Who's More to Blame: Ben Bernanke or Credit Derivatives?

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The case for credit derivatives, by Dan Caplinger
In general, when you're looking for a scapegoat, you want to grab the highest-profile person you can find. But with the current financial mess, the real culprits are hiding in the shadows: those who created all those lovely little credit derivatives that still hang over the heads of most financial institutions.

Who they are remains mostly unknown. An article in Portfolio magazine recently discussed the role of a guy named Bill Demchak, currently vice chairman at PNC Financial (NYSE: PNC  ) , who used to work in a group at JPMorgan Chase (NYSE: JPM  ) that pioneered credit derivatives. But you won't find household names among this group of credit-derivative forefathers.

What you will recognize, though, are the results. Credit default swaps have run rampant, causing panic as their values imply cataclysmic business failures ahead. Just this week, swaps on Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) traded at levels that treat the company as a junk-bond issuer. Some even argue that swap holders are actively pushing for companies from Six Flags to Ford Motor (NYSE: F  ) to default -- just so their swaps will pay off.

Don't blame Bernanke
I understand that pointing at some back-room invention from Wall Street isn't as pleasing as fingering a leader like Ben Bernanke for the financial crisis. Plenty of my fellow writers at the Fool have mocked Bernanke relentlessly over the years.

But the derivatives that are behind this debacle have been around a lot longer than the three years that Bernanke has headed the Fed. Even if you really want to blame a policymaker, Bernanke's not your best choice. History will show that while Bernanke had the misfortune of being around when the spit hit the fan, the missteps of the Fed under his predecessor, Alan Greenspan, created the environment where Bill Demchak and others could build their financial Frankenstein.

The case for Ben Bernanke, by Anders Bylund
Oh, Ben, dear Ben. You have done more than your share to bring the world economy to its knees.

As the bearded head of the Federal Reserve, you had the power to effectively put a stop to crazy mortgage-lending practices. Just quadruple the Fed interest rate overnight and see how many new loans get written. It worked in Norway and Sweden 15 years ago, but you chose to take the less controversial stance and emulated Japan's Lost Decade instead. Thanks a lot, pal.

But that's not all. Your damage control was a day late and a dollar long. It was a good sign when Lehman Brothers was allowed to fail -- that's capitalism working as it should -- but then the bailout nonsense started. And kept going and going like a pink drum-beating bunny.

You should know better, Ben. More of the Lehman approach and stricter interest-rate policy would go a long way toward fixing what's wrong with the economy. More undeserved life vests to drowning failures like AIG (NYSE: AIG  ) and General Motors (NYSE: GM  ) just drag the pain out over many years to come.

Let the failures fail. Let the winners win. You're doing neither with these boneheaded policies, Ben.

Don’t blame derivatives
Blaming credit derivatives is betting on the wrong horse: They may have done the damage, but they are just tools of the trade. It's like burning down your house and blaming Swedish Match for selling you the matches. Remember that guns don't kill people. Chuck Norris kills people. Barring that, people with guns kill people.

And that deadly flow of derivatives that spun out of control could have been slowed down with an ice bath of high interest rates. Let high-interest loans kill the crazy mortgage underwriting, and a lot of lunatic derivatives would never have been born.

Or how about this crazy idea -- regulate how to use these potent and potentially devastating tools? Ben (with the help of the SEC) could have been more direct in calling for change there too, using his influence to change policy. Forcing Citigroup and Goldman Sachs to deleverage a bit could have loaded the derivatives with a few more blanks.

No, don't hate the game -- hate the players. Financial derivatives are wealth creators when used properly, but we let the kids play with a whole matchbox unsupervised.

Check out the Fool’s entire 2009 March Madness bracket here.

Fool contributor Dan Caplinger finds derivatives fascinating, even if they seem like an Ebola virus to many. He own shares of Berkshire Hathaway. Fool contributor Anders Bylund has no financial interest in any company mentioned. He does have a mortgage and puts gas in his car, though. Berkshire Hathaway is a Motley Fool Inside Value recommendation and a Motley Fool Stock Advisor selection, and JPMorgan Chase is a former Motley Fool Income Investor selection. The Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy is mad about you.

Read/Post Comments (3) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 17, 2009, at 2:27 PM, cynicalman wrote:

    I would like to have voted to neither since reading an article in the latest "Wired" :

    because of this article I would vote for David X. Li as the person responsible! Because of Mr. Li's formula (flawed as it was) the rating agencies and the SEC put AAA ratings on these credit default swaps and mortgage bundles allowing brokers to buy and sell thinking everything in the bundles were AAA rated when in fact as house prices began to fall the dominos tumbled and now we are left with someone trying to value these bundles when there is no way to value them once Mr. Li's formula failed. Mr. Li has left the country and the world is left with a mess!

  • Report this Comment On March 17, 2009, at 2:31 PM, ResponsibleMoney wrote:

    "It was a good sign when Lehman Brothers was allowed to fail -- that's capitalism working as it should -- but then the bailout nonsense started."

    The fall of Lehman led to the "bailout nonsense" as you put it. When Lehman went down, it froze the credit markets. Frozen. No movement whatsoever. We've been slowly trying to get out of that collapse ever since. What Lehman did was make everyone -- creditors, debtors, government officials, professional investors -- realize that system risk was a reality. It wasn't a theoretical concept any longer. It exists, and it will destroy everything if it is not addressed. Do you really think that the government wants to pull down its pants and bend over for AIG? Do you really think any President would want to do that when so much of the electorate wants AIG to fail? Heck, I want AIG to fail but I know it's not an option right now for anyone who's sane -- not until all its derivatives and questionable insurance policies are unwound. That is going to take years. It took Berkshire 4-5 years to unwind its derivatives in General Re. Thank goodness you're not in government. We'd be in chaos right now.

  • Report this Comment On March 17, 2009, at 2:34 PM, tom23456 wrote:

    Where's the blame on Barney Frank who lowered the Fannie & Freddie credit policy so low that a dog could get a loan. The whole time stuffing his pockets with all those illegal kickbacks and contributions. Never has one man caused so many problems for greed and then blame everyone else. Just once I would like to see one of these corrupt congessman stand up and take any blame. It's so corrupt it sickens me.

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