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Meet the new Goldman derivatives business, Commentary: Bank sure to exploit loopholes in current derivatives bill

April 25, 2010 – Comments (6)

This might have already made the rounds here, but it is an article worth reading.

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Meet the new Goldman derivatives business
Commentary: Bank sure to exploit loopholes in current derivatives bill
By David Callaway, MarketWatch
April 22, 2010, 12:01 a.m. EDT
http://www.marketwatch.com/story/meet-the-new-goldman-derivatives-business-2010-04-22

Meet Goldman Sachs, international airline. No baggage fees; volcano proof; business class only.

[excerpt]

That's about how easy it would be for Goldman Sachs Group Inc. to fly through the ash-cloud of loopholes an over-heated Congress is spitting up in its latest attempt to regulate the derivatives market. In its zeal to punish Wall Street for the financial crisis, Congress is now focused on the middle of the three most bearish ways to regulate banks.

The momma bear way, or too soft, is the Volcker rule, which would prohibit proprietary trading at big banks. This is a small part of bank profits and would do little to affect their businesses, or bank stocks. Congress and President Obama understand this, which is why they want more. The papa bear way, or too hard, is the nuclear option of a forced break-up of the six biggest banks, which devastates securities markets and the role of the U.S. as the world's financial center. -- My comment: What is "too hard" about doing what is necessary? These entities have far too much power as a direct result of decades of bad US monetary and economic policy. But I digress

The baby bear way, apparently dubbed just right on Capitol Hill, is to require all the big banks to divest themselves of their hugely profitable derivatives desks, and for all future trading of financial derivatives to be on transparent financial exchanges, such as trading in oil or wheat or orange juice is today.

This is a reasonable idea that would shed light on the murky world of over-the-counter structured finance products, such as the now infamous collateralized debt obligations, or CDOs. It might even prevent the so-called financial engineering that got Wall Street into its over-leveraged position to begin with. But as with any legislation in Congress, before the ink is even dry, politicians are racing to protect their interests.

So the version making its way to the Senate floor Wednesday included a host of exemptions for non-bank companies who use derivatives to hedge against quick movements in prices for resources they need. These include airlines, manufacturers, other trading corporations, and pension funds - entities like Enron, for example, or the Orange County, Ca., retirement fund - two infamous financial wizards.

So firms like Goldman, Morgan Stanley, or J.P. Morgan Chase Co. would be able to register as other entities - airlines, manufacturers, pension consultants -- and continue to trade derivatives to their hearts content.

Sounds silly, until you realize that's just what Goldman and a number of other banks did almost two decades ago to enable them to trade widely in commodities index futures. In 1981, Goldman got itself classified as a "hedger," such as a farmer or food producer, so it could trade commodities without fear of limits put on pure speculators. -- My comment: Which is why the "too hard" option above is not too hard. These firms have the power/resources to exploit any loophole. As long as the derivatives market remains "profitable" (and it is profitable up until that market blows up, because these instruments are fraudulent), these firms with enormous power will continue to exploit the system and use these hedges in unintended ways (such as selling MBS packages that are designed to fail and then shorting them, or advising the Greek government while at the same time taking out massive CDS positions on Greek debt).