Rolling the Dice on Derivatives by Ralph Nader

Dandelion Salad

by Ralph Nader
October 10. 2008
Rolling the Dice on Derivatives – The Nader Page

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 Buffett 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 Buffett 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.


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8 thoughts on “Rolling the Dice on Derivatives by Ralph Nader

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  4. well those risky derivatives were avoided, money’s in the banks. And those risky mortgage’s related derivatives went where?
    Fanni, and/or Freddie ?
    A sucker’s born every minute.

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  7. It was the derivative market, stupid. Wall Street has with campaign 2008 stained everyone. It was no longer subprime mortgages. What don’t you get, guys?

    The financial media has finally explained the goings-on in Washington and Wall Street since September 15th. Here are the Cliff Notes, Mr. Obama, Mr. McCain. There were 5 investment banking houses, with $560 trillion in derivatives which were written. The 5 investment banking houses not being regulated by the Securities Exchange Comminssion. The parties were Bear Stearns, Lehman Brothers, Merrill Lynch, Morgan Stanley, and Goldman Sachs. The current Treasury Secretary, Henry Paulson, as well as the former Treasury Secretary, Robert Rubin, were CEOs at Goldman Sachs. During their reign at Goldman Sachs, the derivative market exploded. Paulson’s background includes rising through the ranks of Goldman Sachs since 1974, becoming a partner in 1982, co-head of investment banking in 1990, chief operating officer in 1994, chief operating officer in 1994, and forcing out his co-chairman Jon Corzine in 1998, in what Floyd Norris of the New York Times termed a “coup,” and took over the post of CEO. (In 1970, Paulson entered the Nixon administration fresh from Harvard Business School Masters program, working first as staff assistant to the assistant secretary of defense and then as office assistant to John Erlichman in 1972-73.) Paulson is a Republican. Rubin is a Democrat advising Obama.

    There now is a battle of ideology going on between the credit markets and the equity markets. In the current envirnment, no matter the moves put on by Henry Paulson, a son of Wall Street, banks were not buying in. That was why credit markets froze. Bankers have always been conservatives. They were not buying into the social engineering on capitalism. It was not an issue “more confidence than substance.” Bankers neither trust the balance sheet of another bank nor the government. Nor do I.

    Wall Street, Goldman Sachs, apparently thinks the Fed now lowering interest rates, exactly what created this mess, was going to send the equity markets up. The truth was there really any not quivers left to policy makers, as they had all been used, apparently for political purposes.

    Obama, Mccain, Nader, just were in it for the power.

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