As the Senate moves forward with debate over financial reforms this week, New Yorkers should remember one thing: Weak rules may let Wall Street rake in big profits in the short term, but they will erode confidence in US markets, hurting the financial institutions — and the city — in the long run. What’s vital is to preserve the global perception that American markets treat everyone fairly.
At issue are unrestrained derivatives. These are financial instruments whose value goes up and down if the value of something else goes up or down — so if you think pork-belly prices are going up, you don’t have to buy a pig.
Derivatives have gotten a bad name recently, but the world needs them — even those that seem hurtful. Goldman and its clients have come under fire for using derivatives to “short” the housing market. But how else would a then-minority of investors have convinced the world that the housing bubble had to pop?
If you think California is borrowing more than it can afford, you can’t do much — except buy a derivative whose value rises with the probability of default. The messages that investors send through these instruments are important.
Problem is, derivatives need rules that make them into “markets.” If you buy an old-fashioned derivative, you do so through a regulated exchange. You have to put cash down in case your investment ends up costing you a lot of money — so that the government doesn’t have to bail you out to save everyone else.
The exchange, in turn, releases data on volume and prices. Investors can see what’s happening by watching one type of derivative trade over time, or by comparing related instruments, like oil and natural gas, to each other.
Alas, modern derivatives don’t follow these rules, and Congress has been all over the map on a fix.
Meanwhile, a lot of money is at stake. JPMorgan Chase chief Jamie Dimon estimates that his firm would lose “several hundred million to a couple of billion dollars” annually if Congress makes banks trade derivatives on exchanges. Across other big players, the toll could be $10 billion.
Tax revenues are at stake, too — a few hundred million annually for New York City and state.
Forgoing easy cash now, though, is an investment in the future.
The only way the big banks can make such huge profits is making sure that derivatives don’t become markets. If no derivative instrument looks quite like any other, investors can’t compare them and learn. Instead, investors have to depend on the banks. Obsessive opacity in pursuit of high fees, and future bailouts, may be good for particular Wall Street firms, but they are not good for Wall Street — or New York.
Simpler financial instruments and lower fees would make investors more confident in our markets. Without such confidence, the world will go elsewhere with its money — a bigger threat to New York than, say, a less profitable Goldman.
Investment firms should still be able to construct complex derivatives — but they and their clients should have to put a lot of cash down behind these bets, to prod them toward exchanges.
It’s reasonable to worry that greater derivatives trading could send some business to Chicago or London. But healthy, open derivatives markets would create opportunity, too — requiring programmers and financial engineers to devise elegant solutions to complex problems.
Unfortunately, both parties in Congress have a huge motive to thread derivatives reform with loopholes. It’s hard for voters to follow the details, and faux reform would keep the banks happy.
Democrats were weak on the issue until Arkansas Sen. Blanche Lincoln came along with a tougher proposal. They’ve now spent a week writing exemptions to her rules.
Republicans aren’t doing a good job, either. Yesterday, the GOP finally agreed to open the bill up for debate and a vote — without making robust derivative trading one of its key requests.
Mayor Bloomberg, Sen. Chuck Schumer and the rest of the New York gang support reform — but they, too, have an obvious motive to “tolerate” big exceptions.
The city’s pols should stick up for Wall Street’s future — which means sticking up for markets, not fee factories built on an expectation of bailouts.
Fixing these markets may hurt now — just as slapping similar rules on old-fashioned stocks and bonds hurt in the 1930s. But over the decades, the rules set America apart — and helped more than they hurt.
Nicole Gelinas, Manhattan In stitute senior fellow is author of “After The Fall.”