Wall Street Blues

January 1, 2009 - Wall Street, symbol of investment banking and the stock exchange. The history of Wall Street institutions reveals a pattern of overconfident exploitation of financial advantages, followed by unexpected setbacks and investor panic. The pattern has characteristics in common with progress traps, most notably the ability of financiers to pursue their activities in a culture that is insulated from the world that lies beyond high finance. As it happens, that world is greatly affected by high finance, but financiers are not aware of their effect until panic sets in.

After the 2008 downturn one would expect that swift regulation would end the tendency to trade in financial instruments that have been increasingly abstracted from real assets. According to Lehman Brothers (now defunct) in The Lehman Brothers Guide to Exotic Credit Derivatives "The credit default swap is the basic building block for most ‘exotic’ credit derivatives". However, Bloomberg.com reports that the SEC Chairman Christopher Cox said on Sept. 23, 2008 that "Neither the SEC nor any regulator has authority over the CDS (credit default swap) market, even to require minimal disclosure," and that should be addressed "immediately". At year-end, this remains unregulated, with some critics citing fear of worldwide derivatives market disruption. Didn't this already happen? If the U.S. sub-prime practices caused global shockwaves, surely U.S. regulation would be entirely appropriate.

If you thought it ended at exotic swaps, think again. Financiers trade options on swaps, and the term for that instrument is - you guessed it, "swaptions". Denise Bedell, of Markit magazine, writes in the Winter 2008 issue: "we can still learn lessons from past crises that can help guide the success of current efforts and curb the length and severity of the present turmoil." Tellingly, a sidebar to her article has a history of US financial crises, beginning 1819 and repeating the same mistakes to the present. A recurring feature of these crises is loss of credit to the average citizen, of consumer confidence and jobs in what we now refer to as “Main Street”. These issues receive merely secondary consideration. However, leaders can surely address them regionally without waiting for international coordination.

First published at progresstrap.blogspot.com