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A Greek Tragedy

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7 Responses

  1. A.J. Sutter says:

    What precisely is the distinction you’re making when you say “While commodity derivatives may date back to Mesopotamia … financial derivatives are the product of financial innovation”? What should we call what they did in Mesopotamia? What’s added by calling any sort of instrument “financial innovation”? Does that mean derivatives are somehow worse? or that, as “innovation,” they deserve more respect? The contemporary fetishization of “innovation” masks the fact that much of our society is based on ideas and inventions that have been around for quite a long time. How does the category of “financial innovation” illuminate any pertinent issue here?

    Also, your point about the necessity of international collaboration isn’t necessarily well-illustrated by this case. The entity that used the derivatives was a sovereign government. It seems hard to claim that they didn’t know what they were doing with the derivatives. The motivation for the use of the instruments was the constraint of a common currency, which is pretty rare in the world. A more salient problem in this case is the lack of regulation within the EU, rather than regulation of Goldman or other banks, or cooperation with the US. If the Eurozone member states were to revert to national currencies, it seems as if there should be less occasion for this particular problem to come up (at least, as distinct from a country’s treasury possibly using derivatives for pure financial speculation, à la California’s Orange County in the early 1990s).

    BTW, the Goldman-Greece-derivatives story was broken by Germany’s Der Spiegel on 02/02, almost 2 weeks before it hit the NYT. It was also common knowledge in financial circles here in Japan within a day or two after the German report. But before the story broke in a major Anglophone news outlet, Goldman had cut Greek and Italian banks to ‘sell’ and lowered its public euro-vs-dollar forecast because of “Greece turmoil.” Maybe a first step to regulating derivatives markets would be a moratorium on Goldmanites in the US government (retroactive, please), so that the firm’s life might be a bit less charmed. To say nothing of regulators’ learning to read news reports in foreign languages.

  2. A.J. Sutter says:

    [Correction: The Spiegel story was 2010/02/06, still more than a week before major English-speaking media gave it prominent space.]

  3. Frank Pasquale says:

    Thank you for an illuminating commentary on the problems here.

    I completely agree on the need for international cooperation. I’ve been reading DeLong and Cohen’s The End of Influence, and it reinforces my impression that capital is mobile enough to evade many domestic strictures. But given the lack of effective international regulators, we’re forced to hope that some states at the hub of the neoliberal order “set the tone” in matters like this. I just hope that Gary Gensler manages to educate enough congressmen to back his version of derivatives regulation. See
    http://www.businessweek.com/magazine/content/10_08/b4167068042271.htm?chan=magazine+channel_what%27s+next

    (And given the article title “A Goldman Guy Turns on the Street,” we may well be in a “Nixon goes to China” moment here, A.J.!)

  4. Mike Zimmer says:

    I understand that there can be economic value to derivatives that do involve actual hedging of risks of various types. What I don’t understand is why deriviatives that are unconnected to any economic actiity that justifies hedging are anything other than gambling contracts. As such, shouldn’t they be as illegal as my betting on the outcome of the NCAA’s March Madness?

  5. Kristin Johnson says:

    A.J.,
    Thank you for your thoughtful comment. If there is anything new under the sun with respect to the derivatives that are at issue it centers on the investment instruments that are the subject matter of the agreements. I believe that we agree that historic examples of each of the four classes of derivatives disproves arguments that derivatives are nascent creatures. Unlike the many historic examples, however, the harsh spotlight in domestic and international press has focused upon derivatives for which the reference asset is a financial product such as a stock or bond, an equity or debt index, or interest or currency exchange rate. Instruments like naked credit default swaps which may settle for cash permit a counterparty to enter into a derivative arrangement without any expectation of physical delivery of the reference asset at settlement (largely because the protection buyer does not actually own the reference asset).

    I agree that the Grecian example is not perfectly matched with the argument. I actually make the argument in a longer paper in the context of competition among international regulators and a possible race to the bottom if there is not international collaboration. The point about the ubiquitousness of the significant market participants, and my experience as a former employee for two of the largest of those players, suggests that like hedge-fund and private equity fund capital, if lesser regulation exists in any jurisdiction, operations will find their way to the same location – tiny island or hot, dry dessert! Greece’s struggles are a more useful example of the interconnected of nations’ economies and the extent to which there is, if you will, a “international moral hazard” for countries within the Eurozone.

  6. Kristin Johnson says:

    Frank,

    Thank you so much for your comments. Following on from my comments to AJ and concurring with your reflections, capital is unbounded by the imagined (?) jurisdictional boundaries that stymie regulators efforts’ to address uniformly disconcerting industry practices or systemic risk engendering products. I just had a call with a friend who works with hedge funds who suggested- much to my surprise – that the industry expects for many of the most significant reforms proposed to fall by the wayside due to lack of political will for adoption of the same. I am familiar with Gensler’s position and due to his tenacious efforts and his comprehensive understanding of these instruments, I believed that there was a movement afoot to ensure adoption of key proposals such as imposition of clearinghouse platforms for OTC derivatives. It looks like the movement has waned and maybe the most critical elements of the initially proposed reforms will not find their way into adopted reforms. That would be unfortunate.

  7. A.J. Sutter says:

    Frank, some of us of a certain age recall that Nixon was still Nixon when he returned from China. E.g., his burglary years were ahead of him at that point. Is a Charles Colson, born-again analogy more suitable? Minus a prison stint, will it be durable?