Sunday, July 26, 2009

Derivative Regulation

"Any doubt about how broadly US corporations rely on fancy financial instruments vanishes with a look at who's lobbying Congress to forestall tougher regulation. ... Many in Congress blame such instruments for exacerbating the financial crisis last fall. ... Caterpillar, which uses derivatives to offset increases in the price of copper, says new regulations may drive US companies to seek financing overseas. ... At least 42 nonfinancial companies and trade associations are lobbying Congress on derivatives, according to a Wall Street Journal analysis of lobbying disclosure forms filed through April. ... 'Not all derivatives have put the financial system at risk and they should not all be treated the same,' Janet Yeomans, treasurer of 3M, wrote in a letter to Sen. Mike Crapo (R., Idaho). ... Treasury officials say their aim is to prevent another financial meltdown caused by hidden exposure to derivatives risk. ... Companies use derivatives to hedge risk. A company that borrows money at a variable interest rate might buy instruments to turn the borrowing into fixed-rate debt. ... Lobbyists say at least 90% of Fortune 500 companies use over-the-counter derivatives. ... The clearing-house would require daily pricing of the assets which could require companies to post additional collateral, in the form of cash or short-term securities", my emphasis, Kara Scannell at the WSJ, 10 July 2009, link:

Hedge, or create risks? Derivatives are zero-sum games. The risk goes somewhere. Someone must be compensated to take it. Accounting games spur much derivative use, i.e., they are used to cook books. Whether a derivative is designated a hedge or a speculation is arbitrary. If a company wanted to issue fixed-rate debt, it could have. What's really going on? An investment banker told some fool corporate treasurer his investment banking firm can predict the direction of interest rates and the company converting variable into fixed-rate debt through a derivative was told interest rates will rise. If so, why doesn't it issue say 20-year fixed-rate debt? I am close to favoring banning the sale of interest-rate swaps. Period. US corporations existed before derivatives, they can exist again without them. How can Caterpillar use derivatives to "offset increases in the price of copper"? Does it buy copper futures? They have been around for decades. If Cat is concerned, let it buy a copper mine. Hey Cat, here's an idea. Buy Asarco! Oh, and don't forget you owe me $25 million for the idea. Let US companies keep this crap overseas. Then if they need bailouts, they can go to the European Central Bank or Bank of England. See my 21 July 2009 post, link:

1 comment:

Anonymous said...

I remember someone explaining total return swaps to me around '98 when the Asian markets blew up...

They were developing them for the users to avoid taxes... I think the counterparties were mostly in different countries.

So there was a "risk transfer" but also a big advantage to shielding income. Which was their primary selling point.

As for regulating derivatives I'm not sure that Congress can do it. They got buffaloed by Rubin and Greenspan and I could see them getting overwhelmed again. Get a couple good lobbyists with soundbits or get 42 nonfinancial firms magically lobbying at the same time with the same "story".

If I were a betting man I'd probably put my money on Wall Street in this fight.