Wednesday, May 13, 2009

Obama's plan to regulate OTCs will not do the job

From 2000 to 2004, I worked in the "over-the-counter" equities derivatives market as a bean counter. The primary reason I left the job was the commute, but I also concluded that the business itself was too complicated for me to control properly. I tried to understand the stuff... and could, but not instantly and that's what the traders wanted. And after a few years I felt most people were faking it in an effort to get that seven-figure job on the trading floor.

Fast forward five years and Reuters is reporting:

The Obama administration moved on Wednesday to exert more control over the shadowy over-the-counter derivatives market, now closely linked to the global credit crisis.

Unfortunately, this won't work. It's another Political Class feel-good measure to appease people who are not particularly knowledgable about OTCs.

See... OTCs are generally classified in two categories:

1) vanilla - consider this a conestoga wagon
2) exotic - consider this a space shuttle

Sure, they're both "transportation vehicles." But one is slightly more complex than the other. And regulating the OTC market is like taking a car mechanic and telling him to do maintenance on a conestoga wagon or a Honda Accord. He's going to be able to do it.

But where's the money?

The money will always be given to the guy who works on the "sexy" stuff - the space shuttle. People will always gravitate there. And NO regulator will ever be able to stay abreast of new developments. If the regulator is that good, s/he's going to jump ship for private industry and go build the next generation of space shuttle.

Or consider this:

Q: Where does Intel make its money?
A: The next generation.

Q: Where does Microsoft make its money?
A: The next generation.

This stuff cannot be properly regulated in the manner Obama and his best-known-liar, Tim Geithner, want. But that's not to say we should sit back idly and do nothing because as Reuters' Charles Abbott and Kevin Drawbaugh continue:

Trading of OTC derivatives, instruments that derive their value from other assets, exploded in size in recent years, with many large firms -- such as mega-insurer American International Group (AIG.N) -- charging into the burgeoning market.

The global market is pegged at about $450 trillion.

When the U.S. real estate bubble burst, firms such as AIG were left with mountains of complex, hard-to-sell financial instruments on their books.

Now I'm not an expert on the underlying issues that enabled this bubble to grow. But my guess is that this could be addressed by a simple law that would prohibit fractional reserve banking. So that's my alternative to another Geithner / Bernanke smoke'n'mirrors show.

But this stuff goes above the head of Taxman Tim and Helicopter Ben.

Once again, President Obama is proving that he has no idea about banking and monetary policy. And frankly, he's in over his head. It's too bad his top two banking legislators - Senator Chris Dodd and Congressman Barney Frank - also fail to understand this stuff.

Tim White

No comments: