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Bonds Are a 'Safe' Investment: A Big Lie Gets Even BiggerWill derivatives be eventually regulated? At the moment, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) are drafting legal language to submit to Congress on the details of regulating the derivatives markets. Just which agency will take the lead in overseeing these markets is not clear at this writing. The SEC is the older of the two agencies.
There had been some talk about merging the two agencies, but political pressure has all but ruled this out. It now looks like they will share the oversight responsibilities.
Speculation in the derivatives market was a major cause of the financial meltdown last fall. It wrecked the financial markets and was a principal cause of the recession that we are now experiencing.
In the United States, four large banks control more than 90% derivatives market. They are JPMorgan Chase & Co. (NYSE: JPM), Bank of America Corp ,(NYSE: BAC), Citigroup Inc. (NYSE: C), and Goldman Sachs Group Inc. (NYSE: GS).
Trading in over-the-counter (OTC) derivatives has exploded in recent years. Huge bets were placed on baskets of securities called collateralized loan obligations (CLOs) when traders didn't even know what was in the package and followed the rating agencies' ratings, which in most cases were bogus. The key to winning or losing gigantic profits was the leverage involved in these trades. Leverage here means that you put up a small amount of money and control an investment having a value worth hundreds or thousands times more than your margin. For example, the futures contract for the 30-year U.S. government bond is for $100,000. However, your margin is only about $3,000. The leverage comes into play on the price change, which is on the $100,000 not the $3,000. With this kind of leverage its easy to see that not only can you lose your original margin, but you can also lose money that you do not have, and your account goes in to deficit. So its easy to see how so much money was lost is such a short time last fall.
You can bet the farm that the four major banks that control the derivatives market have their lobbyists advising the SEC and the CFTC concerning the exact language that any regulation will take. We must keep in mind that, as of now, trading in CDOs and CLOs is a private transaction between the parties. Just how to bring this out in the open and regulate the trades will be the major stumbling block to any oversight.
Do you believe that any meaningful regulation will be enacted by Congress?
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Reader Comments (Page 1 of 1)
6-11-2009 @ 5:58PM
Iridium said...
What is amazing is when you look at the list of the banks that control 90% of the derivative market they are the ones that are talked about being too big to fail.
Perhpas that is the reason why. If the lid was ever blown off this bogus market everyone would see that the entire GDP of the United States is actually made up of debt that has been traded 1000 times its value for years.
We would experience a total collapse as there is not enough money in the world to cover the debt obligations of a single global banking corporation. That is why we had the bailouts and that was the economic Pearl Harbor. The great scam would have been exposed.
That is why the derivatives market will never be regulated. Not enough people actually know what a derivative is to care what happens.
6-11-2009 @ 10:30PM
william lindblad said...
Iridium: I agree, but I want to keep this short.
There is little chance that the human race can effectively
regulate human nature in an Adam Smith environment.
Mater of fact you can't do it in a Marx/Engles either.
Derivative: short for derive - more fitting to an alchemist or witches brew.