You think the Dodd/Obama financial reform bill has a chance of passing without huge loopholes that will the GOP will insert to gut its effectiveness? Dream on, and read Gretchen Morgenson’s NY Times columns It’s Time for Swaps to Lose Their Swagger. She pinpoints the core of the war going on between Wall Street’s high-frequency traders, like Goldman’s team that very often generates $100 million trading profit days, versus Main Street America’s 95 million long-term investors who just want to build a retirement portfolio, not in a day but over 30-40 years. Remember, Wall Street’s spending $400 million on lobbyists to kill reform, they will win … setting up another bigger meltdown. First, listen to Morgenson’s analysis:
High-octane trading may be counterproductive to taxpayers, for sure. But not to the speculators who win big when such transactions pay off. And in the case of A.I.G., the speculators got their winnings from the taxpayers … Derivatives are responsible for much of the interconnectedness between banks and other institutions that made the financial collapse accelerate in the way that it did, costing taxpayers hundreds of billions in bailouts. Yet credit default swaps have been largely untouched by financial reform efforts.
This is not surprising. Given how much money is generated by the big institutions trading these instruments, these entities are showering money on Washington to protect their profits. The Office of the Comptroller of the Currency reported that revenue generated by United States banks in their credit derivatives trading totaled $1.2 billion in the third quarter of 2009. Congressionl “reform” plans for credit default swaps are full of loopholes, guaranteeing that another derivatives-fueled financial crisis awaits us.
Get it? Wall Street’s lobbyists are winning, reform is virtually dead, another derivatives crash is guaranteed! Then, echoing Warren Buffett’s concern that derivatives are “weapons of financial mass destruction, Morgenson adds:
Credit default swaps are “a way to increase the leverage in the system, and the people who were doing it knew that they were doing something on the edge of fraudulent,” said Martin Mayer, a guest scholar at the Brookings Institution and author of 37 books, many of them on banking. “They were not well-motivated.” Mr. Mayer has been critical of credit default swaps almost since they arrived on the scene. In 1999, for example, he wrote an opinion piece for The Wall Street Journal entitled “The Dangers of Derivatives.”
“These ‘over the counter’ derivatives — created, sold and serviced behind closed doors by consenting adults who don’t tell anybody what they’re doing — are also a major source of the almost unlimited leverage that brought the world financial system to the brink of disaster last fall,” he wrote, referring to the market turmoil of 1998. “The derivatives dealers’ demands for liquidity far exceed what the markets can provide on difficult days, and may exceed the abilities of the central banks to maintain orderly conditions.”
Calling credit derivatives “the most dangerous instrument yet,” Mr. Mayer concluded in his article that neither banks nor bank examiners have any idea how to handle them. “The system is easily gamed, and it sacrifices the great strength of banks as financial intermediaries — their knowledge of their borrowers, and their incentive to police the status of the loan,” he wrote.
Pointing to a study by the Federal Reserve Bank of New York, he said: “In the presence of moral hazard — the likelihood that sloughing the bad loans into a swap will be profitable — the growth of a market for default risks could lead to bank insolvencies.” But, “if companies were not implicitly backed by the taxpayers, then managements would get very reluctant to go out after that next billion of notional on swaps,” he said. “They’d look over their shoulder and say, ‘This is getting dangerous.’”
Taxpayers remain decidedly on the hook for future bailouts because Congress has done nothing to eliminate the once-implied but now explicit government guarantees backing large and interconnected companies. And on derivatives trading, lawmakers’ moves have been depressingly incremental. Couldn’t agree more. Too bad Washington doesn’t see it that way.
What is dead ahead is another bigger meltdown, followed by the “Great Depression II.” As former IMF economist, Simon Johnson and his co-author James Kwak, recently said in 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown: ”No one can predict what market will produce the next financial crisis, or when it will occur, but … when it comes, the government will face the same choice it faced in 2008: to bail out a banking system that has grown larger and more concentrated or let it collapse and risk an economic disaster. … There is another choice: The choice to finish the job that Roosevelt began a century ago, and to take a stand against concentrated industrial power. That is a choice Barack Obama could make. It is a choice that the American people need to make—and sooner rather than later. The Panic of 1907 only led to the reforms of the 1930’s by way of the 1929 Crash. We hope that a similar calamity will not be a prerequisite to action again.” But it will be!