It appears that Wall Street is not acting as a force for economic expansion, providing access to capital for companies that make things. Rather, it seems, Wall Street is using government bailouts to lever up.
Wall Street uses exotic financial tools to fund what amounts to unregulated gambling. Wall Street wants to keep its schemes too complicated to understand so that the roulette wheel can keep turning. While derivatives trading can be complex, the underlying concept is simple enough: keep trading secret and off-book and pocket profits from both sides of a trade.
Unregulated derivatives are a cash cow hidden from public view and run with less oversight even than actual casinos. The five largest U.S. commercial banks are on track to earn more than $35 billion this year trading unregulated derivatives. According to the Office of the Comptroller of the Currency, the nation's five largest commercial banks held 95 percent of the $291 trillion derivatives portfolio of the country's 25 largest bank holding companies at the end of the first quarter. More than 90 percent of those derivatives were in unregulated trading.
Prior to 2000, as a matter of federal law, all derivatives were required to be traded on regulated central exchanges overseen by the Commodity Futures Trading Commission, unless specifically exempted by the Commission. The oversight protected the public from the inherent risk posed by derivatives and from the chaos that could result from unscrupulous or reckless trading.
After 2000, the field was cleared of referees and market players were left to run wild with unregulated derivatives.
The change occurred when Wall Street asked for -- and received from Congress -- an exemption from all regulation of a massive class of derivatives, including a preemption of state gambling laws. Literally, gambling laws had to be overridden. Derivatives dealers acknowledged the gambling inherent in derivatives trading and the business they stood to gain from this exemption.
Deal-making became so opaque that it was impossible to follow. The true values of exotic instruments were impossible to determine.
Imposing full transparency and true competition will require moving derivative trades onto regulated exchanges. That would mean full transparency of trading prices and volumes, reporting requirements for large trader positions, and adequate capital reserves to protect against a default. The government needs full anti-fraud and anti-manipulation authority. Giving regulators this power will ensure a transparent and competitive marketplace and will ensure that violators will go to jail.
Wall Street has a lot of reasons for wanting to keep the unregulated derivatives casino open for business. Specifically, Sanford C. Bernstein & Co. analyst Brad Hintz recently estimated that Wall Street revenue from trading unregulated derivatives might decline by 15 percent just by moving trades to clearinghouses. That is because the current system enables banks to profit from secret pricing - pocketing the gap between what they charge customers and what they pay to hedge their trades. With transparent pricing and true competition on an exchange, higher gambling returns are much more difficult to achieve. Public disclosure of price data would also mean that dealers no longer had better price data than clients.
Let's embrace productive capitalism, not casino capitalism, by restoring transparency and true competition in the commodities markets. Our nation's financial sector can act as a great force for job creation and production. We should not stand by and let their dimly lit casino bring us all down once again.
Cross-posted from The Huffington Post.