THE STUMP JANUARY 10, 2012
I’ve been making my way through Dylan Ratigan’s new book, Greedy Bastards, and can report that it includes a number of truly sensible thoughts on everything from health care to energy policy. (Also, there’s the occasional cultural nugget I somehow missed—like the fact that butlering has apparently become a major U.S. growth industry.)
But one of the more intriguing ideas comes courtesy of Dick Grasso, the former New York Stock Exchange chairman who was ousted in 2003 amid a compensation scandal, and who Ratigan spoke with for the book. The subject of their conversation was derivatives, the financial instruments that allow people to bet on the movement of other assets, like stocks, bonds, and foreign currency. I know it’s a bit off-topic for The Stump, but it’s a subject that’s close to my heart, so bear with me as we wait for those New Hampshire results.
The beauty of derivatives is that they act like insurance: If you’re a company (like, say, an airline) that uses a lot of fuel, you can arrange a derivative contract that locks in the price of fuel a year or two in advance so that your costs don’t abruptly rise. The person on the other side of this contract is betting on energy prices to fall, in which case they would book a profit when selling you the fuel next year at the agreed-upon price.
All that’s fine and good. (Though the insurer can get in trouble if they don’t have enough money to pay up should the bet go against them, which is essentially what happened with AIG and the mortgage securities it insured.) What’s more questionable is when financiers place bets on the price of assets they don’t own and have no intention of acquiring. These so-called naked bets are in many ways tantamount to gambling and were a prominent feature of the recent financial crisis. For example, many investors bought insurance on mortgage securities they didn’t own as a way of betting on the price of the securities to fall. However you feel about the social utility of this practice, it’s probably not something that deserves government backing. Yet in many cases the government then bailed out these investors when they bailed out the likes of AIG.
Ratigan’s preferred solution to this problem is to require that derivatives trade on exchanges, the same way we trade stocks. The great benefit, as he writes in the book, would be transparency:
We could all see who was trading and insuring what. One of the greatest obstacles in resolving the financial crisis in 2008 was the need to pay all the $600 trillion in swaps [a type of derivative] because central bankers couldn’t see which swaps were legitimate insurance for energy and commodities—insurance that was essential to the smooth functioning of the economy—and which were idle speculation. Because the central bankers couldn’t see the difference, they were forced to pay off everybody, including the reckless speculators.
But, interestingly, Grasso has an even more radical proposal: Reclassify all the naked derivatives as online gaming. As Grasso tells Ratigan:
I believe regulators should require the product to be … monitored globally to prevent contracts being written in excess of the debt obligations they are designed to insure. … Any contracts written outside these requirements would be deemed null and void by regulators as simply online gaming.
I’m not sure I understand every implication of this—could the bet still be made, just not through a derivative contract, or could it not be made at all? maybe just where gaming is legal? But there’s something truly poetic about officially classifying this stuff as gambling.
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