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Scurry from the Light?

When the lights are flipped on, tradition has it that the cockroaches that feast on the night quickly scurry for the darkness.  Those of us from more Caribbean climates know that the really big Palmetto bugs often keep going on about their roachy business as if light and dark mean nothing to them.  But you have to expect that in languid, humid air better suited for piracy and general disregard for “authority”.

Exactly what climate does the financial world operate in?  We may soon find out.  But there are many reasons to believe JP Morgan, the investment bank, already operates more like Captain Morgan, the pirate.  And they are apparently far from alone.

Just as the Commodity Futures Trading Commission (CFTC) is working to flip the switch, a survey has come out suggesting that it may well not make much immediate difference.  Then again, it does help to know that what you have are, in fact, roaches.

The big news is that there will finally be rules governing “swaps”, or an insurance contract that pays off when someone stops paying their bills.  This is what doomed AIG in 2008, since they were one of the biggest and most lax issuers of this kind of “derivative” – a financial instrument that pays only in the event of another financial event.  When a lot of people stopped paying their bills, AIG’s ability to properly underwrite these contracts with proper risk was put to the test.  They failed.  Literally.

The global market for “swaps” is estimated at between $650-700 Trillion.  That’s over 13 years of total world product at current value.  No one is exactly sure how big the market is, or what it really “insures”, because they were completely unregulated.

In a few months,  new rules will go into effect in the USofA – the place where most of these originated.  They essentially require these “Credit Default Swaps” (CDS) to be traded openly, reported, and remain tied to the underlying asset that they insure.  It’s exactly what Barataria has advocated for over a year.  Mazeltov!

“Light will begin to shine on the swaps market for the first time,” according to CFTC chief Gary Gensler.  What will happen when that light comes up?

The same day that these new regulations were announced, the law firm of Labaton Sucharow published a survey of traders in investment banks on unethical and illegal behavior.  This firm earns its keep with lawsuits on behalf of shareholders, usually as class actions.  You can imagine that they are going to figure prominently in the developing revelations about the London Inter-Bank Offered Rate (LIBOR) scandal.

In this survey of 500 traders, equally from the US and the UK, they found that unethical and illegal activity is pretty common:

According to the survey, 24 percent of respondents reported a belief that financial services professionals may need to engage in unethical or illegal conduct in order to be successful, while 26 percent of respondents indicated that they had observed or had firsthand knowledge of wrongdoing in the workplace.  Particularly troubling, 16 percent of respondents reported that they would commit a crime—insider trading—if they could get away with it.

You may or may not be surprised by this result, depending on your familiarity with the actual habits of Palmetto bugs.  But as new financial regulations are being written it’s very much worth noting just who you are regulating – which may at least become obvious in the light, with or without scurrying.

It’s worth noting that the new regulations on CDSs included one dissenting vote, from Democrat Bart Chilton:

The agency is also allowing for an exemption from the heightened oversight of so-called forwards connected to nonfinancial commodities. A forward is a nonstandardized contract between two parties to buy or sell an asset at a specified future time at an agreed-upon price. Chilton, the Democrat that voted against the rule, said he is concerned about the exemption.

“I’m worried that this provision is sort of a snake in the grass,” said Chilton. “Somebody will call it a forward and then they will not take delivery and use it as an evasive mechanism. It can potentially be the new Enron loophole, and I think that is just icky.”

What will happen when the lights are shone on the big and scary darkness of the derivative market?  We will see just what kind of vermin we have.  But make no mistake, by at least one survey we know that they are, in fact, roaches.

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14 thoughts on “Scurry from the Light?

  1. No qualms with today’s blog.

    We may however be missing an elephant sized possibility walking into our humid financial and political environment: what happens if China goes into a depression? Why aren’t markets taking this account? Why isn’t the mainstream press talking about this? ; ) Actually Time magazine had a cover story on China not too long ago so that they can say, as everybody like to say in the event that it happens, I told you so.

    http://seekingalpha.com/article/713691-china-beyond-the-hard-soft-landing-debate

    • I doubt China will land hard, but it is a possibility. So yes, let’s think this through …
      They probably won’t go easily, it becomes a question of some kind of war with the outside world or a revolution within, I’d say. To tell you the truth, it may not be a bad thing in that it would stop the flow of cheap manufactured goods and might open jobs in the developed world. But I’d be afraid of military problems.
      I think that they are going to have to have major reforms to reach the next level no matter what – even more than what is mentioned in that good article. So they have a rough time ahead no matter what.
      Yuck.

  2. If JP Morgan or Goldman Sachs fail, would it really be so bad? It seems like these guys only play games with each other’s money. Would we miss them?

    • I think it is almost desirable. Every day it seems moreso. I don’t see that much downside, to be honest, if somehow a federal agency can seize the remnants and keep the credit cards working.

  3. If traders are willing to break the law to get ahead there is no way to regulate this market without sending people to jail. If you think about this long enough you realize that they operate around the world. They probably know where they can get away with things that they couldn’t otherwise. So they can hide the illegal things they do and no one will ever find out.
    I guess what I am saying is that there really is no way that you can stop this without really clamping down and that may be next to impossible. I do want to know what happens if we don’t bail them out because this can’t be our problem to fix when they act like this.

    • Exactly. I would like to see a solid effort to send these guys to jail, but if it can’t be done for various reasons the least we can do is start isolating them. That’s what the Glass-Steagall Act was all about – setting up a wall between the ordinary Commercial Banks that keep the economy humming and the cowboys that take big, global risks. The more I think about it EVERY nation needs to have that wall to keep contagion from spreading, which is why I called for a new Bretton Woods international agreement.

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