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Rolling the Dice on Derivatives

Posted by terres on October 14, 2008

Moderators hope that Mr Nader is NOT attempting to promote Mr Buffet’s type of capitalism as one preferable to ‘casino capitalism’ because the two types are one of the same. TERRES

In the Public Interest

by Ralph Nader

The derivatives markets of today have become a high stakes casino of unimaginable magnitude. Wall Street’s bets have gone bad, and now the whole financial system is in peril. In a best-case scenario, it appears, the taxpayers will be required to rescue the system from itself. This is why Warren Buffet labeled derivatives “weapons of financial mass destruction.”

Amazingly, there seems to be some lingering sense that current-day derivatives properly perform an insurance function.

Case in point: Alan Greenspan, the former Federal Reserve Chairman. Greenspan says the world is facing “the type of wrenching financial crisis that comes along only once in a century,” but, reports the New York Times, “his faith in derivatives remains unshaken.” Greenspan believes that the problem is not with derivatives, but that the people using them got greedy, according to the Times.

This is quite a view. Is it a surprise to Alan Greenspan that the people on Wall Street — said to be ruled only by the opposing instincts of greed and fear — “got greedy?”

This might be taken as just a bizarre comment, except that, of course, Alan Greenspan had some considerable influence in driving us to the current financial meltdown through his opposition to regulation of derivatives.

A series of deregulatory moves, blessed by Alan Greenspan, helped immunize Wall Street derivatives traders from proper oversight.

In 1995, Congress enacted the Private Securities Litigation Reform Act (PSLRA) of 1995, which imposed onerous restrictions on plaintiffs suing wrongdoers in the stock market. The law was enacted in the wake of Orange County, California’s government bankruptcy caused by abuses in derivatives trading. An amendment offered by Rep. Ed Markey would have exempted derivatives trading abuse lawsuits from the PSLRA restrictions. In defeating the amendment, then-Representative and now-SEC Chairman Chris Cox quoted Alan Greenspan, saying “it would be a grave error to demonize derivatives;” and, “It would be a serious mistake to respond to these developments [in Orange County, California] by singling out derivative instruments for special regulatory treatment.”

The New York Times reports how the Commodity Futures Trading Commission aimed for some modest regulatory authority over derivatives in the late 1990s. Strident opposition from Treasury Secretary Robert Rubin and Alan Greenspan spelled doom for that effort.

Senator Phil Gramm helped drive the process along with the Commodities Futures Modernization Act of 2000, which deregulated the derivatives market.

Defenders of deregulation argued that sophisticated players were involved in the derivatives markets, and they could handle themselves.

It’s now apparent that not only could these sophisticated players not handle themselves, but that their reckless gambling has placed the entire world’s financial system at risk.

It seems to be then a remarkably modest proposal for derivatives to be brought under regulatory control.

Warren Buffet cut to the heart of the problem in 2003: “Another problem about derivatives is that they can exacerbate trouble that a corporation has run into for completely unrelated reasons,” he wrote in his annual letter to shareholders. “This pile-on effect occurs because many derivatives contracts require that a company suffering a credit downgrade immediately supply collateral to counterparties. Imagine, then, that a company is downgraded because of general adversity and that its derivatives instantly kick in with their requirement, imposing an unexpected and enormous demand for cash collateral on the company. The need to meet this demand can then throw the company into a liquidity crisis that may, in some cases, trigger still more downgrades. It all becomes a spiral that can lead to a corporate meltdown.”

That is to say, our current problems were foreseeable, and foreseen. There is no excuse for those who suggest that present circumstances –what many are calling a once-in-a-hundred-years event — were unimaginable during earlier debates about regulation.

Some ideologues continue to defend derivatives from very strict government control. As Congress moves to adopt new financial regulations next year, hopefully the proponents of casino capitalism will be given no more credence than those insisting that the sun revolves around the earth. [End.]

It would be interesting to see Alan Greenspan nominated for the 2009 Nobel Prize for economics!

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TRS

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Black Holes Suck!

Posted by terres on June 12, 2008

One Day Soon, A Tiny Wall Street Black Hole Will Suck In the Rest of Your Assets! —TERRES

Casinos on Wall Street

by Ralph Nader
June 10, 2008

Move over Las Vegas. The big time gamblers are on Wall Street and they are gambling with your money, your pensions, and your livelihoods.

Unlike Las Vegas casinos, these big investment banks, commercial banks and stock brokerage houses are supposed to have a fiduciary relationship with your money. They are supposed to be trustees for the money you have given them to safeguard, and tell you when they are making risky investments.

Because Washington, D.C. has increasingly become corporate-occupied territory, the Wall Street Boys have been taking even greater risks with your money. The more they produce cycles of financial failure, the more they pay themselves through their rubberstamp boards of directors.

With each cycle of failure, the burden of government bailouts grows larger, meaning debt, deficit and your tax dollars. The Savings and Loan collapse in the late Eighties—costing before the bailout instruments are paid off at least $500 billion, looks small by comparison with what is going on today.

Why is it that these financial bosses never learn? Because they never pay for their gambling. They may be let go, as happened recently to the CEOs of Merril Lynch and Citigroup, but they ride away from their managerial wreckage loaded with compensation and severance gold. Some of it is clearly hush money from those buddies they left behind.

Now comes the latest installment of disastrous management that has been running the venerable Wall Street investment bank, Lehman Brothers. With its stock plummeting because of avaricious risktaking with other people’s money, mixed up with their huge pay packages, Lehman Brothers’ employees look to their leader, Richard S. Fuld. For some time, he and his fellow executives would exude confidence about their ability to manage their risking financial instruments compared to their tanking competitors.

This week, the Lehman Emperor really had no clothes. Mr. Fuld reported a staggering $2.8 billion loss in the second quarter, exceeding the most dire forecasts. Even the hedges that Lehman used to temper the losses from its mortgage investments soured, adding to the losses.

It was just last April that Mr. Fuld announced his belief that “the worst is over” in the markets. For this type of management, he got paid $40 million last year, or nearly a million dollars a week, not counting vacations.

The Wall Street Boys, like all charlatans, develop words and phrases to dress up their megagambling practices. They say they are trying to avoid a “crisis of confidence” when these proclaimed capitalists go to Uncle Sam for a socialistic bailout. That only increases the “moral hazard”—another euphemism—and sets the stage for another round of reckless Wall Street Goliaths being deemed “too big to fail”.

One of Wall Street’s sharpest analysts—Henry Kaufman—believes that the “too big to fail” phenomenon undermines market discipline and encourages the smaller firms to merge with the larger companies to avail themselves of Washington’s bailout criteria.

Writing in the Wall Street Journal last August, Mr. Kaufman acutely traces the growth of ever more complex, abstract financial instruments, removed from their empirical underpinnings in the economy, accelerated by the lightening speed of computerized transactions. He called for “increased supervision over financial institutions and markets.”

“Supervision” was once called federal regulation. Call it what you will, Mr. Kaufman is not expecting anything soon. He writes: “In today’s markets, there is hardly a clarion call for such measures. On the contrary, the markets oppose it, and politicians voice little if any support. For their part, central bankers [read, the Federal Reserve] do not posses a clear vision of how to proceed toward more effective financial supervision.”

Though couched in polite, non-normative language, this is a very troublesome indictment of corporate intransigence and regulatory paralysis. Since August 2007, the situation has gotten worse with the Wall Street Boys producing more huge losses and phony asset valuations.

A few weeks ago, former Federal Reserve Chairman, Paul Volcker, delivered an address in New York voicing similar worries and calls for “supervision,” as did Mr. Kaufman, though in his own inimitable style.

Other astute, former men of Wall Street, have raised alarms about the stock and derivatives marketplace, including former SEC chairman, Arthur Levitt and William Donaldson. Long before anyone came cautionary wisdom of John Bogle, who pioneered stock market indexing and launched Vanguard Fund. (See his new book, The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns)

Still, there is no regulatory action in Washington which doesn’t even move on behalf of consumers to regulate the New York Mercantile Exchange where rampant speculation, not supply and demand, decides what you are paying for gasoline and heating oil.

With the politicians sleepwalking in Washington, while their campaign pockets are filled by Wall Street cash, isn’t it time for the people of America to rouse themselves civically and politically? Act before the financial sector, using your money, shreds itself under the weight of its own top-heavy greed and cliff-hanging mismanagement.

For starters, start demanding more from your politicians, much more!

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