| Stop Gambling with Our Money! |
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| Tuesday, 01 September 2009 02:55 | |
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In our book, The Big Gamble: Are You Investing or Speculating, we ran a red flag up the pole with a warning about putting your money into so-called investments that are actually nothing more than speculation. Along with plenty of historical examples of investments that went south, we also drew comparisons between speculation and gambling. But in each case, we were always referring to the decisions and mistakes you make with your own money. Let's assume you gambled and lost. If you learned from your mistakes, maybe you'd establish some rules and avoid making the same errors in the future. But what if you lost money because of somebody else's gamble? That's a situation that requires a different set of rules. And that's the situation that our federal regulatory bodies are facing today, because somebody else DID gamble and lose . . .and you are paying for it . . .big time. We all know that the collapse of the housing market started a domino effect that brought down the economy and created a global credit crisis. The problem was magnified by the sale of complicated investments that Warren Buffett once called "financial weapons of mass destruction." These weapons are known as credit derivatives or credit default swaps. We reported on that fiasco last fall in our article entitledWall Street's Shadow Market. Just to refresh: Credit default swaps and derivatives are essentially complicated and convoluted financial instruments whose value is based on something else entirely. In this case, they were side bets on the performance of the U.S. mortgage markets. The players were betting on whether people would default on their mortgages. And like an office football pool where you don't own the team you bet on, major financial institutions were wagering on financial outcomes of securities without ever having to buy the underlying assets. It’s the kind of activity that gaming laws would have deemed illegal during most of the last century, but in 2000, Congress made a grave error in assuming the market could regulate itself. It voted to give Wall Street a full exemption from regulating these particular securities, an error which has had dire repercussions. Insurance companies are tightly regulated and required to have adequate resources to cover their claims and losses. But because these derivative investments were no longer regulated, three of the nation's largest financial institutions were free to run wild and make more bad bets than they could possibly afford to pay off. The result: Bear Stearns was sold for pennies on the dollar, Lehman Brothers was allowed to implode, and AIG, considered too huge to let fail, got a transfusion of $180 billion from U.S. taxpayers—in other words, you ended up paying the penalty for somebody else's gambling addiction. Congress seemed shocked and outraged by the consequences of the decision it made eight years ago. But that horse had already left the barn, so where do we go from here? We need the most dramatic restructuring of the regulatory system for financial markets since the New Deal. But already Wall Street is arming for battle and preparing to protect one of its most lucrative domains—the $592 trillion over-the-counter derivatives market, now threatened by the biggest overhaul since its creation 30 years ago. Five U.S. commercial banks, including JPMorgan Chase & Co., Goldman Sachs Group Inc. and Bank of America Corp., are on track to earn more than $35 billion this year trading these unregulated derivatives. It remains to be seen how much of that profit they will realize. In the interim, investment bankers are happy to be overshadowed in the news by the struggle over health care reform. It temporarily pushes their own impending reform off the agenda and creates a smoke screen around how they use their hefty financial and lobbying clout to thwart efforts to regulate derivatives. The wheels of regulatory change grind slowly, and time is of the essence. Wall Street is counting on an improved economy and an uptick in the stock market to soften public sentiment. But some kind of regulation needs to be passed by early 2010, before the congressional election period, because this issue will be a hot potato, too politically charged and divisive, and too risky to be on the table. At this rate, we might not see new legislation until 2011. Meanwhile, the gaming goes on. |