments). These are the very instruments that led to our current global financial meltdown. The value of these instruments have ballooned from about $100 trillion six years ago to $0.5 quadrillion dollars (yes, quadrillion – I did not make it up). When people say that the bailout amounts ($700 billion) proposed is just a drop in the bucket, they are absolutely right...

In 1997, the CFTC, a federal agency that regulates options and futures trading, began exploring derivatives regulation. The commission, then led by a lawyer named Brooksley Born, invited comments about how best to oversee certain derivatives. Born was concerned that unfettered, opaque trading could "threaten our regulated markets or, indeed, our economy without any federal agency knowing about it," she said in Congressional testimony. She called for greater disclosure of trades and reserves to cushion against losses.

Born's views incited fierce opposition from Greenspan and Robert Rubin, the Treasury secretary then. Treasury lawyers concluded that merely discussing new rules threatened the derivatives market. Greenspan warned that too many rules would damage Wall Street, prompting traders to take their business overseas.

"Greenspan told Brooksley that she essentially didn't know what she was doing and she'd cause a financial crisis," said Michael Greenberger, who was a senior director at the commission. "Brooksley was this woman who was not playing tennis with these guys and not having lunch with these guys. There was a little bit of the feeling that this woman was not of Wall Street."

This summer, the Bank for International Settlements, estimated that the face value of derivatives floating around the world is $1.14 quadrillion. That is $1,140,000,000,000,000.00. The breakup was distributed between $548 trillion in listed derivatives or traded on organized exchanges and $596 trillion under over-the-counter derivatives that were basically unregulated and unmonitored.

Maybe Mr. Greenspan should have listened to that little lady warning him then in 1997. Maybe, but hey, she would not play tennis with the guys nor have lunch with the guys... How can such a lady give credible advice? It also does not help that Greenspan was an avid follower of that libertarian cheerleader Ms. Ayn Rand.

Meanwhile, the National Debt Clock in midtown Manhattan has run out of digits to record the growing debt.

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