By opening its matryoshka, Glenn Greenwald is finding out what a small place Wall Street is.
I couldn't agree more that a more serious going investigation ought to be conducted. If that is frustrated by those in high places, it's a huge dysfunction.
As for traded CDS and their associated structured products, in particular, it does seem, even at this late date, that we have yet to come to a collective conclusion about whether these particular derivatives belong in a special category of risk(s), even among types of derivative instruments.
Still, before lamenting a lack of regulation, Glenn could spend some time thinking about what regulation he'd like to see and why. It makes a difference. It requires understanding what went wrong, on a case-by-case basis most likely, and thinking about how regulators could fix it.
For example, what firm are we talking about with this quote from the article he references?When housing prices crashed, the loans also went south, and the massive debt obligations in the derivatives contracts wiped out banks unable to cover them.
I could be wrong, but I seriously doubt it was derivatives, over-the-counter (OTC) or otherwise, that toppled the great Seattle bank (WaMU) or even Wachovia. Even the problems that drown Countrywide, Angelo Mozillo's dreamcart, were not related to OTC derivatives.
The failure to regulate probably most directly relates to the case of AIG, who reportedly set-up their infamous Financial Products division in a way to dodge what regulation there was. I should look it up, but I think they ended up directly under the Office of Thrift Supervision. That's right. What became a huge, complex, derivatives operation was quite possibly classified as a "Thrift" in U.S. law ...
Could the same risk in the case of AIG have been any collection of unregulated hedge funds? Conceptually, yes: a bunch of unregulated (non-reporting, slimly capitalized) entities with systemically important one-way bets. Practically, it's not quite as likely as that, because AIG had a 'AAA' rating, which it used to engage in the type of "regulatory arbitrage" business, helping out European banks by insuring debt instruments that wouldn't qualify without an added guarantee. You could make the case that a savvy regulator might have disallowed credit guarantees for that purpose ... but that's a different Oprah. It's worth noting that such a savvy regulator might NOT have "saved" AIG, who somehow concurrently bet the firm on a traditionally dreary business called 'securities lending'...
The general (indirect) failure to regulate probably relates to regulatory risk reporting, akin to the call reports that are filed by bank holding companies. Something like the lopsided risks that AIG was running might have appeared on even the most basic of aggregate position reporting.
A really forward-looking regulatory scheme might have forestalled that kind of shut-down. It's doubtful that the schema proposed by the CFTC in 1996 would have been that insightful. As it was, demands for collateral proved to be a systemic vasoconstrictor, including a Repo-market lock-up. No regulation probably could have stopped a general deleveraging (intense among hedge funds), and the dry-up of financing for arbitraging inefficiencies created by a massive one-way dash for protection.
The long history of fighting regulation of the OTC market is not entirely sordid, in the sense that many of the dire predictions of OTC disaster, going back to the early 90s, never materialized. What's more, the patchwork of global regulatory schemes have always created the additional, vexing pitfall of "havens", making the role of the Chief Regulator like fighting a Hydra. It's not quite as bad for 'traditional banks', but still.
One could make a strong case that the *real* problems of the past have been with the Corporate Office that does not understand the products that they are selling, even at basic levels. This is a failure to elevate the right kind of management, not of the OTC market, per se. It's hard to tell whether passing "product approval" to regulators, who may be similarly challenged (or paid off by lobbyists), is an obvious public good. Still, one should be open to the possibility that credit products / guarantees may be the exception to the rule ...
From a regulatory point of view, many of those problems relate to having accounting rules and enforceable capital requirements that are adequate to the risks being run and that do not distort the marketplace. As for just bad management, that relates to the ability of 'the system' to avoid too big to fail. Even big, diversified firms can go awry enough to hit the skids.
Last, those interested in yet another layer of perspective, read about the case of Conseco & Green Tree Financial, the Connecticut firm that went bankrupt, before "sub-prime" was anything but a technical term among loan professionals. David Brooks thinks its more about stupidity than about greed or that otherwise clever managements were duped by their own cleverness or by traders? What a belly laugh.
Saturday, April 4, 2009
Regulations
It's not clear whether regulation would have helped, because the CDS market appears to have grown in ways that proved problematic to it.
It's not clear whether regulation would have helped, because the CDS market appears to have grown in ways that proved problematic to it. The paperwork supporting the books grew and grew. When a crisis hit, a crisis like Lehman in which losses were suddenly larger than priced/anticipated, it appears that few had an immediate grasp of what all their counter-party risks were, exactly, and how to get out, go in reverse, cancel-correct. A temporary "shut down" appears to have occured, while everyone sorted that out, to some unknown degree, against the backdrop of heightened perceptions of settlement risks, to boot.Beyond managment's ability to understand the individual risks, did Glenn ever have a look at the staggering amount of collective real-estate debt on the balance sheet of global warship, Merrill Lynch, as it headed for the rocks, spraying its pirate masters with multi-million dollar payouts until the very end?
Beyond managment's ability to understand the individual risks, did Glenn ever have a look at the staggering amount of collective real-estate debt on the balance sheet of global warship, Merrill Lynch, as it headed for the rocks, spraying its pirate masters with multi-million dollar payouts until the very end? How is THAT related to OTC derivatives? Technically, it is, to the extent that they wrote liquidity puts (including the implicit ones) that forced them to suck back stuff they had sold or set-up SPVs that they had to take back on balance sheet, because they "failed". But, in the bigger picture, in that context of prudently managing the risks of the firm, those are not the 'causes', just the mechanisms by which disaster was invited, right?
