The End Game for Wall Street

Derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.
--
Warren Buffett, 2002

Do you remember swaps, those frequently risky and opaque derivatives that nearly brought down the global economy in 2008? They're used for insurance and for gambling, but despite having a notional value estimated at $450 trillion, some of the most dangerous swaps remain totally unregulated, even two years after the financial crisis.

Well, Fools, within just a couple of weeks, we might actually do something about fixing that.

But first, it's important for us to recognize just how crazy and dangerous the swaps market currently is. For example:

No one has any idea what they are worth
Imagine if there were no stock exchanges, and the vast majority of stocks traded over the counter. Five banks -- Goldman Sachs (NYSE: GS  ) , JPMorgan Chase (NYSE: JPM  ) , Morgan Stanley (NYSE: MS  ) , Citigroup (NYSE: C  ) , and Bank of America (NYSE: BAC  ) -- cornered the market, and only they had access to stock prices. 

So in order to buy shares of Microsoft, instead of just looking up its $26 price, you would have to call up Goldman Sachs and ask how much Microsoft will cost you. Goldman offers to sell you Microsoft at $30 per share, offers to buy shares from another customer at $20 per share, and pockets $10 for every share of Microsoft traded. That's basically how the anti-competitive swaps market works. It's an economically inefficient system that benefits too-big-to-fail banks by allowing them to rip off their customers.

They blow up all the time
Unlike the regulated insurance and gambling markets, there's no law that says you can't sell $400 billion of credit protection if you can't afford to cover eventual losses. Yet that's what AIG (NYSE: AIG  ) did in the lead-up to the financial crisis. Moreover, the swaps market forms a series of opaque interlocking contracts all across the industry. So when Lehman Brothers blew up, AIG was on the hook for payments it couldn't afford. And instead of letting the world's largest insurer go bankrupt, and economic panic ensue, taxpayers ended up footing a $180 billion bill.

From Orange County and Procter & Gamble in 1994 to Long Term Capital Management in 1998 to AIG in 2008, swaps have a history of causing massive, unexpected losses. They're a huge part of why the banks mentioned above are so risky, so profitable, and "too big to fail."

We are subsidizing them
Currently, banks can fund their swaps trading units with FDIC-insured deposits. Furthermore, each of the five major dealers mentioned above has access to the Federal Reserve's discount window, which allows them to borrow money for gambling in swaps at near-0% interest rates. But the whole point of FDIC insurance and the discount window is to reassure the public that their deposits are safe, and to protect banks from runs on their deposits -- not for the government to help banks finance their own casinos.

For example, it's been estimated that 80% of credit default swaps -- the kind that blew up AIG -- are "naked," meaning they're pure speculation.

So what's the plan for fixing the swaps market?

The derivatives portion of the House bill is a mess; however, because of public outrage at Wall Street, the Senate section on derivatives didn't sell out. It actually addresses those three problems. And now that key House members are lining up in support of real swaps rules, it looks like the Senate version could prevail. Here's what it would do.

1. Require swaps to trade on exchanges
By putting swaps on exchanges, the Senate bill would make market prices for swaps publicly available, and make it harder for banks to rip off their customers. Wall Street justifies the risks its traders impose on the rest of society by citing the "liquidity" and "price discovery" they allegedly provide. Unless Wall Street CEOs and lobbyists are disingenuous people, you'd thus expect banks to be revved up about getting their products out of the over-the-counter derivatives netherworld, and into the light of day; doing so would promote liquidity and allow them to be priced.

2. Require collateral
The Senate bill also requires swaps traders and users to post collateral to a central clearinghouse. That way, we know that banks and insurers can actually afford to make good on their promises. Furthermore, it untangles the confusing web of interlocking counterparties, so that a single failure will be less likely to cause a market panic.

3. Section 716
Here's the part of the Senate reform bill that's been called a "Hiroshima to the era of greed." Section 716 is a straight ban on federal assistance to banks that continue to deal in swaps. If it's included in the final reform bill, the five swaps dealers mentioned above would need to either spin off their swaps trading desks, or create swap-trading subsidiaries with their own capital, instead of relying on FDIC-insured bank deposits, cheap Federal Reserve interest rates, and bailouts.

Wall Street went completely berserk over Section 716, throwing its full weight against the position. Apparently, the big banks think it's the federal government's job to help them fund gambling.

Section 716 is one of the few strong sections of the financial reform bill lobbyists haven't been able to weaken or gut, even after multiple attempts. Every step of the way, Congress proved less afraid of lobbyists' wrath, and more fearful of looking like sellouts over derivatives reform during an election year. Public pressure really worked.

Wall Street has one more chance to kill derivatives reform, and Section 716 is No. 1 or No. 2 on its hit list. Over the next month, a conference committee of key members from the House and Senate will be choosing what will go into the final House-Senate reform bill, and what will get scrapped. This meeting will likely be the endgame for reforming Wall Street -- until we have another financial crisis.  

What do you think? Should the federal government continue to encourage swaps trading with subsidies? Let us know in the comments box below. And if you have a minute and want to make your voice heard, click the petition below to tell your representatives to support Section 716 of the Senate bill that bans government subsidies for swaps trading.

Petitions by Change.org|Start a Petition »

Fool editor Ilan Moscovitz doesn’t own shares of any company mentioned. The Motley Fool is investors writing for investors.


Read/Post Comments (48) | Recommend This Article (146)

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 June 08, 2010, at 4:36 PM, toweringinferno wrote:

    Let's keep up the pressure to pass the reform bill including Section 716!

    ralphsnelson@q.com

  • Report this Comment On June 08, 2010, at 4:46 PM, jimmybox wrote:

    You make a good point regarding the problem of a "confusing web of interlocking counterparties." As you state, this problem can be rectified by raising collateral requirements.

    However, the swap market is in no way anti-competitive simply because it trades over the counter. The ENTIRE BOND MARKET trades over the counter. Despite the lack of exchange listing, many corporate credit default swaps are more heavily traded that large cap domestic equities. If the customers thought they were getting ripped off, they wouldn't trade the instruments.

  • Report this Comment On June 08, 2010, at 5:00 PM, razzamatazzer1 wrote:

    I say: KILL-KILL-KILL the Too Big to Fail banking programs that are in place and put in new regulations so that if they want to take the big gambles,that they are in the public's eyes and are on their own if they lose and fail.NO MORE BAIL-OUTS!If I took a gamble and lost....it would be my fault and I would have to accept the outcomes.There is no bail-out for me,except through hard work and saving.

  • Report this Comment On June 08, 2010, at 5:08 PM, x1x2x3x4444 wrote:

    First of all, these guys should be in jail - some will rob you with a six gun, some with a fountain pen. No criminal of AIG? Seriously? First it was idiotic to repeal Glass-Steagall without imposing some other safety measures so the public wouldn't be financing Wall Street's sleezy, criminal behavior. It's at times like these that I think we should line a bunch of investment bankers up against a wall and shoot them. For real - nothing slakes their desire for wealth and power and nothing curtails their corruption. Left alone, they will destroy the world - the whole time proclaiming they are the chosen ones, those who do great public good and that their detractors are the poor, the weak, the uneducated who cannot be aloud to drag down the mighty. Why this country is not in open revolt - and I don't mean the Tea Party crowd - I do not understand. These people will stop at nothing until they have exploited every last corner of the world in their greedy, destructive razor-edged, homicidal snare. Regardless of whatever legislation is passed, these people will not stop - they will just move to some other country where they can continue bribing and blazing a glorious homicidal path - can anyone say Halliburton?

  • Report this Comment On June 08, 2010, at 5:11 PM, x1x2x3x4444 wrote:

    Sorry for the spelling errors.

  • Report this Comment On June 08, 2010, at 5:22 PM, eldetorre wrote:

    "If the customers thought they were getting ripped off, they wouldn't trade the instruments."

    You are assuming that the people being ripped off were the ones doing the trading! The people doing the trading used other peoples money.

  • Report this Comment On June 08, 2010, at 5:29 PM, 2beewise wrote:

    I am immensely pleased to see MF address problems like derivatives trading. The Fool is large enough to apply real pressure. Fools are smart people and we have knowledge of Wall Street that few of our neighbors have, regardless of where we live.

    Free enterprise has come to mean, the 'right of big business to kill off it's customers'.

  • Report this Comment On June 08, 2010, at 6:01 PM, ezed1 wrote:

    I have no problem with Wall Street gambling. But let them do it with their own money. Separate the gambling from the things that banks are supposed to do and actually add value to the economy. I strongly support section 716.

  • Report this Comment On June 08, 2010, at 6:07 PM, mountain8 wrote:

    When anyone "insures" in the amount of the next 100 years GDP, something is wrong. And if bankers want it, it's really wrong.

  • Report this Comment On June 08, 2010, at 6:32 PM, chukarlady wrote:

    To quote Mojo Nixon and his song "I Hate Banks", "Wall Street can eat my meat!"

  • Report this Comment On June 08, 2010, at 6:34 PM, ET69 wrote:

    I'm with x1x2x3x4444! Nationalize them WITHOUT compensation and jail time or a job at hard labor in a salt mine would be appropriate. While we are at it the top brass at BP ought to have to pick up oil for life at minimum wage!

  • Report this Comment On June 08, 2010, at 6:47 PM, foolduel wrote:

    "Naked" credit default swaps are nothing but out and out gambling. Take it to Vegas. We need to get this trash off Wall Street.

  • Report this Comment On June 08, 2010, at 6:54 PM, ChrisBern wrote:

    "Section 716 is a straight ban on federal assistance to banks that continue to deal in swaps."

    This sounds great in theory. But these huge entities are still too big to fail (much bigger than they were a few years ago, in fact), meaning if they fail, Section 716 (or any other "ban") will be meaningless in the face of politicians wanting to prop up failing giants in a crisis situation.

    We also have a ban on the president leading us to war without Congressional approval, and on operating under a non-balanced budget--but they'll always work around these types of "bans".

  • Report this Comment On June 08, 2010, at 7:09 PM, RicoCanuch wrote:

    When you walk into a Gambling Casino, you know that you are in a place of high risk and could lose all you money. When you walk into your bank and deposit your money you would assume that your money is being safely stored and not the seed money for high risk financial transactions.

  • Report this Comment On June 08, 2010, at 7:29 PM, TMFDiogenes wrote:

    Hey Chris,

    That's an excellent point. Nothing in this bill would completely put an end to the problem of too-big-to-fail. But on the scale of legislative bans, this is one of the stronger ones I've seen language-wise. The Fed doesn't get to issue exemptions if it feels like it, for example.

    Should we have another financial crisis, Congress could be forced to pass an emergency bill temporarily repealing 716, if it turns out the the swaps entities are undercapitalized and about to fail. However, 1) it's better that we make them at least *try* to hold their own capital without relying on the rest of the bank so that they have some of their own reserves, 2) ending this subsidy could help to shrink TBTF banks, or at least stop artificially encouraging the growth of dangerous TBTF swaps trading.

    Thanks for the great comments, everyone, and thanks again for signing

    http://www.change.org/petitions/view/tell_congress_to_stop_s...

    Ilan

  • Report this Comment On June 08, 2010, at 7:30 PM, xetn wrote:

    I don't approve of CDSs but nobody is holding a gun to your head to purchase them. As the Fool consistently states, don't buy something you don't understand. That is great advice. As for "too-big-to-fail", never should have happened. We have bankruptcy courts for this sort of thing and it should have been used. The biggest problem, and the major reason that bankruptcy was not used and bailout were is that the politicians were beholden to these failures and forced the taxpayers to pay for their mistakes. A previous poster said these crooks should be in jail; and that includes the politicians that forced (over broad public protest) the bailouts.

    Has anybody noticed that we do not have a representative government? Another example: the passage of MaobamaCare over the protest of a majority of voters.

    Now, our lord and masters want to tax blogs which disagree with "public policy" and give the money (well, some of it) to the failing newspapers. You know; the people who support all the socialists programs.

  • Report this Comment On June 08, 2010, at 7:38 PM, tbrenna wrote:

    All of the reform needs to stay intact. especially Section 716. Swaps have always looked like a shell game to me. In the 1990s, Orange County California found out the hard way.

  • Report this Comment On June 08, 2010, at 7:42 PM, TMFHousel wrote:

    "As for "too-big-to-fail", never should have happened. We have bankruptcy courts for this sort of thing and it should have been used."

    It was used with Lehman Brothers, and it was an utter cluster. Within 24 hours, the entire credit market shut down and hundreds of billions of dollars of money market assets were being drained. The only reason people don't remember how disastrous those few days were is because the Fed and Treasury got out in front and started plugging holes, albeit with taxpayers' money. The same people who think our freedom is being taken away think it's fine to let one bank blow up and take down everyone else in their wake. Irony everywhere.

  • Report this Comment On June 08, 2010, at 8:30 PM, Wheretheflavoris wrote:

    While I applaud the momentum to stop this non-productive madness in the financial sector, I'll sleep better when the federal government stops it's own madness. Right now, I don't trust the sorry excuses for executive and legislative leadership to ever do the right thing. So we may have half a loaf. We need the whole loaf.

  • Report this Comment On June 08, 2010, at 8:47 PM, csd128 wrote:

    "or create swap-trading subsidiaries with their own capital, instead of relying on FDIC-insured bank deposits, cheap Federal Reserve interest rates, and bailouts."

    Skin in the game equals corporate responsibility if, and only if, it is corporate "skin".

    Section 716 may become transmogrified in hands of compromised commiteefolk, so do not promote the section 716 blindly; be certain it continues to contain the requirement for self-funding of CDS activities, AND call/message/write and demand that our senators craft such legislation.

  • Report this Comment On June 08, 2010, at 9:18 PM, MKArch wrote:

    I don't know very much about swaps but I understand a lot of the swaps banks engage in are things like simple interest rate swaps used to hedge their risk. Will Section 716 prevent banks from doing what seems to be good risk managment? What about swaps for their clients?

    I was getting ready to make a statement about how I agree banks shouldn't be betting on things like whether some other business is going to go BK or not when I started thinking about what is it that banks do? They bet on whether businesses can repay a loan or home owners can repay their mortgages. Some of the stories about swaps that came out during the crisis did sound excessive and I have no doubt there was plenty of excess but is just banning swaps outright for banks the best solution?

  • Report this Comment On June 08, 2010, at 9:35 PM, weslindsey wrote:

    I trash TMF for constantly posting sales pitches for their newsletters. This is actual useful financial news.

    Thanks.

  • Report this Comment On June 08, 2010, at 10:46 PM, TMFDiogenes wrote:

    MKArch,

    That's an excellent question. There's been a lot of misinformation about that issue. Even with 716, banks would still be able to use swaps as end users to hedge their own risk. And they could still be traders and market-makers, but they would need to supply their own capital for the trading and market-making functions, or spin off those desks into other companies that aren't attached to the FDIC/Fed safety net.

    If you're curious, here's the best explanation and defense of 716 I've seen:

    http://www.peri.umass.edu/fileadmin/pdf/other_publication_ty...

    Ilan

  • Report this Comment On June 08, 2010, at 10:47 PM, TMFDiogenes wrote:

    Thanks, weslindsey, it's much appreciated.

  • Report this Comment On June 08, 2010, at 10:54 PM, pauljfitzgerald wrote:

    I'm not an MBA, I'm a psychologist, but my "gut check" over the last few years running up to the big crash told me that there was a house of cards being built, by people who thought they could whip up froth out of froth and make the rest of us believe it was wealth. My gut told me that anything that doesn't somehow make a contribution of value to society - whether it's a funny movie, a really good sump pump, or even an iPhone app - doesn't merit the kind of moneymaking that was going on. My gut told me people should either work for their money or invest in people who do. Turns out my gut was right and all those guys who told us we were dumb to miss out on their oh-so-clever deals were wrong. So are they out of business for good yet? No, that's why we need these laws. In the 1800's you could call yourself a doctor and peddle concoctions of mercury and opium. We created laws to stop it. Nowadays you can call yourself a banker and peddle Air Swaps. They ain't bankers. My dad was a banker. He lived and breathed accountability and responsibility, because it was the depositors' money he was working with. We need that again. And Glass-Steagall back along with it.

  • Report this Comment On June 08, 2010, at 10:55 PM, MotleyReader wrote:

    Let the private NGO named "The Federal Reserve" subsidize the casino of its member-bank-stockholders with the unconstitutional/illegal interest it has collected for the past 80+ years from "We The People"... or better yet, how about if Congress takes back its constitutional right to control the money supply from those private profiteers, whose shenanigans always resulted in asset bubbles historically, which defrauded those tax-payer investors via rigged markets?

    The worst part of this whole deal is that the casino money taken up to this point via FDIC insured deposits and short term loans from the Fed on the taxpayer's dime are multiplied 10 times to get the amount of trading capital in the casino. So, if the bank is loaned $100 billion by the Fed, it can play with a $1 trillion of risk... and through the use of derivatives, supposedly shielding each other from risk, they leverage the leverage itself to amplify further the destructive swaps casino's size. Ever wonder why the Fed stopped publishing M3 in 2006? Ever wonder why the stock market reacts opposite to common wisdom when large fundamental events occur?

    Mark my words, the current CDS derivatives market is the next asset bubble and we are right in the middle of it, having been highly inflated by the reckless and irresponsible actions of many complicit parties and beneficiaries. This is like Financial Armageddon if left unchecked and may ultimately ruin our country.

  • Report this Comment On June 09, 2010, at 12:02 AM, madhat007 wrote:

    yes it has not been easy to break the propaganda of the big banks maybe it will come to an end but i still want to see Paulson get what he deserves for the phony bailout of the big banks that could have failed especially government sachs who takes their former executives and somehow place them in prominent positions to look after their interests rather than the interests of the united states treasury!!why has the fed taken the role of treasury from the people and the congress!...most fools know that banks are different than brokers!!! so if you're a broker...no guarantee!!!

  • Report this Comment On June 09, 2010, at 12:10 AM, mmr23 wrote:

    This needs to circulate through all investment sites where can be posted on message boards where there are thousands who will support it. So few investors know the details of the fraud being perpetrated or how to get their voice heard.

    Same goes for flash trading/frontrunning by those with the super fast computers. Market is manipulated to feed the coffers of these corrupt institutuions.

  • Report this Comment On June 09, 2010, at 4:40 AM, esotericrajen wrote:

    Why can't the general media cover these issues in such simple language? This article was great in presenting the key issues. If all the public had access to information about bills, they could get active and actually influence their representatives in Congress.

    But, the way this country operates, big business manages to hide the key facts and present their spin through the corporate media channels.

    I am not hopeful that these tough restrictions will prevail - wait for the congress and senate to water everything down as their paymasters are dictating.

  • Report this Comment On June 09, 2010, at 5:53 AM, MotleyReader wrote:

    @esotericrajen: The general media will not, because it is not in the best interests of those who control the media in this country.

    @mmr23: regarding flash trading, etc., all we need is a per-order placement fee of $0.001 (yes, that is one tenth of one cent) that will not affect the typical investor or even large funds, but will virtually eliminate this cancer called "high frequency trading." Also, it wouldn't hurt to create a new tax on derivatives activity, actually a small per-transaction tax let's say 0.1%, that would generate more than $100 billion per year of new revenue for the government and create a case for reporting via IRS of ALL derivatives transactions.

    Talk about shining a light on the matter.

  • Report this Comment On June 09, 2010, at 9:27 AM, ewent0 wrote:

    Greed is an obscenity. It implies a limitlessness of mechanisms to reach formerly impossible levels of wealth by simply employing fraudulent or barely legal techniques.

    So, the frauds steal from the little guy and then when the little guy wants restitution, the fraud ask, "How dare you?".

    Wealth isn't the problem. Obscene greed to be obscenely wealthy is. We aren't talking about people who earned their wealth by the sweat of their brow. We're talking about men who stay awake nights figuring out how to defraud those whose money he's salivating over.

  • Report this Comment On June 09, 2010, at 11:06 AM, hingping wrote:

    ma

  • Report this Comment On June 09, 2010, at 12:49 PM, TMFSoccer wrote:

    I really enjoyed the read, Ilan. Are some Banks worse than others? If so, how best to find the exposure?

  • Report this Comment On June 09, 2010, at 12:56 PM, joroi wrote:

    You call the House and Senate versions of the bill REFORM? All I see is a string of idiocy in those bills. Don't agree with your #1 and #2, although I am in agreement on #3 if it is on its own without the other 400 pages of garbage.

    As other have stated, you don't need exchange-traded swaps to have a competitive market. And it is not as easy to arrange as trading of stocks or commodities.

  • Report this Comment On June 09, 2010, at 1:10 PM, DJDynamicNC wrote:

    @ xetn - you said: "I don't approve of CDSs but nobody is holding a gun to your head to purchase them. As the Fool consistently states, don't buy something you don't understand. That is great advice."

    True... but I DO work in this economy, which means my fate is now tied to the fate of these banks. And as anyone who has not been as fortunate as I have about retaining their job can tell you, that can be a dicey position to be in. Giving financial control of their lives back to individual people should be something both parties can easily agree on, particularly given the rhetoric we're forced to endure.

    "Has anybody noticed that we do not have a representative government? Another example: the passage of MaobamaCare over the protest of a majority of voters. "

    :lol: Couldn't resist taking potshots at the President, eh? But for reference, here is some polling data - http://voices.washingtonpost.com/ezra-klein/2010/03/poll_hea...

    Please carefully note the meaning of the term "majority." Please also carefully note that Senate Democrats represent vastly more people than Senate Republicans (both from outnumbering the Republicans, and from representing regions with far higher population densities), and there are more House Democrats than House Republicans, and President Obama won by millions of votes. This means that passing a Democratic bill is entirely representative. In fact, that's pretty much the definition of representative.

    This, by the way, is precisely how the Constitution designed our government to work. When you say "non-representative," what you mean is "my side lost and I'm sour about it." Please do try to use the correct terminology when expressing yourself. Accuracy is important.

  • Report this Comment On June 09, 2010, at 2:04 PM, steve353 wrote:

    Yes this must absolutely be done to seperate this high risk trading from the function of mainstream banking. But don't get your hopes up that this will get included. The Senate with presure from Wall Street has managed to effectively water down everthing that would effect real change in the way the financial industry operates. Watch closely Fools and be prepared to scream at your Senators if you see this happening.

  • Report this Comment On June 09, 2010, at 11:01 PM, SetMyPeopleFree wrote:

    It's amazing how maNY cOMMIES, WHICH NOW INCLUDES ALL DEM DIEHARDSW AND ANYONE STIIL FOR COMMIE-OBAMIE, ARE ON HERE. ARE THEY REALLY INVESTORS OR SHILLS? DO THEY WANT TO MAKE MONEY BY INVESTING IN THE FEW COMPANIES THEY THINK THE COMMIE TAKEOVER WILL LET STIIL PROFIT? DOING SOMETHING ABOUT REGULATING, TRANSPARENCY AND GOV'T BACKING OF STRAIGHT GAMBLING IS IMPORTANT, BUT MANY READERS AND ALLL ALL DEMS BUT A FEW WANT TO TAKE OVER EVERYTHING BY USING CLASS WARFARE AND A CRISI MENTALITY FOR EVERYTHING, EVEN SOUNDF SYSTEMS NOT NEAR AS DIASTER FRAUGHT AS THIS. PLEASE REMEBER WE , FREEDOM LOVING, ESPECIALLY FINANCIAL FREEDOM LOVING, AMERICANS WANT WALL STREET AND ALL STREETS TO MAKE MONE AS LONG AS IT IS KEPT IN REALM OF RESPNSIBLE AND TRUE FREE MARKET IDEAs; not scams and especially not China/Venezuala type toalitarian bs corruption market. God hel us if ther are many more out there like some of toal idiots that would give up country out of jealousy or revenge as I see here.

  • Report this Comment On June 10, 2010, at 1:09 AM, gs8212 wrote:

    I think I get Collateralized Debt Obligations (CDO). I think I get Repos that provide IBM with somewhere to invest some money (hundreds of millions?) overnight - I understand IBM is not going to let it sit in BOA alongside my $1,000 checking account.

    But CDS's I don't get. I'm not the sharpest knife in the drawer, but if I cannot understand what the real value is of something like this, then I have to wonder about it.

    If someone has skin in the game such as actually holding the debt itself, CDS's have some hedging value. But if you are completely speculating in it, then that's okay I guess, so long as you take the risk. But if we are privatizing the profit, don't nationalize the losses, like we have with AIG, Fannie/Freddie, etc.

    I'm about as free market, liberty first, take the risk, keep the profit (not get taxed to death), as you can get. But if you take the Gov't money (ie are insured by the gov't - call it want you want, too big to fail, gov't guarantee, implicit, explicit, etc.) then you deserve to have to play by their rules. If you don't want the rules, don't take the money - i.e. guarantee.

    TBTF is crap. Let the market work itself out. I can hear the howls now - that's stupid, it will never happen, we were at the edge of the cliff, blah, blah. Where do you think we are now with the Fed taking a rather unprecedented step of financing budget deficits by swelling its balance sheet - not for purposes of interest rates, inflation, money supply etc. But simply buying Fed securities because the Chinese wouldn't, thereby "giving" the gov't the "money" to keep spending. This has become truly frightening. The only thing more disconcerting is Congress will be writing the rules to control this monster!

  • Report this Comment On June 10, 2010, at 1:10 AM, mcdanielph wrote:

    I fail to see the value of a tradable market in credit default swaps. If swaps are insurance against default on specific financial obligations such as bonds or collatoralized debe obligations, then only persons or institutions that actually own the insured obligations should be allowed to purchase the insurance.

    Another missing element of financial reform would be a strict provision forbidding FDIC insured institutions from selling any loans they write, or purchasing insurance on such loans. Only fixed rate loans upon which the borrower had paid for a minimum of one year could be bundled and sold. Not variable, optional payments, balloon or other risky loans.

  • Report this Comment On June 10, 2010, at 8:37 AM, Notsonovice wrote:

    I am not often in favor of financial "reform" bills because they usually do not address the issues they are intended to. If the section 117 portion of the bill isn't diluted, I am all in favor of it.

    The small investor is continuously being whipsawed by by the major investment houses that call themselves "banks". There need to be some controls in this market to reduce the volatility. I would also be infavor of controlling the amount of naked shorts being allowed. It is getting quite popular to beat up on a handful of stocks with no real purpose other than to make money

  • Report this Comment On June 10, 2010, at 2:15 PM, vebb wrote:

    Yes!! This is a no brainer and the sooner the better.

    Sickntired

  • Report this Comment On June 10, 2010, at 9:27 PM, TMFDiogenes wrote:

    TMFSoccer,

    The five banks that control 97% of the derivatives market are Goldman Sachs, Morgan Stanley, JPMorgan, Citigroup, and Bank of America. The first three do far more proprietary trading than the other two.

  • Report this Comment On June 10, 2010, at 9:29 PM, TMFDiogenes wrote:

    Thanks everyone for your gracious comments and supporting this fight -- it's really appreciated.

    Ilan

  • Report this Comment On June 10, 2010, at 9:48 PM, TMFDiogenes wrote:

    I lot of people expressed skepticism about the value of permitting CDSs, which are basically swaps used to short debt, to exist. The reasons given for them are that they can be used to provide a form of credit insurance when they're covered (you own the underlying credit) and can be used by speculators to provide market signals about weak companies when they're naked (don't own the underlying credit). (Another reason why they exist is that they can help companies escape insurance regulation because they aren't regulated as insurance or as gambling.)

    I can understand the argument that naked CDSs should be allowed, provided you are required to post the appropriate collateral (as AIG did not) and you have enough confidence in that collateral, the formulas that tell you how much collateral is needed, and the regulatory mechanisms to keep all this working. Personally, I think it would be safer just to ban the naked variety since I'm somewhat skeptical their social value outweighs the risks given how easy it is for one of these parts to go wrong and how big the disaster is when they do. CDSs have only been around for about 15 years or so, and the economy functioned just fine -- better even -- in prior decades. But if we do allow them, certainly FDIC-insured banks should have to use their own capital.

    For those interested, retiring Senator Dorgen (who tried forcing banks to divest swaps in 1994) tried again this May to pass an amendment banning naked CDSs. When it didn't come up for a vote, he pulled parliamentary maneuvers to force the rest of the Senate to take a vote on tabling (killing) his amendment. They did, but he make everyone go on the record with their votes. If you're curious, here's how they voted:

    http://www.senate.gov/legislative/LIS/roll_call_lists/roll_c...

    Ilan

  • Report this Comment On June 11, 2010, at 2:08 PM, Big50Shooter wrote:

    I like this article, and I agree with x1x2x3, & Xetn...

    We had better get this "banking complex" under control or they will be watching all of us going to work in their labor camps in very short order...

    Also, on the $$$ value of these BS derivatives (world wide), I have heard the number 1.14 QUADRILLION $$$ batted around before!!!

    That's WAY too much "gambling" with OUR money these "to big to fail" types have been doing!

  • Report this Comment On June 11, 2010, at 2:44 PM, BodhiSun wrote:

    nice article Ilan, thanks. i signed the change.org petition too.

    in light,

    bodhi goforth

    eugene, or usa

  • Report this Comment On June 11, 2010, at 5:13 PM, drborst wrote:

    I fully support Section 716, and posting collatoral makes sense, but I'm not all the way convinced about creating an exchange for credit default swaps. It actually scares me.

    A steadily increasing percentage of people own stocks. I don't know anyone who owns a credit defeult swap (do you even own it?). What scares me is I've seen people start with a short position, then move on to a call or a put. (I don't know how those work, and I'm convinced the guy I know who trades them only thinks he does).

    If there is a market, next thing you know your inbox gets a special invitation from MF inviting you to pay for their special research service covering the CDS market (it's the one that is entirely free of Buffett quotes).

    I don't want commoners like me trading these things. (that said, the paulson story tells me that "sophisticated investors" aren't that much better) If you explain to me how we prevent that, I'll the marketplace concept.

    PS where do I invest in if it happens, NYSE? NASDAQ?

  • Report this Comment On June 13, 2010, at 4:31 PM, philkek wrote:

    Good M.F. information here. Free people in the USA have the power of the single vote. Are WE THE PEOPLE too big to fail ?! As the song goes "God bless America...". At least, as long as possible. You free speech fools sure are smart. Vote your conscience. That is my 2c worth. Fool on.

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