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It's About Derivatives, Twice

You might wonder how the Senate Committee on Agriculture, Nutrition, and Forestry could hold a hearing on issues that are central to the financial crisis and cleaning up the aftermath. That’s easy: derivatives – options to buy and sell crops – matter a great deal for agricultural producers. If these markets work well, that helps farmers. If the markets malfunction (a euphemism for someone doing bad things), farmers get angry – with good reason.

Today, the committee is convening two panels on derivatives. The first has just one witness, Gary Gensler, incoming chairman of the Commodity Futures Trading Commission. It’s the CFTC that you hear so much about from the debate of the 1990s – the head, Brooksley Born, wanted to regulate derivatives, and others, such as Gensler (then at Treasury) were opposed. The Treasury team won that round and you know how the movie ended. Now we’re watching the sequel and it will be fascinating to see what Mr. Gensler has to say. My guess: “When the facts change, I change my opinions; what do you do?” This is currently Larry Summers’s favorite saying, and Gensler used to work for Summers in the 1990s – perhaps in some important senses he still does, as Summers is the administration’s overall economic guru.

The second panel is an all-star line up of experts and advocates from various sides of the broader issue; names and positions are below. Richard Bookstaber is a blogger, with deep experience in the financial markets. He favors some fairly limited reforms. Lynn Stout is a professor, probably inclined to push further and harder toward real change. The other witnesses are from various parts of the industry and seem likely to favor keeping markets more or less as they are – tell me if you think I’m proved wrong about that.

Panel 2:

  • Lynn Stout, Professor, UCLA School of Law, Los Angeles

  • Mark Lenczowski, managing director, J.P. Morgan Chase, Washington

  • Richard Bookstaber, New York

  • David Dines, president, Cargill Risk Management, Hopkins, Minn.

  • Michael Masters, Partnership Financial Consulting, Atlanta

  • Daniel A. Driscoll, executive vice president and chief operating officer, National Futures Association, Chicago

--Simon Johnson

By Terri Rupar  |  June 4, 2009; 7:30 AM ET
Categories:  Regulation  
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Credit Default Swaps -- three little words that just about destroyed the world's financial system. From a humble beginning 15-20 years ago, these "instruments of financial destruction" (to quote Warren Buffet) have grown to dollar amounts that have range up to almost $600T (against a World GDP of about $53T), as reported in the following item:

100 Year Crash: McCain advisor spurred $62 trillion derivatives market that will swamp global markets

Lurking in the background of this weekend's collapse of two of Wall Street's biggest names, is a $62 trillion segment of the $450 trillion market for derivatives that grew huge thanks to John McCain's chief economic advisor, Phil "Americans are Whiners" Gramm. That's because in December 2000, Gramm, while a U.S. Senator, snuck in a 262-page amendment to a government re-authorization bill that created what is now the $62 trillion market for credit default swaps (CDSs).

While maybe CDS's make sense if you happen to have an interest in the underlying asset in which you are invested, the Investment Banksters became greedy (particularly AIGFP) and began selling "naked" CDSs--people could now bet on the failure of various financial instruments without having any direct interest in the underlying assets themselves. And now, thanks to Congress, the American Taxpayer has bailed out AIG to the tune of almost $200B--much of this money going to European banks.

Congress needs to take full responsibility here--and explain how the American Taxpayer can be responsible for paying off any portion of $500T in "Investment Bankers' bets"!

Posted by: wmartin46 | June 4, 2009 11:54 AM | Report abuse

Yes, Madoff was supposedly being "regulated" and how did that work out? And how can you regulate something you can't understand? I think derivatives would regulate themselves quite nicely once everybody understands THERE WILL BE NO BAILOUTS AND YOU CAN LOSE ALL YOUR MONEY!!! The demand for these instruments would decrease greatly and the only ones still playing them would be the gamblers who can afford to lose.

Posted by: brewstercounty | June 7, 2009 10:23 AM | Report abuse

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