Saturday, February 04, 2012

Financial Derivatives and The Bankers Who Love Them

Why were the financial derivatives markets so beloved of the giant investment banks, and why did they fight so hard to keep them unregulated? Ron Süßkind tells the story (which Cynthia has already mentioned in comments) of how Greenspan, Rubin, and Summers defeated Brooksley Born's plan to bring them into the regulatory fold, and reveals how they manage to extract gigantic rents from them.

The magic rent extraction potion is information. The first ingredient of an efficient market is perfect information, and as long as derivatives were the proprietary property of a few big banks, they could hoard information so that buyer and seller saw only what they wanted them to see. Stock and commodities exchanges were established to free their respective items of commerce from this kind of "dark pool" and Born wanted the same for derivatives. She lost that battle and the big banks won and the rest of us got stuck with the financial meltdown.

At the start of his term, Obama had to pick an economics team. He had a choice between his original advisors, like Goolsbee and former fed Chairman Volker, but decided to go with the advice to leave the home boys home and picked a crew of what he hoped were more market savvy insiders: Geithner and Summers. Christina Romer was added too, but as it happened, her good advice was mostly ignored or trumped by Summers and Geithner.

So why did he pick those whose hands were already implicated in the disaster? I don't buy the conspiracy theory version, so why else? I blame a combination of Obama's inexperience in running anything plus his innate conservatism and instinct for compromise. If he went with Volker, he would need to bust the big banks, and the carnage would be terrible. As it happened, the carnage was pretty terrible anyway, and the bankers whose empires he saved would turn on him and become the treasury of his enemies.

It was almost certainly a mistake, but every President makes them, and those who face the worst crises, like Lincoln and Rooseveldt, make the most. The real question is, what did he learn from those mistakes. We are still finding out.