Streetwise Professor

July 15, 2009

Timmy Says: This is weally, weally, hawd

Filed under: Commodities,Derivatives,Economics,Exchanges,Financial crisis,Politics — The Professor @ 9:06 pm

Tim Geithner has made a startling discovery: completely reorganizing one of the world’s largest financial markets–OTC derivatives–is an extremely difficult task, worthy of Hercules.  According to Forbes:

The Obama Administration has given itself two months to tell Congress what new legislation is needed to control over-the-counter derivatives, and testimony by Secretary of the Treasury Timothy Geithner late last week indicated how incredibly difficult the job of writing a law is going to be.

Scores of House members turned up to express their special concerns: Will grain elevator operators be required to register as users of derivatives? Can utilities continue to enter into the customized OTC contracts they regard as essential to their business? How, Secretary Geithner, are you going to prevent the derivatives business from migrating to Dubai?

Answering his critics, Geithner said repeatedly the government needed “to find the right balance” between conflicting arguments and conceded that regulation will be “an enormously complex process.” But failure is not an option, he said, because the economic crisis has demonstrated how destructive derivatives can be and how urgent the need is to subject them to new oversight.

Imagine that.  A root-and-branch shakeup of a market involving trillions of dollars of complex transactions, hundreds of firms, some of them quite complex and opaque, in just about every financial and commodity product, is going to be complicated.  Who knew?  

Boilerplate about “find[ing] the right balance” and “failure is not an option” (cliche alert!!!) is woefully inadequate.  There are myriad interconnected decisions that the “reformers” will have to make, each one of them bursting with unintended consequences, and potential for workaround and exploitation and regulatory arbitrage.  In going after the devils it thinks it knows (but really doesn’t), the administration will end up tangling with more heretofore unknown devils that it could possibly imagine.  

It would be comforting if the administration had a coherent diagnosis of just how OTC derivatives contributed to the financial crisis; a better understanding of how structural changes could mitigate these problems; and an appreciation of some of the likely adverse consequences of the proposed reforms.  Instead, we get reruns of the AIG melodrama and airy statements about how clearing and improved transparency will work wonders.  

Hence, failure is quite definitely an option.  Sadly, failure is most likely to result if Geither and the administration “succeed” at implementing their “reform” plan.  A plan that presumes one of the largest market failures in history, but which does not state coherently just what that market failure is and how it will be addressed, is a disaster waiting to happen. With no coherent overarching understanding of the source of market failure, there is no way to implement all necessary details of any plan intended to address it.  Moreover, lacking any such overarching understanding, it will be very difficult to distinguish the legitimate arguments of affected market participants from special interest self-pleading.  With so many decisions to be made, and so many affected interests, this will degenerate into a political bazaar like Waxman-Markey, and which health care “reform” promises to be.  And, just like Waxman-Markey, what is likely to emerge is a Frankenstein monster of regulation that is more likely to be the cause of the next crisis, than our deliverance from one.

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  1. If you are a hammer everything looks like a nail. What do you expect from these “reform” minded lefty nutwits, our we-know-what’s-best-for-you overlords, that collectively for the most part in Congress and in the administration have never taken the risk, started up and ran a successful small business or seen first hand what regulation does adversely.

    I’m convinced that Cap and Trade, besides being based on no hard science, will be the most horrific economy killer. It will kill economic recovery for a generation.

    Sad isn’t it that the lessons of history get forgotten and we have to suffer rediscovering them from time to time.

    Comment by penny — July 16, 2009 @ 12:30 pm

  2. The analogies that come to my mind are the Sorcerer’s Apprentice, or some guy who has read “Surgery for Dummies,” and thinks he can do thoracic surgery. They start out with this overweening confidence, and then things overwhelm them with tragic results. Another one–Geithner et al sometimes remind me of those guys in the commercial: “No, I’m not a lion tamer, but I did stay at a Holiday Express last night.”

    They really need to read Hayek’s “The Pretense of Knowledge.”

    The ProfessorComment by The Professor — July 16, 2009 @ 3:53 pm

  3. …but which does not state coherently just what that market failure is and how it will be addressed…

    The bank stress test, a quick fix simplistic charade and utter failure as far as I’m concerned, that has still left us with zombie banks says a lot about Geithner. Economic events have overwhelmed the guy, all of them.

    Comment by penny — July 16, 2009 @ 10:41 pm

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