How much did Tiger Woods cost shareholders?

Oh why not, one more before I really take a break from blogging. From Will Ambrosini, Christopher Knittel and Victor Stango from UC Davis have found the following interesting conclusion: “We estimate that in the days beginning with Tiger Woods’ recent car accident and ending with his announced ‘indefinite leave’ from golf, shareholders of companies that Mr. Woods endorses lost $5-12 billion in wealth.” They give us this chart:

Felix Salmon already points out obvious problems. Here’s what I notice. From the paper:

“We weight the returns proportionally by the market value of each parent company (see Table 1). So, TLC Vision has only a small effect on the losses felt by shareholders because it is very small, while PepsiCo (Gatorade) has a very large effect because it is worth $90 billion.”

So for the “Big Three”, the dotted green line above that is also included in the other two lines, we have Nike, EA and PepsiCo. PepsiCo is $95 billions market cap, EA $6 billion, and Nike $32 billion. So because of the weighting, these results are driven in large part by movements in PepsiCo stock price.

And sure enough, PepsiCo took a hit in its EPS estimates for 2010 in order to focus more on investments in China, and this happened to fall right around the time the chart above takes a nosedive. From Yahoo Finance:

(December 9th) Shares of PepsiCo Inc. declined on Wednesday after the world’s second-largest drink company trimmed its fiscal 2009 outlook because it is spending more to invest in developing markets such as China….The stock declined $2.39, or 3.8 percent, to $61.09 in midday trading….

PepsiCo…said Tuesday that 2009 sales will rise 5 percent and earnings per share will climb between 5 percent and 6 percent. Previously, PepsiCo expected both profit and sales to rise by a percentage in the mid-to-high single digits. The new outlook puts 2009 adjusted earnings per share between $3.86 and $3.90. Analysts surveyed by Thomson Reuters predict earnings of $3.72 per share.

And a quick peak at a current chart of all three stocks shows that PepsiCo has kept this lower value while the other two have bounced back (it’s worth noting that PepsiCo has half the vol of ERTS). So we really need to see this with this earnings announcement taken out (or corrected for?). It’s telling, as Felix noted, that Accenture hasn’t taken a hit even though they had the most invested.

So my guess is that this is driven by an earnings announcement by Pepsi. Isn’t it great that sometimes fundamentals actually drive stock prices, instead of mathematical algorithms programmed to bet against each other and whatever headline is on tmz in a given day?

Happy Holidays and New Year

Hazards

It’s worth noting that it has been 5 days since the Senate voted for Health Care Reform, and since then I’ve become unemployed, and have spent the last week eating waayy too much polish sausage and italian beef sandwiches, drinking nice bourbon to all hours of the night and then getting 3am tacos at Western and Armitage.

Above, is me looking for italian beef and cheeseburgers at Nickys Chicago, and my behavior lately looks exactly like what the conservatives worried about: moral hazard! risk homeostasis! bad work incentives!

Ha! That’s not the actual motivations; I’m just transitioning from San Francisco to the new job in New York via a debauched holiday break in Chicago with family and friends. Have you ever had an italian beef sandwich with hot peppers? Delicious. Here’s the wikipedia page for Italian Beef.

The 00s have given me some great local bar haunts: Old Tuman’s (RIP), the camaraderie of Champaign’s excellent Mike and Molly’s, San Francisco’s Dovre Club, and especially Chicago’s very own California Clipper, where I got to enjoy a game of Bingo last night, something friends of mine host every Monday night and is worth an evening of your time. It all brought back a lot of good memories.

Work the Holidays?

So did you go to work this week? That’s always the debate with an office job: On one hand, you get a giant break for the cost of three days off. On the other hand, if you go to work this Monday through Wednesday, there’s nobody there, so you can either get a lot of actual work done and/or do very little depending.

The statement “Now that the blogosphere is empty and everyone is taking this time off, I can get finally some serious blogging done” makes very little sense, so since I didn’t say it before I’ll be back next week, in a new job and a new city. I hope you’ve had a Happy Holidays and continue it with a Happy New Year.

Did the 00s suck?

Allright, time to clean out the entirety of entries that have been sitting in the Draft Folder for a while in a single rambling post.

I’m noticing a lot of Best of Decade lists, but I’m not hearing an important question on the blogs: Did the 00s suck? For the United States, I’m way too close to it; I graduated college 3 months before 9/11, and turned 30 shortly after Obama became President, so the 00s are the story of the Bush Years and are also the stories of my 20s. The internet turned out to be fantastic, far better than I expected 10 years ago. A 65 year old widowed friend of my mom’s found her old high school sweetheart on facebook in another part of the country, also widowed, and they are going on small romantic trips together, which is just amazing. But there’s all the other stuff…

The Worst Thing a Person Said in the 00s

- To start, what was the worst thing a person said in the 00s? I know the obvious is the “You gotta hear this one song it’ll change your life I swear” scene in Garden State. I get where people are coming from, not because of the twee-ness (I really liked that Shins album, especially “Caring is Creepy”) but at the horror that Zach Braff is going to be the muse of my generation, walking me life event to life event. But that’s not the winner.

The winner? This:

[4/11/03]…Q: Mr. Secretary…television pictures are showing looting and other signs of lawlessness….

Rumsfeld: Let me say one other thing. The images you are seeing on television you are seeing over, and over, and over, and it’s the same picture of some person walking out of some building with a vase, and you see it 20 times, and you think, “My goodness, were there that many vases?” (Laughter.) “Is it possible that there were that many vases in the whole country?”

“Is it possible that there were that many vases in the whole country?” wins, hands down. I’m still kind of amazed by it. It’s tough to read old press briefing transcripts like these because they are a pretty chummy affair. But still. A lot of neocons in the buildup to the war tried to convince me that there’s no way Rumsfeld wasn’t going to manage this war well. Hearing him say this made me think “It’s possible this guy is a real sociopath.” At the time all I could do was reflect on this Get Your War On Cartoon:

I remember thinking that things were going to get real nice for the people of Baghdad.

Youths

- So right after college I moved to Chicago and lived with my friend Ed (of ginandtacos.com fame). I started work at Motorola doing the statistical numbers and the programming. After 9/11, Motorola would go on to announce, over the course of several years, the layoffs of somewhere around 1/3rd of its workforce. My suspicion was that my job was more safe than normal because I had no health care expenses, while veterans and lifers were getting cut left and right.

- A lot of people linked to this interesting discussion of The Office being depressing because of Jim’s situation with being promoted to middle management at a floundering company this season. I actually love the new dimension and wish they would take it further; there’s something about the experience of “I hope they don’t lay me off this job I really don’t want to be doing” that the civilians among you can’t relate to unless you’ve experienced it yourself.

- Ed, god bless him, was hired as a manager for a medical debt collection company. You sometimes hear about how debt collection is happy technicians using smart computers to dynamically give you the most dynamical debt schedule, but at Ed’s firm it really was hiring goons and thugs to call and then scream and threaten sick people who couldn’t make their payments. (He has a great story about their best collector always showing up to work, and doing his job, with a knife strapped to his leg.) You can’t even imagine the turnaround Ed was able to pull off in taking the GRE and applying to graduate school.

- So several early formative adult experiences involved watching the Keynesian-Fordist corporate pact in complete implosion mode, and hearing about the ugliest part of debt collection carried out among those unlucky enough to not be able to afford health care. My politics adjusted accordingly.

Gems

- You probably already know all the best stuff. Some gems you may not know that I’d highly recommend saving from this decade: The BBC show Black Books, a “High Fidelty” with a boozy angry Dylan Moran in a used book store, with an excellent first season that later gets a bit slapsticky. Also Los Angeles Plays Itself, a 3h experimental documentary consisting of 191 clips of movies set in Los Angeles that explore the city via the movies and the movies via the city (it will probably never be released formally because of the insane copyright, but it does float out there as a bit torrent…). It seems that Mclusky and Hot Snakes are slipping through the cracks on top lists of music for the decade, which is very unfortunate.

Zombies, Survival, Torture Porn

- Though I’m not usually a fan, I think trends in horror movies are always onto something. What to make of the wave of torture porn in horror? I think this, from American Stranger, is interesting here:

The cultural debts owed by most of this decade’s horror are painfully obvious: the Golden Age of the 1970s, when the genre was infused with as much ’social commentary’ as fake blood and pigs’ guts…

No, the legacy of ’70s horror (in the sense of its effect on later filmmakers) is not politics but reductionism. Zombies, ‘torture porn,’ even the sometimes more highbrow ‘new European extremity’ of Gaspar Noe, Alexandre Aja, Michael Haneke, Bruno Dumont, etc., strip their horror scenarios of everything but the bare premise: the dead walk, a killer attacks at random, now deal with it. Watch.

That there is nothing for the protagonists to do but live or die, nothing to mean but success or failure, is no longer a mere precondition for a broader recontextualization of ideology but the entire narrative and ideological point…Even more than the cartoonish ’slasher’ monsters (Michael Myers, Freddy, Jason), but for notable exceptions like Jigsaw, the new breed are absent non-entities, a-causal killers. In Funny Games the murdering duo are fictional tropes — in Hostel torture is just a business. The Dark Knight’s Joker,There Will Be Blood’s Plainview, and No Country For Old Men’s Chigurh all borrow the trope: the ’00s were the age of monsters without reason.

Music

- Like Dostoevsky, I think you haven’t really appreciated t.A.T.u. until you’ve experienced it in the original Russian. Thanks to youtube, you can click to hear “Ya Soshla S Uma” and “Nas Ne Dogonyat”. Someone really should do one of those slate pieces where they argue t.A.T.u. is the essential band of the 00s; faux-lesbians, bad pop music, Universal Music lawyers and Russian mobsters breathing heavily in the recording studio while explaining to the girls that they have to keep making out for the cameras until their record recoups expenses, which it never does (I can’t even imagine how Russian mob accountants count money).

- I don’t give enough Scharpling & Wurster love at this blog, a radio station that does some comedy clips, but this track from their CD is one of my favorite comedy clips from the decade. Come listen to the story of Corey Harris, lead singer of Mother 13, playing “Bud Light/Snickers Dancing in the District Festival” for Clear Channel on the hopes that their album recoups. It’s a funny version of Albini’s The Problem with Music. “Some of your friends are probably already this fucked…” is a rallying cry, and the internet has opened up a realm for musicians to get their stuff out without having to mimic the twisted market structure of the recording industry. I think that’s the obvious win for music in this time period.

- In mid-2008, after discussing some terrible shows we’ve seen, a friend said “You know, we had to live through the Bush Years, and we didn’t even get a decent punk band out of it. All we got was Vampire Weekend!”

- You weren’t there. But here’s something I love and want you to see anyway: The Top 20 Champaign-Urbana Albums of the 00s. The Headlights are starting to get some attention; this great video and song remind me of that place and time.

Someone was complaining about how terrible music was in the 00s, and he wanted to trace the source of what he hated to Braid. I disagreed, and pointed out what he hated was really more of a Cap’n Jazz thing (the singer is later the Joan of Arc guy, the drummer the guy from the Promise Ring). But I love all those bands, and all things upper-midwest more generally.

- Someone just recently reminded me of this, and I had forgotten how much I enjoyed it. Superhero Ted Leo sings “Since U Been Gone” with “Maps” in the middle:

Is that how it goes? I forgot all the terrible stuff, and just remember all the little parts that I really enjoyed? That’s not so bad. What’s your take?

H-Kayne’s “Jil Jdid”

Cleaning out the draft box, I just realized I never posted this music video, a welcome break from a long couple weeks. Setup: David Brooks had an editorial a while ago about how twitter and facebook and everything else internets were ruining dating and the young people. I agree in the sense that my gut reaction is that ‘the kids these days’ are in fact terrible. So much of my favorite music, even when I was a kid, was about how terrible the kids are.

Ms. Rortybomb (abbreviated K.) is currently in Morocco for a year of field work studying Moroccan hip-hop, and the way Moroccans use hip-hop as a way of navigating identities, globalization and neoliberalization, and I read his editorial right around the time K sent me a music video for H-Kayne’s “Jil Jdid”, which is a tongue-in-cheek track about how the kids of Morocco waste all kinds of time messing around on facebook and going on internet dates. H-Kayne is a new and very popular hip-hop group out of Morocco; you can see their myspace page here.

The video is the story of a kid who goes on a 17 hour internet bender and needs to go to the hospital where doctors, played by the rappers, have to hook him up to iphones and playstation controllers in order to get his body going again. The rest of the video involves middle-class Moroccan teens going on facebook, meeting up for internet dates, playing video games, having that odd expression of staring into a computer monitor, etc. (in the middle of all the Moroccan Arabic you can hear the words “myspace” and “skype”). It’s pretty amazing:

I imagine Brooks is one of those who think hip hop corrupts everything, but I certainly like the idea of a team up between him and this hip-hop group; if there must be one, there is no End of History theory more comforting to me that the nations of the globe teaming up to complain about how the kids are wasting their time jerking around with crap on the internet. That is post-ideological.

Things I’m reading, 12/22

There’s no way you are actually accomplishing work this week, is there? Here’s some really good wonk stuff I’ve read recently online:

- Ryan Avent on Bernanke’s testimony and Person of the Year award.

- Felix Salmon makes a list of the Fed’s regulatory errors after reading this excellent Washington Post piece. It’s amazing to me how much the current ideas behind the Frank bill codify the problems Felix points out: “Overreliance on internal bank risk officers…” is the living will concept, “A touching belief in securitization and triple-A credit ratings” is still there and the Fed’s new methodology of risk states for the largest institutions is strikingly similar to that original ratings style, “A feeling that banks had to be able to compete…” is the argument for returns to scale (and the implicit justification behind the fact that the largest institutions are now getting bigger as a result of government action).

- Ezra Klein responds to Jane Hamsher’s 10 reasons to kill the bill, the critique of the Health Care bill from the left. I’m excited to get the Health Care bill behind us if only for Ezra’s mental health.

- Yglesias and Krugman (and to a an extent, Kevin Drum) have said that financial reform should be the issue that the left doesn’t compromise on: “So there’s a strong case for coming out swinging against denouncing a too-weak [financial] bill as a sham and drawing some bright lines.” Nice. I’ll do my best in 2010 to help pick the spots where we dig the trenches.

- Noam Scheiber on how top MBAs moving from business to finance both as an educational curriculum and a matter of job desirability has left us with an interesting question: could anyone manage a rise in manufacturing anymore? I’m reading this fascinating ethnography of Wall Street analysts (more on which later), so I’m very interested in the fashioning of our current business elite these days, and I think this change is important across the board. As a practical matter, the rise of “management consulting”, the other big boom market for elite MBAs next to investment banking, could be able to address Noam’s worries about manufacturing – but does it? (Paging James…)

- Visiting home for the holidays, it’s amazing to me how certain groups of friends, who I mostly considered in the generic Republicans/conservatives camp, have been wading deeper into the Ron Paul territory. “Abolish the Fed” is one thing, but what surprised me the most was when I was at a Christmas party several people mentioned, fairly out of nowhere, how bad FDIC is for the economy. I think they thought that regular depositors could have done a better job vetting financial institutions than major sophisticated shareholders. When I tried to point out how if there wasn’t FDIC and millions of savings accounts were getting wiped out in ordinary bank runs we’d almost certainly have a wave of turn-of-the-last-century style violence that is hard for us to even imagine now – think bomb throwing anarchist violence – they seemed to be ok with that.

What have you been reading?

The Broken OTC Markets

From Professor Jayanth Varma’s blog, last Friday saw an interesting hidden news dump from the SEC related to ICAP and the the OTC market (pdf here).

On the UST desks, ICAP, through the Brokers, engaged in deceptive conduct by displaying fictitious “flash” trades on ICAP’s screens seen by its UST customers, who took that information into account in making their trading decisions. In addition, the firm represented to its customers that the ICAP trading screens would handle customer orders in accordance with certain workup protocols, which the firm and the Brokers circumvented when Brokers used manual tickets to liquidate house positions that were acquired through error trades or through ICAP’s posting of executable bids and offers. Between December 1, 2004 and December 31, 2005, certain ICAP UST brokers displayed thousands of fictitious trades on ICAP’s screens, and used manual tickets in thousands of instances to close out of house inventory positions acquired as a result of error trades or through ICAP’s posting of executable bids and offers, in certain of which instances ICAP’s customers’ orders received different treatment than the customers expected pursuant to the workup protocols.

They pay $25m in fees, don’t admit any guilt, and agree to bring in a consultant to give an all clear on deceptive, fictitious trading and traders liquidating their own positions. Finding a way to reform this market needs to be a priority for 2010. As Varma says:

The question in my mind now is how badly broken are the OTC markets. Whenever, people describe the stock exchanges as casinos, my response is that even if many of the participants are only gambling, the stock exchange still performs the socially useful purpose of price discovery. OTC markets that do not provide transparent price discovery do not perform this function and are much closer to pure casinos. Those that distort the price discovery are worse than casinos.

Release the AIG Emails!

Take a minute, if you missed it already, to check out this editorial in the NYTimes by Eliot Spitzer, Frank Partnoy and Bill Black (three people who have investigated a fair amount of financial fraud) where they call for an open source investigation of what went wrong at AIG:

we know where the answers are. They are in the trove of e-mail messages still backed up on A.I.G. servers, as well as in the key internal accounting documents and financial models generated by A.I.G. during the past decade. Before releasing its regulatory clutches, the government should insist that the company immediately make these materials public. By putting the evidence online, the government could establish a new form of “open source” investigation.

Once the documents are available for everyone to inspect, a thousand journalistic flowers can bloom, as reporters, victims and angry citizens have a chance to piece together the story. In past cases of financial fraud — from the complex swaps that Bankers Trust sold to Procter & Gamble in the early 1990s to the I.P.O. kickback schemes of the late 1990s to the fall of Enron — e-mail messages and internal documents became the central exhibits in our collective understanding of what happened, and why.

It’s really possible that we’ll come away with a much better impression of AIG as a result. They may have simply been the victim of incredibly poor timing and getting in a little over their head rather than having acted as major villains of the crisis. It would also shine some light on their post-bailout activities, activities that have also worried many, including myself, in whether they are playing favorites with taxpayer money. And it would involve crowd-sourcing investigations, so we can see if the financial blogosphere is up for the challenge.

The Roosevelt Institute is putting together an online petition here if you are interested in signing or reproducing it on facebook or twitter. Click through if interested!

Culture Norms and Walking Away

It’s Christmas Week! I’m going to go ahead and write some fun quasi-off-topic rough draft stuff this week since we’ve been wandering in financial reform for some time.

To start: Megan McArdle and Steve Waldman are having an interesting back and forth on the idea of cultural norms and strategic defaulting. (In order, Megan, Steve, Megan, Steve. I really enjoyed Steve last post there, but they are all worth a read.) It starts with McArdle referring to strategic defaulters, those who could continue to pay on an underwater mortgage but decide to mail in the keys and stop payments, as “The New Breed of Deadbeats.” Though they aren’t breaking any laws, and are probably acting in their own financial best interest, they are tearing up the implicit social norms that create the conditions for our excellent credit markets. Megan:

I am afraid that I am one of those people who have no patience for people who refuse to pay their debts… There is a sizable school of thought that says why shouldn’t they? They made a contract with the bank under known rules, and as long as they’re willing to pay the penalties, why shouldn’t they just walk away, the way a corporation would? Well, for one thing, companies don’t always behave like this, and those who get a reputation for stiffing their suppliers run into trouble. But for another, because society doesn’t really work on such clean logic. The reason we can have easy bankruptcy and a pretty robust credit market (usually) is that most people act like debts are obligations which should always be paid off if possible.

EoC On The Lynch Amendment

Economics of Contempt has a post up where he called the Lynch Amendment, an amendment which would limit the ownership of clearinghouses and exchange for major swap dealers at 20%, and which I wrote in favor of in this post, “Bizarre and Confused”:

Why on earth would we want to discourage the dealer banks—who, for better or worse, are the only ones capable of being market-makers in OTC derivatives—from mutualizing losses? That’s what the Lynch amendment would do. The clearing members are the ones who are ultimately on the hook for a default in a clearinghouse model, so of course they’re going to want to have a say in the kinds of contracts the clearinghouse accepts, and in the clearinghouse’s risk management practices. A dealer is unlikely to trade through a clearinghouse if it’s prohibited by law from having a say in the kinds of contracts that it—as a clearing member—is being put on the hook for. Clearing members should have a say in those kinds of matters—it’s exactly the kind of aligning of economic interests that we’re looking for!

Take a second and read that quote. It’s saying that of course we want the largest swap dealers having a say in what kind of trades go through a clearinghouse and what kind of trades will be pushed back onto the OTC market. It’s an excellent alignment of economic interests, what could possible go wrong?

Po-po

Well, here’s one thing. Bloomberg, Aug 3rd (my underline):

Markit Group Ltd., the data provider majority-owned by Wall Street’s largest banks, is under Justice Department scrutiny for potential anticompetitive practices ranging from requiring customers to buy bundled services to restricting which trades can be cleared in the $26 trillion credit-default swap market.

Markit told a swaps clearinghouse customer to purchase a pricing service as a condition for granting use of its benchmark indexes, said a person with knowledge of the transactions. Markit permitted use of its indexes by another clearinghouse only if every swap guaranteed by the company included a dealer, such as one of its owners, said other people familiar with those negotiations.

“That’s a legitimate area of inquiry,” said Evan Stewart, a partner at Zuckerman Spaeder LLP in New York who has practiced antitrust law for more than 30 years and isn’t involved in the case. “If you want to get into the market with Markit with access to real-time prices, this is where you have to play,” he said. “You don’t have a supermarket of other choices.”

Right now the Department of Justice is investigating the largest players in the derivatives market for anticompetitive practices, one of which is manipulating which types of instruments can clear in a clearinghouse.

To put it a different way, opponents of full financial reform are saying that the a few concentrated market players can be trusted to not manipulate the clearinghouses at exactly the same moment as a few concentrated market players are being investigated by the Department of Justice for manipulating the clearinghouses. Change we can believe in!

I know what the retort is. “Mike, you know that po-po is always fucking with a working man who is just trying to hustle some (financial) product on the corner to feed his kids.” I’m sympathetic to critiques of “po-po” myself. But this was the point of the recent Slate piece on the Lynch Amendment; giving the largest players a legal ability to sit together in the same room and make rules for trading and clearing swaps at the same exact moment they are being investigated for a conspiracy to do that is a terrible idea.

More generally, EoC has very little use for exchanges or swap execution facilities. He believes that if 7-8 major players sit down and report a price that takes place if a trade takes place is enough price discovery. I think having prices at which multiple parties would be willing to trade at a moment in time is far more important. With technology and financial innovation, this will cut into lucrative spreads enjoyed by the biggest banks, hence their completely rational interest in not seeing it go through. I wrote out my arguments for why exchanges and swap execution facilities are better than simply clearing in the previous entry.

An Argument for Exchanges and Swap Execution Facilities

Over at FT Alphaville, Craig Pirrong has a response to my concerns that OTC derivative regulation has major loopholes.

Pirrong validates my worries as he also believes these loopholes are real, but instead chooses to cheer them on:

“That is, whereas reform advocates envisioned that under the new law swaps would be traded almost exclusively on exchanges or transparent, exchange-like venues, they claim that the new language would perpetuate the existing ways of trading swaps in scary “dark” markets.

This is not a bad thing at all – contrary to what some have argued…the authors are to be commended. To the extent that the bill still imposes unnecessary mandates, they are to be criticized.”

He goes on to press that exchanges were tried in the agricultural and commodities act and failed, and that my concerns reflect a “standardization religion.” There’s a couple of things going on, and that baseline post was fairly insider baseball, so let’s back up and talk through some things here.

For Exchanges

Let’s define some terms. Many people are comfortable forcing OTC derivatives to be forced into clearing (though I don’t think the author above does). I like that, but I and others worried about financial reform want to see more. Let’s talk about exchanges versus clearing. Now as opposed to the FT article, I’m not saying everything needs to be forced onto an exchange proper. There are plenty of great innovations going on in the swap execution facility (SEF) world. What I am worried about is that the swap execution facility will move away from a formal “trading facility” definition towards a vague nebulous definition of whatever people can get away with.

So what are the features that I want to see? I want to see pre-trade price transparency. I want a facility where multiple parties can see and execute on offers from other parties. A facility that collects the prices at which multiple parties would be willing to trade a a moment in time, and update those prices as time passes.

Right now people will tell you that clearing derivatives still gives market prices, and these prices can be transparent with a few tweaks. However a clearinghouse only sees one price, the price at which the deal was struck, and it only sees that price after the deal is completed. So yes, this is a history, but it is only a partial history. A fuller price history will give us information available for use by many different parties to carry out their own transactions, the very heart of what prices are supposed to do in a market.

Now some argue that some financial instruments, say a CDS contract, can’t be forced into clearing, since it would be unprofitable to post the margins and collateral necessary to clear. Your response should be: fantastic! This is an example of where sunlight is the best disinfectant. If an instrument trades only because people are uncertain about how it will ever get paid off, or if an instrument trades only because there’s an implicit (and nowadays, explicit) government guarantee of using taxpayer money, and without this guarantee nobody would be involved, then you don’t actually have a market.

Better Than Clearing

Others argue that having clearinghouses plus a certain amount of disclosure is just as good as having exchange-like mechanisms. I think there are a few things missing from this that you would get with exchanges and SEF.

The first is price transparency, where those looking for swaps to manage risk could find the best price cheaply and easily. The more actively traded the contracts become and the more transparent prices get, the narrower the spread. There are less economic rents, and markets becomes more efficient. The second is that a high resolution audit trail gives managers and regulators something to investigate and observe performance. This is good for managers, who can help resolve the obvious principal-agent problems that we see with the stark promotion/bonus/risk tradeoffs in finance. It is also good for regulators, who will be able to see both corruption and systematic financial risks easier.

The OTC market needs to change. To whatever extent it had problems before, the battle cry of “No More Lehmans!” has given everyone a perverse incentive to participate with Too Big To Fail banks. How can a small dealer compete in this new landscape?

Several people have been questioning whether or not the bills Obama and the Democrats have put together are too big, and whether smaller incremental changes would be a better way to go. Matthew Steinglass had an excellent post in the opposite vein a while back regarding health care, where he noted that each plank of reform moving by itself causes problems, and it is only when they move together can reform actually take place. This is crucial with OTC derivatives, as we can’t make Too Big To Fail progress without substantial new OTC derivatives regulation. Living wills, et al only make sense in the context that counterparty risk is more clearly defined, and that the playing field is leveled for more players.