Tuesday, October 27, 2009

The Warning 1



"A derivative is a financial instrument that is derived from some other asset, index, event, value or condition (known as the underlying asset). Rather than trade or exchange the underlying asset itself, derivative traders enter into an agreement to exchange cash or assets over time based on the underlying asset. A simple example is a futures contract: an agreement to exchange the underlying asset at a future date. Derivatives are often leveraged, such that a small movement in the underlying value can cause a large difference in the value of the derivative. Derivatives can be used by investors to speculate and to make a profit if the value of the underlying [asset] moves the way they expect (e.g. moves in a given direction, stays in or out of a specified range, reaches a certain level). Alternatively, traders can use derivatives to hedge or mitigate risk in the underlying [asset], by entering into a derivative contract whose value moves in the opposite direction to their underlying [asset] position and cancels part or all of it."


In other words the Derivatives Market is a huge, unholy, unregulated mess.

Listen: "The use of derivatives can result in large losses because of the use of leverage, or borrowing. Derivatives allow investors to earn large returns from small movements in the underlying asset's [say, the housing market] price. However, investors could lose large amounts if the price of the underlying [asset] moves against them significantly. There have been several instances of massive losses in derivative markets, such as: The need to recapitalize insurer American International Group (AIG) with $85 billion of debt provided by the US federal government. An AIG subsidiary had lost more than $18 billion over the preceding three quarters on Credit Default Swaps (CDS) it had written."


"Groupthink is a type of thought exhibited by group members who try to minimize conflict and reach consensus without critically testing, analyzing, and evaluating ideas. Individual creativity, uniqueness, and independent thinking are lost in the pursuit of group cohesiveness, as are the advantages of reasonable balance in choice and thought that might normally be obtained by making decisions as a group. During groupthink, members of the group avoid promoting viewpoints outside the comfort zone of consensus thinking. A variety of motives for this may exist such as a desire to avoid being seen as foolish, or a desire to avoid embarrassing or angering other members of the group. Groupthink may cause groups to make hasty, irrational decisions, where individual doubts are set aside, for fear of upsetting the group’s balance. The term is frequently used pejoratively, with hindsight."
 
Brooksley Born, like me, majored in English. Unlike me, she graduated from Stanford University in 1961 (I was only six years old at the time. How could I be expected to graduate from Stanford?), and wanted to enter the field of medicine and become a doctor. Her guidance counselor thought that any woman who stated her desire to become a doctor rather than the more suitable profession of a nurse, was just in it for the bucks, and not sincere about treating patients.
Instead she entered Stanford Law School, one of only seven women in her class. She was the first woman to be named president of the Stanford Law Review, and graduated first in her class. Take that, guidance counselor!
After law school she was selected as a law clerk for Judge Henry Edgerton of the U.S. Court of Appeals for the District of Columbia Circuit. Following that she became an associate in the Washington D.C. based international law firm of Arnold and Porter, where she worked on international trade law. She became familiar with complex litigation and arbitration cases involving financial market transactions. She made partner at Arnold & Porter and eventually rose to be the head of the firm's derivatives practice.
In 1993, after President Clinton took office, she was considered for the office of Attorney General, but Clinton found her too "boring," and the more electrifying Janet Reno was selected.
Instead she was appointed chairman of the Commodity Futures Trading Commission (CFTC), a bipartisan regulatory agency of the federal government, specifically designed to prohibit fraudulent conduct in the trading of futures contracts.
The stated mission of the CFTC is to protect market users and the public from fraud, manipulation, and abusive practices related to the sale of commodity and financial futures and options, and to foster open, competitive, and financially sound futures and option markets.
From this office, the head of a little known, little listened to, backwater agency designed to pay lip service to the role of federal regulation in the financial markets of powerful Wall Street entrenched interests, Brooksley Born would come into direct conflict with the most powerful men involved with the economic policies of the United States government. Men with names like Levitt, Rubin, Summers, and Alan Greenspan, Chairman of the Federal Reserve.
To be continued.

main image copyright © michael o'neill/corbis outline

No comments:

Post a Comment