In the USA "financial regulator seeks powers to curb excess speculation." How far can it go? They tried it in the USSR in the past.
Here is an article on the subject from Anchorage Daily News: http://www.adn.com/usbusiness/story/819636.html
I remember, when in the Soviet Union one could go to jail for selling or buying a couple of hundred dollars in the street. This was considered foreign currency speculation and was a criminal offense.
Clarification added June 11, 2009:
Speculation, according to Merriam-Webster Dictionary is "assumption of unusual business risk in hopes of obtaining commensurate gain".
Who is to judge whether the risk a person takes is "unusual". Is the government going to measure it? Even if it was possible to measure, how do we differentiate between taking "unusual" risk, form acting on information known to only a small minority, which would make it not an "unusual" risk? What if it is not information, but an educated guess, based on which the person doesn't think that it is a big risk? What if a person acts on a gut feel, and cannot prove it to the government that it was not an "unusual" risk?
Clarification added June 14, 2009:
The Soviet system almost from the start established monopoly on price control. No analogy is exact, and there are different ways to monopolize price generation.
What I am against (and this is the reason, why I posted the link to the article and my question) is creation of any regulatory tools allowing manipulation of prices by the government under the guise of preventing manipulations of prices by the market players.
Even if the tools are not created for that purpose, the mere possibility that they may be used that way suggests to me that one day government, or someone in the government, may decide to use them that way. And this is one of many dangers that needs to be addressed.
Clarification added June 14, 2009:
The article is, in part, about artificially keeping oil price down by punishing those who act in a way that may push it up. It is exactly what they were doing in the Soviet Union to keep the dollar exchange rate down, and my example was to illustrate that.
Answers (12)
Frank F.
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Trading $200 on the streets in a country when the currency was not convertible was an offense, but I would not call it speculation. I remember the days when the UK had exchange controls also.
But excessive speculation is what we have seen in the financial markets where multiple $-billions have been speculated on derivatives, commodities, and currencies, all with no ties to any underlying business or trade transaction. Rampant speculation causes bubbles, which sooner or later burst, as we have seen. Such excesses ought to be curbed and regulated as they bear no reality to what is going on in the underlying economy.
Leonid L.
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I hate socialism, but your example is a bit extreme. How much regulation - that's a tricky question. None is not the right answer IMO, not with these bailouts, and the future possibility of them. Present me with Wall Street which can fail without any consequences for te rest of the economy - then fine. Let them bet 100 trillion (which they have and can afford to lose) on horse raacing. With the current system, where US greenbacks are the only legal tender that the govt recognizes as valid payment for debt, I do not want the FED to CHEAPLY lend money they do not have to hedge funds that collectively cannot pay it back. I use the same money to buy milk from a farmer. Why cannot the farmer borrow money as cheaply as a hedge fund?
I do not have a solution. A simpler system is necessary. However, zero regulation will not work either. Of course, politicians are likely to FUBAR this thing. Not the first time ... Please watch Mr Taleb on hidden risk.
Links:
Sean C.
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Hi Vladimir
I find it funny that the US governement is in a rush to start writing more regulation right at this moment. They should step back for a bit and make absolutely sure they have the causes of the current situation correct before they begin writing rules that will only make everything worse. I think it is too soon to be releasing new regulation. I didn't say it is not needed.
As for the USSR example if the US starts seperating people from their assets including cash then we run for the hills because it's over!
Cheers!
Clarification added June 13, 2009:
If the government is going to be dictating what is appropriate risk to the individual then they have fully realized their dream of being "Big Brother".
Also if the government is now able to define and measure risks then we can shut down the capital markets as we don't need them anymore.
The individual defines risk not the government. What happened to the pursuit of happiness, life and liberty???
Michael G.
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How would anyone in government know what risk is in the first place? They work for the government to have "job security" so for them to evaluate risk is like me diagnosing cancer. I know nothing about it even though I may have the best of intentions.
The problem with regulations is that once in place, those who are in charge of enforcing soon want more and more regulation to justify theri job and position. The problems we are seeing are in par t a result of the regualtions imposed by government enablers and politically correct legislatures seeking votes by enacting the CRA.
Jeff M.
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Yes, the USSR tried a controlled economy and then guided by Harvard, unrestrained speculative capitalism, concluding in the economic collapse and devaluation of the rouble in 1998.
What was successful after that was the concept of localised economic development and it started in Tomsk, then was replicated in Novisbirsk and several other cities. Tomsk yielded 10,000 new entreprenuers with survival rates of over 95%
Below are links to How Harvard Lost Russia, The Tomsk Regional Iniitiative and an interview conducted later in Crimea about a 'new form of capitalism' which is now advocated by many others.
Links:
Andy A.
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In a free country one ought to be able to assume risk in expectation of reward. I remember when America was a free country.
Clarification added June 12, 2009:
Hi Bob --
Derivatives were the financial communities response to diversifying the risk that the federal government required them to take on via the CRA and it's subsequent strengthenings. Financial institutions were under attack by the government and denied merger opportunities, branch expansion opportunities, etc. if they didn't meet quota requirements to lend to "underserved markets", which is of course a euphamism for people who until the 1980's couldn't afford a loan because of bad credit, insufficient income, insufficient wealth, or other risk factors. Since the government began requiring banks to forego things like ratio analysis and substantial downpayments on mortgage loans, banks began accumulating risk within their four walls. They had no choice but to sell that risk into the general market.
So until the federal government understands that it's own interference in the responsible lending practices of banks was responsible for the subsequent onslaught of high risk financial instruments I don't want to hear from them again. Let them undo the damage they've done first. Then and only then is it appropriate to look at whether the free market is adequately managing risk in the marketplace, as it most certainly was prior to the CRA.
Government is more often than not the problem, and not the solution.
Bob M.
Senior software developer
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If you want to take your own money and speculate in the stock market, or bet it all on a single roll of the dice on a Vegas craps table, feel free. That's not what's being discussed in Washington.
The discussion is around regulating derivatives and other highly leveraged financial instruments where the traders don't have the capital to cover their losses, so somebody else who had nothing to do with it gets stuck with the bill.
I'd call that "unusual". If you'd like some examples...
One man, Nick Leeson, brought down Barings Bank after 233 years in business via unauthorized derivatives trades that lost $1.3 billion, which was twice the bank's available trading capital.
One man, Robert Citron, lost $2 billion by improperly trading repos and FRNs when he was Treasurer-Tax Collector of Orange County, California. Orange County went bankrupt, and 3,000 government employees lost their jobs.
I could go on and on. See the links below for the wall of shame. People who had no say in these situations have lost their jobs, their retirement funds, and sometimes (as in the case of Enron manipulating energy prices in California during heat waves) their lives due to the arrogance and greed that has run rampant in this unregulated market.
Links:
- http://en.wikipedia.org/wiki/List_of_trading_losses
- http://en.wikipedia.org/wiki/Rogue_trader
- http://books.google.com/books?id=bCEb0VwD8nUC&pg=PA26&lpg=PA26&dq=chile+der...
Clarification added June 12, 2009:
Vladimir pointed out that my non-Enron examples involved criminal unauthorized trading. Here are some authorized losses due to leveraged speculation:
- LTCM, $4.6 billion in 1998, requiring a NY Fed-orchestrated bailout to avoid a general market collapse
- Amaranth, $6 billion in 2006, wound up liquidating
But really, the point is not whether it's criminal, it's preventing damage to society.
I'm a chemist with an interest in fireworks. Now, it's against the law for me to construct fireworks at my suburban house. Let's say I go ahead and do it anyway - like some folks have done - and blow up my house, and kill the two little kids next door - again, like some folks have done. Slapping me in jail after the fact is not going to bring those kids back to life.
So in addition to the criminal penalties, the government requires a permit to buy certain fireworks chemicals such as powdered aluminum and perchlorate-based oxidants. And if I use them, I have to do it in a specially constructed building at a specified minimum distance from anything else. It's regulation, and it's a damn good thing, because it keeps innocent people from getting killed.
By the same token, there is a history in the US of highly leveraged investments taking out innocent bystanders. The 1929 stock market collapse was primarily fueled by leveraged stock purchases by investors with insufficient capital to make their margin calls, leading to sell-offs, leading to more margin calls, and a vicious downward spiral. The resulting liquidity crisis triggered the Great Depression, in the course of which my mom and uncle and grandparents - who had nothing to do with the stock market - lost their house when Granddad's hours were cut at work and they couldn't make the mortgage payments.
It was after this irresponsible investing in the 20s that the US government came up with the current regulations around buying stocks on margin, and we haven't had a stock price collapse like that since.
We've now seen that some people will be irresponsible with derivatives and cause huge, worldwide, systemic collateral damage - and neither ethics nor criminal penalties deter them. So we need another solution that prevents such damage. I can understand people who don't like government regulation on ideological grounds, but until they come up with viable alternatives to prevent innocent people from being injured, as far as I'm concerned, they can just suck it up.
Greg P.
Audiovisual Services for Corporate and Special Events. Author.
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Nicely put, Bob Murphy!
Lynn W.
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I've been doing some amount with the scan of the early 30s Glass-Steagall (Pecora) hearings, from pg. 7281:
BROKERS' LOANS AND INDUSTRIAL DEPRESSION
For the purpose of making it perfectly clear that the present industrial depression was due to the inflation of credit on brokers' loans, as obtained from the Bureau of Research of the Federal Reserve Board, the figures show that the inflation of credit for speculative purposes on stock exchanges were responsible directly for a rise in the average of quotations of the stocks from sixty in 1922 to 225 in 1929 to 35 in 1932 and that the change in the value of such Stocks listed on the New York Stock Exchange went through the same identical changes in almost identical percentages.
... snip ..
there is a correspondence between the speculation in the real-estate market leveraging (ARM) loans from unregulated, non-depository loan-origination institutions (which used securitization as source of funds) and the speculation in the '20s stock market using brokers' loans.
One one-side was the unregulated, non-depository loan origination institutions able to leverage securitization as source of funds ... as well as being able to
"buy" triple-A ratings for the frequently toxic instruments, significantly increasing the ability to sell them off. Being able to get triple-A ratings and immediately sell-off the loans (no matter how bad), eliminating any motivation to pay attention to borrowers' qualification and/or loan quality. Speculators then found no-documentation, no-down, 1% payment-only ARMs quite attractive, since carrying cost was less than real-estate inflation in many parts of the country (planning on flipping before the rates adjusted; in fact, the speculation further fueled the inflation, at least until the bubble burst).
On the other side was unregulated investment banking arms (courtesy of GLBA and repeal of Glass-Steagall) or regulated depository institutions, buying the (triple-A rated, toxic) securities and carrying them off-balance. The circuitous routed of the transactions, besides skirting regulations, also generated significant fees, commissions, and bonuses for the individual involved (especially when compared to traditional, legacy loan-origination).
The collapse of the real-estate speculation bubble is still going on (analogous to the '29 stock market collapse). However, on the other side, there are the large financial institutions still holding trillions of dollars in these toxic securities ... which also has to adjust.
Part of the current scenario is what happened in the credit market when investors realized that it was possible to "buy" triple-A ratings ... for securities that weren't necessarily triple-A.
Barney Frank Backs Off
http://www.forbes.com/2009/05/04/barney-frank-defers-opinions-contributors-regulation.html
from above
The crisis did not begin when Lehman failed; it began in the summer of 2007 with the markets' sudden realization that the triple-A ratings on asset-backed securities were not accurate. The resulting loss of confidence in ratings was a powerful external shock to the market, causing a collapse in trading of all asset-backed securities. That market is still frozen, and the Fed's efforts to revive it through TALF have not borne fruit.
... snip ...
In the congressional hearings into the rating agencies last fall, several times it was said that both the issuers/sellers and the rating agencies knew that the securities weren't worth the triple-A ratings ... but it was possible to "buy" such ratings anyway.
The triple-A ratings enormously increased the amount of such toxic securities that could be sold and therefor the amount of money available to unregulated, non-depository loan-origination institutions (coupled with the repeal of Glass-Steagall, and unregulated investment banking arms of regulated depository institutions buying them up).
Links:
- http://www.forbes.com/2009/05/04/barney-frank-defers-opinions-contributors-...
- http://money.cnn.com/2009/05/27/news/mortgage.overhang.fortune/index.htm?po...
- http://www.bloomberg.com/apps/news?pid=20601109&sid=alC3LxSjomZ8
Clarification added June 13, 2009:
recent article on the real-estate speculation side of the subject:
The $4 trillion housing headache; House prices have returned to 2002 levels, but mortgage debt hasn't deflated from its bubbly highs.
http://money.cnn.com/2009/05/27/news/mortgage.overhang.fortune/index.htm?postversion=2009052716
from above:
To get the mortgage debt-to-GDP ratio down to a more normal level such as the 46% average of the 1990s, Americans would have to cut their mortgage debt to $6.6 trillion from $10.5 trillion at the end of 2008. The last time the national mortgage debt count was below $7 trillion was 2003, according to Federal Reserve data.
... snip ...
and the large (regulated, depository) financial institution side with all those off-balance toxic assets (courtesy of the repeal of Glass-Steagall and their unregulated investment banking arms)
Bank Profits From Accounting Rules Masking Looming Loan Losses
http://www.bloomberg.com/apps/news?pid=20601109&sid=alC3LxSjomZ8
from above:
Bogus Profit
Citigroup's $1.6 billion in first-quarter profit would vanish if accounting were more stringent, says Martin Weiss of Weiss Research Inc. in Jupiter, Florida. "The big banks' profits were totally bogus," says Weiss, whose 38-year-old firm rates financial
companies. "The new accounting rules, the stress tests: They're all part of a major effort to put lipstick on a pig."
... snip ...
Clarification added June 13, 2009:
The Man Who Beat The Shorts
http://www.forbes.com/personalfinance/global/2008/1124/042.html
from above:
Watsa's only sin was in being a little too early with his prediction that the era of credit expansion would end badly. This is what he said in Fairfax's 2003 annual report: "It seems to us that securitization eliminates the incentive for the originator of [a] loan to be credit sensitive. Prior to securitization, the dealer would be very concerned about who was given credit to buy an automobile. With securitization, the dealer (almost) does not care."
... snip ...
Bernanke Says Crisis Damage Likely to Be Long-Lasting
http://www.bloomberg.com/apps/news?pid=20601087&sid=arpJXeelvfY4&refer=home
from above (something of an understatement):
Bernanke said the packaging and sale of mortgages into securities "appears to have been one source of the decline in underwriting standards" because originators have less stake in the risk of a loan.
... snip ...
Evil Wall Street Exports Boomed With 'Fools' Born to Buy Debt
http://www.bloomberg.com/apps/news?pid=20601109&refer=home&sid=a0jln3.CSS6c
from above:
The bundling of consumer loans and home mortgages into packages of securities -- a process known as securitization -- was the biggest U.S. export business of the 21st century. More than $27 trillion of these securities have been sold since 2001, according to the Securities Industry Financial Markets Association, an industry trade group. That's almost twice last year's U.S. gross domestic product of $13.8 trillion.
... snip ...
Bank's Hidden Junk Menaces $1 Trillion Purge
http://www.bloomberg.com/apps/news?pid=20601039&sid=akv_p6LBNIdw&refer=home
from above:
So investors betting for quick solutions to the financial crisis could be disappointed. The tangled web that banks wove over the years will take a long time to undo.
At the end of 2008, for example, off-balance-sheet assets at just the four biggest U.S. banks -- Bank of America Corp., Citigroup Inc., JPMorgan Chase Co. and Wells Fargo Co. -- were about $5.2 trillion, according to their 2008 annual filings.
... snip ...
if these had been traditionally originated loans by the regulated depository institutions carried "on the books", there would have been lots more due diligence; however (courtesy of repeal of Glass-Steagall), they could have their unregulated investment banking arms buy up triple-A rated toxic asset-backed securities ... packaged by unregulated non-depository loan-origination institutions.
25 People to Blame for the Financial Crisis; Phil Gramm
http://www.time.com/time/specials/packages/article/0,28804,1877351_1877350_1877330,00.html
from above:
He played a leading role in writing and pushing through Congress the 1999 repeal of the Depression-era Glass-Steagall Act, which separated commercial banks from Wall Street. He also inserted a key provision into the 2000 Commodity Futures Modernization Act that exempted over-the-counter derivatives like credit-default swaps from regulation by the Commodity Futures Trading Commission. Credit-default swaps took down AIG, which has cost the U.S. $150 billion thus far.
... snip ...
If You Think the Worst Is Behind Banks, Read This
http://www.fool.com/investing/general/2009/05/12/if-you-think-the-worst-is-behind-banks-read-this.aspx
from above:
Don't confuse what that's saying: In terms of losses and writedowns, the next 18 months are expected to be worse than the preceding 18 months.
... snip ...
Clarification added June 14, 2009:
Phil Gramm's Enron Favor
http://www.villagevoice.com/2002-01-15/news/phil-gramm-s-enron-favor/
from above:
A few days after she got the ball rolling on the exemption, Wendy Gramm resigned from the commission. Enron soon appointed her to its board of directors, where she served on the audit committee, which oversees the inner financial workings of the corporation. For this, the company paid her between $915,000 and $1.85 million in stocks and dividends, as much as $50,000 in annual salary, and $176,000 in attendance fees,
... snip ...
Greenspan Slept as Off-Books Debt Escaped Scrutiny
http://www.bloomberg.com/apps/news?pid=20601109&refer=home&sid=aYJZOB_gZi0I
from above:
That same year Greenspan, Treasury Secretary Robert Rubin and SEC Chairman Arthur Levitt opposed an attempt by Brooksley Born, head of the Commodity Futures Trading Commission, to study regulating over-the-counter derivatives. In 2000, Congress passed a law keeping them unregulated.
... snip ...
Born must have been fairly quickly replaced by Gramm's wife, before she left to join Enron.
In the wake of Enron, Congress passed Sarbanes-Oxley ... placing much of the responsibility on SEC ... but didn't do anything about the underlying problem (which then resulted in AIG).
Possibly because GAO, also didn't think that SEC was doing much ... they started a database of financial filings with problems (which supposedly should have been prosecuted by SEC ... at least under SOX)
http://www.gao.gov/special.pubs/gao-06-1079sp/index.html
from above:
The database consists of two files: (1) a file that lists 1,390 restatement announcements that we identified as having been made because of financial reporting fraud and/or accounting errors between July 1, 2002, and September 30, 2005, and (2) a file that lists 396 restatement announcements that we identified as having been made because of financial reporting fraud and/or accounting errors between October 1, 2005, and June 30, 2006.
... snip ...
Sarbanes-Oxley supposedly also had SEC doing something about the rating agencies (found to be "selling" triple-A ratings for toxic asset-backed securities) ... but there didn't appear to be anything except this report:
Report on the Role and Function of Credit Rating Agencies in the
Operation of the Securities Markets; As Required by Section 702(b) of
the Sarbanes-Oxley Act of 2002
http://www.sec.gov/news/studies/credratingreport0103.pdf
In the recent congressional hearings into Madoff Ponzi scheme, there was testimony by somebody that had been trying unsuccesfully for a decade to get SEC to do something about Madoff. They repeated refrain was that while there was requirement for additional requlation, much more important was the need for visibility and transparency. They also mentioned that statistics show that "tips" uncover 13 times more fraud than audits and that SEC has no "tips" hotline ... but SEC do have a hotline for corporations to complain about too vigorous investigations.
Clarification added June 15, 2009:
we had been called in to consult with a small client/server startup that wanted to do payment transactions on their server ... and they had invented this technology called SSL they wanted to use. The result is now frequently referred to as "electronic commerce".
Somewhat as a result, in the mid-90s, we were asked to participate in the x9a10 financial standard working group that had been given the requirement to preserve the integrity of the financial infrastructure for all retail payments (*ALL* as in debit, credit, stored value, point-of-sale, attended, unattended, internet, low-value, high-value, transit turnstyle, aka *ALL*). The result was the x9.59 financial transaction standard
http://www.garlic.com/~lynn/x959.html#x959
Somewhat as a result, we were asked in to NCSS (since merged with DTC to be DTCC) to look at doing something similar for all trader operations. Fairly early that was suspended apparently because a side-effect would have significantly increased transparency and visibility in trader operations ... and that apparently isn't part of their culture.
Dimitri V.
EM quant Вулис ווּליס Վուլիս Ⴅულის ﻭﻠﻴﺺ ヴリシ वूलीस् 울잇
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My understanding of Soviet laws is that any risk-taking was government monopoly. For example, if an aspiring entrepreneur babushka bought some raw ingredients from a state store, cooked some pierogies in her kitchen, and tried to sell them - she'd be guilty of speculation (and several other "economic crimes"). Likewise, dissident artists who combined canvas and paint to create works of art and sold them to make a living, were guilty of speculation (and possibly "anti-Soviet propaganda"). Their contributions, which increased the value of the goods they bought and re-sold, did not change the speculative nature of their business.
Expect the same in the U.S. in our lifetime.
Susan S.
Oppenheimer & Co. Inc., financial marketing writer.
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False analogy between a black market economy turned kleptocracy after the breakdown of government and an ill-regulated amalgam of free market and regulation.
Tawfik D.
Territory Sales Manager at Ansell Healthcare
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Vladimir,
I too once lived in an economy where trading dollars was a crime. I think it is more a matter of state control (foreign currency) and control of the black market which the government is heavily involved. I'm a believer in the free market. I think the fear of regulation to prevent speculation is well justified. Once the government is in, it will be hard to get them out. I think speculators carry their own risk and those who lost big are those who leveraged and speculated the most. I don't think the government should interfere in speculation nor should they interfere in saving anyone for make poor decisions. If I decide to buy candy at $100 when I believe its value to be $1, but I do it under the assumption that it will go to $110. Then I should not be surprised when I can only sell it for $1. I think the world and governments should grow some collective sack and allow those giants who are too big to fail, fail. Let people speculate as much as they want and let those who win, win and those who lose, lose. It seems everyone is too sensitive about failures when it is obvious that the world is full of people who make poor decisions.
As you can tell, I think the government should simply provide the playing field, appoint a ref, take the tickets and let those who play ball, play ball.
