One of the shocking facts that continues today – more than 4 years after the collapse of Lehman Brothers and the financial crisis of 2008 – is how unbalanced in the media and reporting about Wall Street and financial reform continues to be. It is amazing that so much of the reporting continues to be one-sided, without any recognition that there might even be another side. This was virtually the uniform view before the financial collapse of 2008, where even cheerleading Wall Street was routine, but it continues unchanged in far too many places today.
Part of it is just overwhelming volume: Wall Street, the financial industry, its allies and innumerable paid mouthpieces churn out mountains of “content” every day which almost requires coverage according today’s news “standards.” But, part of it seems to be that it simply doesn’t occur to reporters and editors that there is another side. The industry makes assertions and claims (always self-serving and almost always unsupported) as if they are facts and the media reports them as if they are facts.
If the stakes weren’t so high, it might not matter. But this isn’t sports reporting. The stakes are nothing less than our financial system, our economy and our standard of living. The most recent financial crisis almost caused a second Great Depression and it’s going to cost more than $12.8 trillion dollars, which doesn’t include the incalculable human suffering from tens of millions unemployed, millions thrown out of their homes, lost savings, retirements and educations, not to mention the loss of faith in the American Dream. (See our report on the Cost of the Crisis for details.)
A recent Politico Pro article, “Brokers Await Rules As Landscape Shifts,” (unfortunately it is behind their pay wall), is a recent example of a one-sided industry article, which misses some very key issues, both at the big picture level and the micro-level. It reads more like an anti-Dodd Frank, anti-Title VII industry press release.
First and foremost, there is absolutely no mention of why we have Title VII and the need for SEFs: the financial crisis arose and spread like wildfire, in large part, due to unseen, unregulated and unknown risks in the nontransparent, unregulated bilateral $650+ trillion notional derivatives market. That market acted like a conveyor belt of risk and panic, bringing the entire global financial system to the brink of collapse and necessitating trillions in bailouts and emergency government measures, as Better Markets detailed in its report on the “Cost of the Crisis.”
There can be no genuine debate among anyone not directly or indirectly on the payroll of the financial industry that the nontransparent, unregulated, anti-competitive derivatives markets needed extensive regulation to eliminate or reduce the systemic risk it posed to US taxpayers, the financial system and, indeed, our entire economy.
Second, Wall Street, its lawyers, lobbyists and its mostly purchased political, academic, media and other allies (although a few are merely ideological allies) fought desperately to kill or limit any regulation of the derivatives markets because they are the most lucrative in terms of huge margins, revenue and bonuses. Without transparency or regulation, Wall St’s wizards could do whatever they wanted and no one would know what they were doing; what they were charging; what their margins were, or anything else.
As a result, there was no competition and the 5 biggest banks controlled between 96% and 98% of the derivatives markets year-in and year-out (according to statistics compiled by the Office of the Comptroller of the Currency). History shows, no competition, no transparency and no regulation are breeding grounds for predatory conduct and systemic risk. Great for Wall Street, but bad for everyone else.
Third, unsurprisingly, most of the problems (if they can even be called that) with derivatives regulation in general and SEFs in particular are because the industry beat back the preferred approach of open trading on exchanges (like stock exchanges), which would have provided transparency, price discovery, regulation and fair competition while reducing systemic risk. It would also have crushed Wall Street’s oligopoly, fat margins and huge bonuses.
Thus, Wall Street has used its unlimited resources in a war on financial reform generally and derivatives regulation in particular, which includes not just SEFs, but all derivatives rules plus the Volcker Rule, cross border application of key rules, and so much more.
Fourth, the discussion in the article regarding the conversion of swaps to futures ignores, among other things, the previous conversion of futures to swaps. This is not the result of the laughable, pro-industry anti-regulatory “swapophobia” term used in the article (not coincidentally used by one of the industry’s favorite academics). Once a law was passed in 2000 that prohibited the regulation of the swaps derivatives markets (the crescendo of the deregulatory zeal that unleashed Wall Street predators on our financial markets which lead directly to financial wilding and the financial crisis), all sorts of financial instruments were re-structured to become unregulated swaps, including futures.
It was widely known that many swaps were just disguised futures: loopholes like the swap loophole always result in form trumping substance and Wall Street force-fitting as much as possible through the loophole so they can hit the cash jackpot that always comes from deregulation and loopholes. (This is what happened with credit default swaps (CDS) which, in substance, are nothing more than insurance agreements, but which were structured in the form of swaps to avoid insurance regulation: that’s what enabled AIG – an insurance company – to sell massive, indeed, lethal amounts of CDS without any regulation, collateral or capital behind them and to collapse as a result, requiring more than $180 billion taxpayer funded or backed bailout.)
Fifth, the article repeats other industry propaganda as if it were truth. One key example is this:
“Unlike the exchange-traded futures market, where standardized, commoditized contracts can trade in high volumes on a centralized market, setting up a more customized swap can take more finesse. The default mode in some swaps markets with relatively less activity is the telephone, because liquidity isn’t high enough to justify trading on an electronic, screen-based platform.”
There is simply little or no independent evidence for most of what is stated as fact here. For example, almost all swaps aren’t really complex or, more accurately, don’t have to be complex. Complexity is one of Wall Street’s long-time profit creation and maximization strategies. So-called “complex swaps” are almost always artificially created so that the consumer (no matter how “sophisticated”) can ever figure it out or, much more importantly, discern how much profit for the bank is embedded in all the layers of the swap. This also, not coincidentally, prevents a swap purchaser from being able to “shop around” for better terms or pricing, i.e., because it’s created/sold as customized. This created complexity has the big benefit of preventing competition (and the lower margins/profits that would result from that competition).
The truth is that even the most complex swaps are mere aggregations of often simple, two legged swaps and those complex swaps can be disaggregated into relatively easy to understand two legged swaps. Indeed, the biggest open secret on Wall Street is that all the big banks do that already: while many/most swaps are constructed and sold as “complex,” they are nonetheless hedged, laid off or prop traded on a disaggregated leg basis by the bank that created the complex swap in the first place. The Street knows (and their internal practices prove) that almost all swaps are or can readily be standardized and commoditized and, therefore, traded on SEFs or exchanges.
This also kills the bogus argument about liquidity: break down the swaps, trade them openly in competitive markets and there will be plenty of liquidity for most of them. For the very small percentage that are in fact complex, customized and relatively illiquid, make special rules for them, but don’t buy the false arguments restated as fact in the article that the market is all/mostly complex and customized with little liquidity.
Sixth, as for what is referred to in the article as “rules for the middlemen” and the “technology” they want to use, the article again ignores recent history and so much more. First, the primary weapon of Wall Street in defeating regulation (after it failed to kill the law altogether) is to try to replicate its oligopoly in the new supposedly regulated marketplace. They key to that was keeping as much trading as possible off regulated SEFs with pre-and post-trade transparency and on nontransparent bilateral transactions that are done without competition. In this upside down world of profit protection, the 19th century invention, the telephone, is the ideal bilateral mode and the open 21st century electronic screen based system is bad. Eliminating the self-serving rhetoric, it is clear that Wall Street is merely trying to replicate as much of the pre-crash bilateral OTC market as possible, albeit without saying so and with new jargon.
So, they argued for and got an $8 billion so-called de minimis exception (referred to by Better Markets as a “de maximum” exception). They are now seeking to get a huge so-called block trades exception which is so large that it would allow even average size trades to be traded off SEFs (rather than the 5% or so of trades that are arguably so large that they cannot be traded without moving the market). And, they are trying to get the CFTC to allow as many bilateral so-called voice-brokered or telephone trades as possible. This and so much more are all part of the multi-front war Wall St is waging on derivatives regulation and it is, at best, incomplete and misleading to discuss each part in isolation or to not at least mention that each are part of a larger whole.
Finally, while there is much more to discuss/rebut, it cannot go unsaid that to conclude with a quote from CFTC Commissioner Scott O’Malia without mentioning that he has been one of the leading and most vociferous voices against Dodd Frank, financial reform and all the rules is simply inexcusable. Moreover, the quote is as misleading as holding him up as a regulator trying to get the rules right: “it is important to make the necessary regulatory adjustments in order to avoid a complete shutdown of the swaps market.” The “sky is falling” (“complete shutdown”) is not only baseless, but the daily cry of Wall Street for 100 years or so in response to any regulation – which has been repeatedly proved false by history.
Ironically, however, in a very real sense, a complete shutdown of the pre-crisis, nontransparent, anti-competitive, unregulated swaps markets is exactly what financial reform is intended to do. That is where some of the greatest and gravest dangers to the global financial system hide and thrive. That market must be moved from over-the-counter, bilateral, largely secret and unseen deals to transparent, competitive, regulated markets that protect taxpayers not Wall Street profits.
It would be nice to see more articles that at least mention some non-industry talking points and spin. The public deserves better, especially when the stakes are so high.