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The Spectacle Blog
While discussing government regulation with Gerri Willis on Fox News on Tuesday, anchor Shepard Smith noted that there are more government regulations than words in the English language and implied a proper skepticism about the value of such onerous regulation.
He then said — in a rather odd tangent — that the derivatives market is essentially unregulated and that it is “bigger than our entire economy…times three.”
Instead of reaching what I would have thought to be the obvious conclusion, namely that regulation stifles growth, Smith lamented that “we have no control whatsoever” over derivatives trading.
If one looks at the recent financial meltdown, there is precious little evidence that the unregulated sector of the financial markets played a starring role. Instead, what crushed banks, markets, and the economy was perhaps the single most regulated part of America’s financial tapestry: banking and mortgage banking. Papers and books can be and have been written on this. More broadly, government entanglement in private business (which is what most regulation in the financial sector is), destroyed any ability for a “free market” to function (not that we’ve had anything particularly close to a free market in banking even before the 2008-2009 bailouts, TARP, etc) and destroyed the public’s belief that there is a functioning market. (See this interesting paper by Bruce Yandle on the topic of “Lost Trust.”)
Beyond the fact that a large part of the derivatives market is in fact highly regulated (such as everything that trades on every options or futures exchange), Smith’s observation that the unregulated portion of derivatives trading dwarfs most other markets is a clarion call for reducing regulation elsewhere, not increasing regulation in a sector which has served the nation and world admirably, even if not flawlessly, for many years.
I would suggest that Shepard Smith reconsider the lesson to be learned from the success of largely unencumbered markets such as derivatives or the Internet, versus the outcomes from the highly regulated sectors of our economy, such as mortgages and health insurance. After all, which sectors — the highly regulated or the lightly regulated — do you think have happier employees, happier customers, and more opportunity to provide jobs and profits for American workers and investors?
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More Blog Posts by Ross Kaminsky
http://spectator.org/blog/2011/01/19/anti-derivatives
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dad29| 1.19.11 @ 4:52PM
Umnnhhh...
The derivatives market is NOT a problem, so long as shareholders of firms which collapse due to mismanagement of the portfolio are the ONLY ones who pay for the mess.
But we already know how that worked out, right?
Clint| 1.19.11 @ 6:05PM
"Bailing out AIG effectively meant rescuing Goldman Sachs, Morgan Stanley, Bank of America and Merrill Lynch (as well as a dozens of European banks) from huge losses. Those financial institutions played the derivatives game with AIG, the esoteric practice of placing financial bets on future events. AIG lost its bets, which led to its collapse. But other gamblers—the counterparties in AIG’s derivative deals—were made whole on their bets, paid off 100 cents on the dollar. Taxpayers got stuck with the bill."
Is Too Big Too Fail Bogus Here ?
Anyone ? Anyone ? Bueller ? Kaminsky?
Martin| 1.19.11 @ 6:18PM
Having in the past run a derivatives desk, I can confidently say that this piece is rubbish. Risk management in the derivatives arena is very primitive indeed and based on the fallacious theories of efficient market theory. Given the grossly excessive incentives on Wall Street, disaster was inevitable. Credit default swaps, in particular, are a product which in a properly regulated market would not exist, since they are far too leveraged to be manageable except with impossible capital allocations.
Dodd-Frank did nothing useful to control this; the not-very-bright Democrat congressional leaders were humbugged by Wall Street lobbyists. Furthermore, nobody has taken adequate steps to get Bernanke under control and stop the Fed creating ever larger bubbles. Thus if the last financial crash did not convince the world of the dangers of derivatives, the upcoming one undoubtedly will..
Ross Kaminsky| 1.19.11 @ 8:31PM
Martin,
If, as the first two commenters noted, the losses had remained with the shareholders, rather than socialized, the problems -- not least the future moral hazard -- would have been much less.
Furthermore, while you note a part of the derivatives market that had some issues, there are billions or trillions of dollars in derivatives on the stock market, bond market, commodities markets, etc., all of which seems to work extremely well almost all the time.
Furthermore, nothing you said contradicts my point that nothing in the history of highly regulated markets implies that they're inherently less risky to "the system" than the less regulated or unregulated markets.
My point was not primarily that derivatives can't be dangerous, but that government regulation are extremely unlikely to lessen any danger. Indeed, government is more likely to skew incentives in a way which would increase the likelihood of a blow-up, just as they did with the mortgage market.
Martin| 1.19.11 @ 8:58PM
I agree with the free-market principle, but we're not in a free market because of the existence of the Fed. Once those nitwits can go round creating bubble after bubble, the dangers of Las Vegas trading desks and casino-style risk management are hugely enhanced. Once you have the Fed, you have to introduce rules on e.g. risk management and capital adequacy to counter its ill effects. You could only run a regulation-free banking system under a Gold Standard, ideally with no central bank.
Video Savant| 1.20.11 @ 2:58PM
What is often lost in any discussion of the financial meltdown is that the problem wasn't that firms made big and bad bets on the future directions of markets and lost. The problem was that the losers -- remember for every losing position, there's a winning position -- were made whole by intervention.
The market should have been allowed to function. If losers go out of business, so be it -- that is the most desirable outcome. Winners would either assume the leadership role of the extinct firms or make capital available for creation of new institutions that take the place of the losers.
And today, the problem is not a lack of capital -- it's a lack of trust in the system.