Dangerous Game of Derivatives Enabled by Democrat, Republican Lawmakers
By Ralph Nader
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
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
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
Defenders of deregulation argued that
sophisticated players were involved in the derivatives markets, and they could
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
Ralph Nader is running for president as an independent.
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October 13, 2008)