6 ms·

A Secretive Banking Elite Rules Trading in Derivatives

53 points by wallflower 16y ago

stretchwithme 16y ago
I don't care what the market players do, as long as the taxpayer is not on the hook when things blow up in their faces. The fact that we are lets them take dumber risks.
- joe_the_user 16y ago
  You've got to understand that when you create a massively interlocked system whose collapse would seem likely to bring the entire economy down with it, you've institutionalized that system's bailout without any laws being passed. And yes, that lets the risks pile up too. And no, I don't think the bailout left us better off but the fix was in long before October 2008.
  - stretchwithme 16y ago
    The key phrase is "would seem likely". And it seems even more likely with people like Hank Paulson claiming that if he doesn't get a slush fund, the world will end. Even though its really just profits at Goldman Sachs that would end. That doesn't mean we can start unwinding things by rolling back the individual policies that are causing the risky behaviors. The government could, for example, ensuring only 80% of their bank deposits. We could start phasing out subsidies for housing by 2% per year. We could let the market set interest rates. Of course, the people in charge (regardless of which party) seem to think only more government interference in the economy could possibly help. They seem incapable of examining anything they've done or admitting any errors.
    - eftpotrm 16y ago
      Or we could recognise that a financial services organisation over a certain size engagine in certain risky practices is no more inherently safe for society than a factory dumping toxic waste, and restrict it accordingly. Sometimes 'big government' creates risk, but sometimes it controls it as well.
      - joe_the_user 16y ago
        Yes, Though one should also look at the number and sophistication of the people a company deals-with, the amount of leverage it uses and so-forth. But this kind of analysis isn't really new. It is what central banks are supposed to do. The Fed's job was "to take away the punch bowl just as the party gets going," (http://en.wikipedia.org/wiki/William_McChesney_Martin,_Jr. http://en.wikipedia.org/wiki/William_McChesney_Martin,_Jr.). Unfortunately, the Fed joined party itself with the repeal of the Glass-Steagel act and we've had stimulus-through-speculation over the last twenty years. The rise of speculative excess has a societal and psychological dynamic and once it gets going it is sustained by the social power achieved by the speculators. The pattern is old and has ended in grief a number of earlier times in history. I would recommend http://prudentbear.com/ http://prudentbear.com/ and Doug Noland's Credit Bubble Bulletin. This gives an intelligent analysis of the last twenty years' speculative excesses. Also, before tossing out knee-jerk anti-regulation comments, consider how well Alan Greenspan used this sort of ideology as "covering fire" for the speculator economy. I'm neutral on whether a libertarian system could be built soundly from the ground up. But I think it's crucial to note how the use of a bit libertarian rhetoric to dodge regulations when convenient has been instrumental in leading us to the unsound ground we are currently on. (I would admit that Ron Paul's critiques Greenspan's policy actually have been quite good over the years).
        stretchwithme 16y ago
        One big problem with regulation is how subject to manipulation it is. It provides a false sense of security to just assume government regulation means someone is actually writing sensible rules and that someone is actually enforcing them. The idea that there is some central intelligence that can decide the soundness of investments deceives the average investor or saver into thinking they need do nothing themselves. All the while the government is actively making things less sustainable and handing out favors along the way. One could argue that the same is true of private stamps of approval. But there is competition and many voices out there, each having their own tolerance for risk. To have government regulating things is like your brain never having doubts, never weighing competing concerns except for political ones. And many people think that way, just going along with the crowd. But we can't afford to have that sort of thinking govern everything.
  - igravious 16y ago
    How are things coupled? And how to we decouple them? Serious questions.
    - joe_the_user 16y ago
      Understanding banking system (and by extension the overall finance system) requires some study to say the least. You might start with http://en.wikipedia.org/wiki/Money_creation http://en.wikipedia.org/wiki/Money_creation. But considering we live in a complex, interdependent society, I'm skeptical that risk is going to be decoupled any time soon. I actually think regulating the most risky behavior is more practical than arranging for each person's risky behavior to only affects them.
      - stretchwithme 16y ago
        Maybe its more practical in the next five minutes but I think less practical in the long run. Every time someone fails and the government assumes all the consequences, more people find it profitable to engage in the stupidity. And those who are prudent get taxed more to pay for it. Long term its a game we can't win and it will collapse. And that collapse may ruin the US's ability to compete in the world, letting others win the next technology battle and leave us subject to their whims. The whole mess can keep going, but ultimately it must compete with less stupid societies.
- jbjohns 16y ago
  Even worse, those who picked well missed out. There were banks who realized this was going to blow up and stayed out of it with the idea of buying the banks that failed. What did they learn from this crisis? They missed out on millions by avoiding the subprime frenzy.
fooandbarify 16y ago
The world of high finance has intrigued me as of late. I recently watched the documentary "Inside Job" and it made me feel incredibly stupid, so I've set out to learn what I can about the industry. What an odd little world of its own. I can't even say any more than that about the article - it would be like when my Mom tries to talk about programming. I just thought I'd drop a little plug for the film here (no affiliation) in case anyone else wanted an interesting and easy starting point for this stuff :)
- Nrsolis 16y ago
  Inside job is a bit sensationalistic. That said, you can probably learn a decent amount by reading a book called "Hedgehogging.". It goes into some of the cultural aspects of finance. Just keep in mind that "trading" is all about having a better eye for value than the other guy. In every respect. If you're bad, you'll get fleeced. And by you, I mean everyone who has placed money with you.
  - fooandbarify 16y ago
    I thought it might be. I'd be curious to hear a more balanced perspective on the crisis, and I suspect part of that will come as I just inform myself about the industry as a whole. Thanks for the recommendation - I will be buying Hedgehogging this week if I can't find it at the library.
    - Nrsolis 16y ago
      There are a lot of books on the subject and I've read quite a few of them. Like most things, different perspectives led different people to arrive at different conclusions about what led to the crisis. Put very simply, the folks in charge (traders) were simply allowed to take on too much risk. And by risk, I mean that they were allowed to borrow money to make bets on the future value of securities. They believed that most of that risk was offloaded to a company that could absorb it (AIG) but it turns out that they couldn't. When everyone found out that AIG couldn't absorb that risk (defaults on mortgage-backed securities), they ran for the hills (refused to lend money with mortgage-backed securities as collateral). Hedgehogging will give you a good idea of the people/mentality that drives traders and how managing big money works. It's a complicated business and quite different from your regular mom-and-pop investor. One of the lessons I took from the book was that being very successful in your fund can lead people to WITHDRAW their money from your account. It's like they expect you to be unable to repeat your performance. Another lesson is that a lot of hedge funds fail. Their fund manager can't get out of a slump and everyone takes their money out. The fund closes. But the best lesson is the analogy of fund managers to star athletes. Those managers that can consistently beat the market are paid very well because they are making a lot of other people very very rich. That's rare and not a lot of people can manage it.
mynameishere 16y ago
Their lock on the market is less than 100 percent. http://tinyurl.com/22pu34p http://tinyurl.com/22pu34p
murcielago 16y ago
I am writing from my "other" account and I make a living in financial modeling. While in general the article is true, as always, journalists fudge truth just a bit to sound more sensationalistic. > But Mr. Singer wonders if his company, Robison Oil, should be getting a better deal. He uses derivatives like swaps and options to create his fixed plans. But he has no idea how much lower his prices — and his customers’ prices — could be, he says, because banks don’t disclose fees associated with the derivatives. Sure there are fees, but most of the premium is the price of risk, the price of the insurance if you will. While banks sometimes do some proprietary pricing enhancements, the foundation methods are usually the same and can be picked from books (like the bible of derivative pricing by John C. Hull) and papers. I know for a fact that big commodity companies (e.g. oil companies) have their own financial analysts on staff to double check derivative pricing. And it is not just that this allows you to haggle with the banks - you do no want to get derivatives that are too cheap either. That may be a result of incompetence or a sign of trouble - should the derivative seller pay to you they will not have enough capital to cover their obligations. That is exactly what happened with AIG and Lehman Brothers. Now, Robison Oil may not be that big to have financial analysts on staff, but they could use third-party pricing consultants, at least.
- pmorici 16y ago
  "proprietary pricing enhancements", that sounds like a scam if I've ever heard one.
mkramlich 16y ago
step 1 in their evil scheme: hide all their plans behind a NYT login wall
known 16y ago
Govt will not take any action because Wall Street is the highest tax payer and job creator.
- parallax7d 16y ago
  Govt will not take any action because Wall Street floods politician's election campaigns with dollars so they play ball. If they don't play ball, Wall Street funds a challenger to the seat.
  - igravious 16y ago
    How does Wall St, collectively and en masse decide and go about doing this? I'm not saying that they don't - I think that it has been fairly well reported that the sums of money coming from Wall St. as campaign contributions are large - I would just like to know if there is any coordinated mechanism or is it a kind of wisdom of the financial crowds ...
    - JabavuAdams 16y ago
      Well, it's not that complicated. In a tribe, you help your friends and you hinder your enemies. Imagine some techie eating lunch with his techie buddies. Is he likely to talk about how he's against net-neutrality, or is it likely that he's for it? If he were against it, he'd seem weird. Basically, you're not going to screw the people you hang out with all the time, and might want to work with later.
tmsh 16y ago
It's a pretty amazing thing to see a NYT reporter write a five page story about 'derivatives' and not realize that the people she's talking to are referring very specifically to CDS derivatives and heating oil derivatives only. This was my favorite quote: To get a transparent exchange going, Citadel offered the use of its technological prowess for a joint venture with the Chicago Mercantile Exchange, which is best-known as a trading outpost for contracts on commodities like coffee and cotton. Right.... First of all, get the name right. It's significantly been called the CME Group for years now -- and refers to the fact that this is a collection of all sorts of markets, the vast majority of which are financial derivatives. Ken Griffin proposed a very specific trading platform for CDS derivatives a couple of years back. The CBOT and CME (merged as the CME Group) meanwhile have been trading other financial derivatives, as the majority of their business, for three decades now. The key point that is missed in all this imprecision -- is that CDS derivatives markets are not like other derivatives markets -- which are regulated. They are contracts that occur between large financial institutions only. That is the 'secret'. The rest is just the equivalent of a high school tourist at the visitor's desk. That said, she's in the general right direction (I won't say ballpark). But yeah, it's almost like complex businesses require three levels of understanding that people go through: (1) it's a conspiracy (2) it's actually not so bad (3) there are targeted ways to improve it Fields shrouded in first-semester textbooks, though mired in specific cases of catastrophic misuse (financial crisis), I suppose take a little more effort to get to step 3....
- igravious 16y ago
  I think that most "lay" people would know about the exchange in Chicago by its old name. It's not like the name change of 2007 is decades ago. And I'm guessing that CME Group stands for Chicago Mercantile Exchange Group so referring to the institution as the Chicago Mercantile Exchange is hardly a howling mistake. And presumably derivatives are a type of contract, and the derivatives are based on commodities, and oil is a commodity, thus the reporter seems to be largely right. Instead of being pedantic and snarky why don't you enlighten us all instead of using acronyms for everything? CBOT appears to be the Chicago Board of Trade. But CDS? Is this the famous credit default swaps that helped bring about the current mess that we are in? And the banks are unwilling to have a light shone on these dealings. ? What a surprise. She doesn't imply it is a conspiracy - she actually shows that there appears to be collusion and monopolistic practices. There is no, "we think they are up to something but don't know what", it's "they are up to something and aren't playing ball".
pmorici 16y ago
I saw a good Frontline documentary on this the other day, http://www.pbs.org/wgbh/pages/frontline/warning/view/ http://www.pbs.org/wgbh/pages/frontline/warning/view/ apparently this whole mess started back in the 90's and the head of the CFTC then, Brooksley Born, wanted to put rules in place then to make the derivatives more transparent but was vehemently opposed by Greenspan, Rubin, and Summers. Turns out that the current head of the CFTC, Gary Gensler was one of the deputies of the three guys opposing any regulation of derivatives in the 90's. The three actually went so far as to get a law passed saying that the CFTC couldn't regulate derivatives. Bottom line is anyone that acts surprised by the lack of regulation shouldn't be because Congress voted on and passed a law specifically prohibiting regulation of derivatives in the 90's. A law that was promoted by the same people who now run all the US government agencies like CFTC, Treasury etc...
patrickk 16y ago
Single page: http://www.nytimes.com/2010/12/12/business/12advantage.html?_r=1&pagewanted=all http://www.nytimes.com/2010/12/12/business/12advantage.html?...

53 points by wallflower 16y ago

I don't care what the market players do, as long as the taxpayer is not on the hook when things blow up in their faces. The fact that we are lets them take dumber risks.

joe_the_user 16y ago
You've got to understand that when you create a massively interlocked system whose collapse would seem likely to bring the entire economy down with it, you've institutionalized that system's bailout without any laws being passed. And yes, that lets the risks pile up too. And no, I don't think the bailout left us better off but the fix was in long before October 2008.
- stretchwithme 16y ago
  The key phrase is "would seem likely". And it seems even more likely with people like Hank Paulson claiming that if he doesn't get a slush fund, the world will end. Even though its really just profits at Goldman Sachs that would end. That doesn't mean we can start unwinding things by rolling back the individual policies that are causing the risky behaviors. The government could, for example, ensuring only 80% of their bank deposits. We could start phasing out subsidies for housing by 2% per year. We could let the market set interest rates. Of course, the people in charge (regardless of which party) seem to think only more government interference in the economy could possibly help. They seem incapable of examining anything they've done or admitting any errors.
  - eftpotrm 16y ago
    Or we could recognise that a financial services organisation over a certain size engagine in certain risky practices is no more inherently safe for society than a factory dumping toxic waste, and restrict it accordingly. Sometimes 'big government' creates risk, but sometimes it controls it as well.
    - joe_the_user 16y ago
      Yes, Though one should also look at the number and sophistication of the people a company deals-with, the amount of leverage it uses and so-forth. But this kind of analysis isn't really new. It is what central banks are supposed to do. The Fed's job was "to take away the punch bowl just as the party gets going," (http://en.wikipedia.org/wiki/William_McChesney_Martin,_Jr. http://en.wikipedia.org/wiki/William_McChesney_Martin,_Jr.). Unfortunately, the Fed joined party itself with the repeal of the Glass-Steagel act and we've had stimulus-through-speculation over the last twenty years. The rise of speculative excess has a societal and psychological dynamic and once it gets going it is sustained by the social power achieved by the speculators. The pattern is old and has ended in grief a number of earlier times in history. I would recommend http://prudentbear.com/ http://prudentbear.com/ and Doug Noland's Credit Bubble Bulletin. This gives an intelligent analysis of the last twenty years' speculative excesses. Also, before tossing out knee-jerk anti-regulation comments, consider how well Alan Greenspan used this sort of ideology as "covering fire" for the speculator economy. I'm neutral on whether a libertarian system could be built soundly from the ground up. But I think it's crucial to note how the use of a bit libertarian rhetoric to dodge regulations when convenient has been instrumental in leading us to the unsound ground we are currently on. (I would admit that Ron Paul's critiques Greenspan's policy actually have been quite good over the years).
      - stretchwithme 16y ago
        One big problem with regulation is how subject to manipulation it is. It provides a false sense of security to just assume government regulation means someone is actually writing sensible rules and that someone is actually enforcing them. The idea that there is some central intelligence that can decide the soundness of investments deceives the average investor or saver into thinking they need do nothing themselves. All the while the government is actively making things less sustainable and handing out favors along the way. One could argue that the same is true of private stamps of approval. But there is competition and many voices out there, each having their own tolerance for risk. To have government regulating things is like your brain never having doubts, never weighing competing concerns except for political ones. And many people think that way, just going along with the crowd. But we can't afford to have that sort of thinking govern everything.
- igravious 16y ago
  How are things coupled? And how to we decouple them? Serious questions.
  - joe_the_user 16y ago
    Understanding banking system (and by extension the overall finance system) requires some study to say the least. You might start with http://en.wikipedia.org/wiki/Money_creation http://en.wikipedia.org/wiki/Money_creation. But considering we live in a complex, interdependent society, I'm skeptical that risk is going to be decoupled any time soon. I actually think regulating the most risky behavior is more practical than arranging for each person's risky behavior to only affects them.
    - stretchwithme 16y ago
      Maybe its more practical in the next five minutes but I think less practical in the long run. Every time someone fails and the government assumes all the consequences, more people find it profitable to engage in the stupidity. And those who are prudent get taxed more to pay for it. Long term its a game we can't win and it will collapse. And that collapse may ruin the US's ability to compete in the world, letting others win the next technology battle and leave us subject to their whims. The whole mess can keep going, but ultimately it must compete with less stupid societies.
jbjohns 16y ago
Even worse, those who picked well missed out. There were banks who realized this was going to blow up and stayed out of it with the idea of buying the banks that failed. What did they learn from this crisis? They missed out on millions by avoiding the subprime frenzy.

fooandbarify 16y ago

The world of high finance has intrigued me as of late. I recently watched the documentary "Inside Job" and it made me feel incredibly stupid, so I've set out to learn what I can about the industry. What an odd little world of its own. I can't even say any more than that about the article - it would be like when my Mom tries to talk about programming. I just thought I'd drop a little plug for the film here (no affiliation) in case anyone else wanted an interesting and easy starting point for this stuff :)

Nrsolis 16y ago
Inside job is a bit sensationalistic. That said, you can probably learn a decent amount by reading a book called "Hedgehogging.". It goes into some of the cultural aspects of finance. Just keep in mind that "trading" is all about having a better eye for value than the other guy. In every respect. If you're bad, you'll get fleeced. And by you, I mean everyone who has placed money with you.
- fooandbarify 16y ago
  I thought it might be. I'd be curious to hear a more balanced perspective on the crisis, and I suspect part of that will come as I just inform myself about the industry as a whole. Thanks for the recommendation - I will be buying Hedgehogging this week if I can't find it at the library.
  - Nrsolis 16y ago
    There are a lot of books on the subject and I've read quite a few of them. Like most things, different perspectives led different people to arrive at different conclusions about what led to the crisis. Put very simply, the folks in charge (traders) were simply allowed to take on too much risk. And by risk, I mean that they were allowed to borrow money to make bets on the future value of securities. They believed that most of that risk was offloaded to a company that could absorb it (AIG) but it turns out that they couldn't. When everyone found out that AIG couldn't absorb that risk (defaults on mortgage-backed securities), they ran for the hills (refused to lend money with mortgage-backed securities as collateral). Hedgehogging will give you a good idea of the people/mentality that drives traders and how managing big money works. It's a complicated business and quite different from your regular mom-and-pop investor. One of the lessons I took from the book was that being very successful in your fund can lead people to WITHDRAW their money from your account. It's like they expect you to be unable to repeat your performance. Another lesson is that a lot of hedge funds fail. Their fund manager can't get out of a slump and everyone takes their money out. The fund closes. But the best lesson is the analogy of fund managers to star athletes. Those managers that can consistently beat the market are paid very well because they are making a lot of other people very very rich. That's rare and not a lot of people can manage it.

mynameishere 16y ago

Their lock on the market is less than 100 percent. http://tinyurl.com/22pu34p http://tinyurl.com/22pu34p

murcielago 16y ago

I am writing from my "other" account and I make a living in financial modeling. While in general the article is true, as always, journalists fudge truth just a bit to sound more sensationalistic. > But Mr. Singer wonders if his company, Robison Oil, should be getting a better deal. He uses derivatives like swaps and options to create his fixed plans. But he has no idea how much lower his prices — and his customers’ prices — could be, he says, because banks don’t disclose fees associated with the derivatives. Sure there are fees, but most of the premium is the price of risk, the price of the insurance if you will. While banks sometimes do some proprietary pricing enhancements, the foundation methods are usually the same and can be picked from books (like the bible of derivative pricing by John C. Hull) and papers. I know for a fact that big commodity companies (e.g. oil companies) have their own financial analysts on staff to double check derivative pricing. And it is not just that this allows you to haggle with the banks - you do no want to get derivatives that are too cheap either. That may be a result of incompetence or a sign of trouble - should the derivative seller pay to you they will not have enough capital to cover their obligations. That is exactly what happened with AIG and Lehman Brothers. Now, Robison Oil may not be that big to have financial analysts on staff, but they could use third-party pricing consultants, at least.

pmorici 16y ago
"proprietary pricing enhancements", that sounds like a scam if I've ever heard one.

mkramlich 16y ago

step 1 in their evil scheme: hide all their plans behind a NYT login wall

known 16y ago

Govt will not take any action because Wall Street is the highest tax payer and job creator.

parallax7d 16y ago
Govt will not take any action because Wall Street floods politician's election campaigns with dollars so they play ball. If they don't play ball, Wall Street funds a challenger to the seat.
- igravious 16y ago
  How does Wall St, collectively and en masse decide and go about doing this? I'm not saying that they don't - I think that it has been fairly well reported that the sums of money coming from Wall St. as campaign contributions are large - I would just like to know if there is any coordinated mechanism or is it a kind of wisdom of the financial crowds ...
  - JabavuAdams 16y ago
    Well, it's not that complicated. In a tribe, you help your friends and you hinder your enemies. Imagine some techie eating lunch with his techie buddies. Is he likely to talk about how he's against net-neutrality, or is it likely that he's for it? If he were against it, he'd seem weird. Basically, you're not going to screw the people you hang out with all the time, and might want to work with later.

tmsh 16y ago

It's a pretty amazing thing to see a NYT reporter write a five page story about 'derivatives' and not realize that the people she's talking to are referring very specifically to CDS derivatives and heating oil derivatives only. This was my favorite quote: To get a transparent exchange going, Citadel offered the use of its technological prowess for a joint venture with the Chicago Mercantile Exchange, which is best-known as a trading outpost for contracts on commodities like coffee and cotton. Right.... First of all, get the name right. It's significantly been called the CME Group for years now -- and refers to the fact that this is a collection of all sorts of markets, the vast majority of which are financial derivatives. Ken Griffin proposed a very specific trading platform for CDS derivatives a couple of years back. The CBOT and CME (merged as the CME Group) meanwhile have been trading other financial derivatives, as the majority of their business, for three decades now. The key point that is missed in all this imprecision -- is that CDS derivatives markets are not like other derivatives markets -- which are regulated. They are contracts that occur between large financial institutions only. That is the 'secret'. The rest is just the equivalent of a high school tourist at the visitor's desk. That said, she's in the general right direction (I won't say ballpark). But yeah, it's almost like complex businesses require three levels of understanding that people go through: (1) it's a conspiracy (2) it's actually not so bad (3) there are targeted ways to improve it Fields shrouded in first-semester textbooks, though mired in specific cases of catastrophic misuse (financial crisis), I suppose take a little more effort to get to step 3....

igravious 16y ago
I think that most "lay" people would know about the exchange in Chicago by its old name. It's not like the name change of 2007 is decades ago. And I'm guessing that CME Group stands for Chicago Mercantile Exchange Group so referring to the institution as the Chicago Mercantile Exchange is hardly a howling mistake. And presumably derivatives are a type of contract, and the derivatives are based on commodities, and oil is a commodity, thus the reporter seems to be largely right. Instead of being pedantic and snarky why don't you enlighten us all instead of using acronyms for everything? CBOT appears to be the Chicago Board of Trade. But CDS? Is this the famous credit default swaps that helped bring about the current mess that we are in? And the banks are unwilling to have a light shone on these dealings. ? What a surprise. She doesn't imply it is a conspiracy - she actually shows that there appears to be collusion and monopolistic practices. There is no, "we think they are up to something but don't know what", it's "they are up to something and aren't playing ball".

pmorici 16y ago

I saw a good Frontline documentary on this the other day, http://www.pbs.org/wgbh/pages/frontline/warning/view/ http://www.pbs.org/wgbh/pages/frontline/warning/view/ apparently this whole mess started back in the 90's and the head of the CFTC then, Brooksley Born, wanted to put rules in place then to make the derivatives more transparent but was vehemently opposed by Greenspan, Rubin, and Summers. Turns out that the current head of the CFTC, Gary Gensler was one of the deputies of the three guys opposing any regulation of derivatives in the 90's. The three actually went so far as to get a law passed saying that the CFTC couldn't regulate derivatives. Bottom line is anyone that acts surprised by the lack of regulation shouldn't be because Congress voted on and passed a law specifically prohibiting regulation of derivatives in the 90's. A law that was promoted by the same people who now run all the US government agencies like CFTC, Treasury etc...

patrickk 16y ago

Single page: http://www.nytimes.com/2010/12/12/business/12advantage.html?_r=1&pagewanted=all http://www.nytimes.com/2010/12/12/business/12advantage.html?...