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Join the Fool as we assess blame for this financial meltdown -- March Madness bracket style! Below is one of four second-round matchups you can vote on … enjoy!
The case for derivatives, by Dan Caplinger
Having already made the general case for why derivatives are most to blame for the financial crisis, I wanted to share some thoughts from a well-respected analyst on the subject:
- In correctly predicting last July that Wachovia would burn your portfolio, he cited accounting practices that "disguise the true extent of derivatives losses" as a primary factor for his winning call. The stock's price fell from $17 when he made this call to below $1 before Wells Fargo (NYSE: WFC ) grabbed the bank out from under Citigroup's (NYSE: C ) nose for $7.
- A year ago, he pointed out how the crisis would spread to Europe, noting that "toxic securitized debt instruments and deleveraging derivatives may be among the leading exports from the U.S. for a while."
- One oft-cited factor in his bullish calls for gold stocks like Yamana Gold (NYSE: AUY ) is how "[c]redit markets remain effectively dysfunctional, and the multi-trillion-dollar derivatives market appears set to continue de-leveraging."
Who's this prescient analyst? None other than Christopher Barker, my esteemed opponent, who finds himself somewhat awkwardly on the other side of the argument in this debate.
Admittedly, I can see how the repeal of Glass-Steagall could seem like a tempting scapegoat for the crisis. Combining banks with securities firms carries the potential for huge conflicts of interest. But it fails to explain a number of things:
- How did banks and other lenders that didn't even have securities businesses, such as Countrywide Financial, Washington Mutual, and IndyMac, manage to set in motion the cycle of toxic mortgages that got us in this mess in the first place?
- How did securities firms that until recently had absolutely no banking exposure, including Goldman Sachs (NYSE: GS ) and Morgan Stanley (NYSE: MS ) , get to the point of needing capital infusions in order to survive?
The answer to those questions is the proliferation of derivatives. That's why I believe derivatives deserve more of the blame.
The case for the repeal of the Glass-Steagall Act, by Christopher Barker
I'm proud of you, Fools!
Alan Greenspan certainly helped set the stage for this crisis by fostering excessive liquidity in the credit markets. Ben Bernanke is presently dumping indebtedness upon unborn generations of Americans in what I consider a fatally flawed response strategy.
Nonetheless, you well-informed Fools peered beyond those alluring scapegoats and voiced your greater discontent with the fateful extinguishing of Glass-Steagall and the creation of those convoluted instruments called derivatives. By selecting these factors over Greenspan and Bernanke, you exhibit a keen understanding of the historic events now unfolding.
You can't have a chicken without first having an egg. The relaxing of Glass-Steagall back in the 1980s -- which permitted the predecessors of JPMorgan Chase (NYSE: JPM ) , Citigroup, and others to deal in instruments like mortgage-backed securities and commercial paper -- was the rotten egg which eventually hatched into the present derivatives debacle. The failure to heed the lessons of history permitted history to repeat itself.
Derivatives became the scourge of the Earth only after flourishing in a sea of deregulation. Indeed, the unchecked expansion of derivatives in recent years formed a key foundation for my reluctant bearishness toward the U.S. dollar. Since 2002, when Warren Buffett called derivatives "financial weapons of mass destruction" in a letter to Berkshire Hathaway (NYSE: BRK-B ) shareholders, the global derivatives market has ballooned from $100 trillion to at least $684 trillion. Jim Sinclair, chairman and CEO of Tanzanian Royalty Exploration, estimates a notional value of well over $1 quadrillion (that's 1,000 of these!).
The unwinding of these instruments may indeed yield shock and awe, but the mess could never have been made with those Depression-era regulations intact. If you select the Glass-Steagall repealers on the basis of this argument, I will highlight the significant role of derivatives in subsequent rounds.
Check out the Fool’s entire 2009 March Madness bracket here.