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"We have learned that voluntary regulation does not work," SEC chairman Christopher Cox told a House committee today (Oct. 23). More significantly, former Federal Reserve Chairman Alan Greenspan confessed, "I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms." Greenspan was admitting that he did not understand that, among many things, banks and other companies were operating for short term gain and to maximize the already-obscene pay of top executives, and they were happy to put their shareholders at risk to achieve these repugnant objectives. Greenspan did not want regulation of derivatives. This means that he watched housing prices zoom, knew that mortgages were being bundled and sold to investors as derivatives, and he didn't consider the possibility of the bursting housing bubble blowing up the whole derivatives edifice. Between the lines, he is also admitting that he saw the credit default swaps, essentially insurance on debt through derivatives, and didn't foresee that derivative-choked financial institutions, including insurance companies, would become insolvent, setting off a chain reaction as institutions could not hold up their end of the credit default swap contracts. Apparently, Greenspan did not understand that the essence of white collar fraud is contrived complexity. Derivatives are bewilderingly complex -- deliberately. Few understand them. And here's our dilemma: regulators wouldn't have understood them, either. However, regulators at least could have kept track of who owned credit default swaps. And regulators could have performed other administrative tasks. The question: is it too late? Can all this be unwound? The SEC has failed in its regulation, too. It will pounce on a guy who makes $100,000 in a pump and dump, but look the other way at the nabob who rakes in $500 million in a pump and dump. This happens largely because of the symbiosis between SEC lawyers and the large securities law firms that the regulators will eventually work for.

Comments
8

"The essence of white collar fraud is contrived complexity" is original with yours truly -- several years ago.

I think we should tattoo your insightful observation on Mr. Bubble’s forehead.

BTW, I liked David Cay Johnston's book "Free Lunch" so much I bought his older book, 2003's "Prefectly Legal". He really dives into phony tax avoidance schemes used by large corps and wealthy individuals, and just like you Don-he lays the basis for these schemes on contrived complexity.

Oct. 23, 2008

"Apparently, Greenspan did not understand that the essence of white collar fraud is contrived complexity."

Good line. Equity-indexed annuities come to mind.

Oct. 23, 2008

Good article.

Oct. 23, 2008

Don, it's shameful how we have ended up in this position.

And it was certainly not beyond prediction...The Economist was warning about derivatives at least a decade ago.

The last four administrations have been willfully deaf, dumb, and blind.

Or perhaps it really is just the fallibility of our still evolving human brains? We evolved brain structures that are very well-suited to the African savanna. We can spot patterns (even when they don't exist) and react quickly to perceived dangers. We evolved the ability to cooperate with others and even read their emotions if not their intent. Language has given us the ability to rapidly pass along a lot of information as well as technology to our offspring.

Yet all these advantages can be turned against our own self-interest in the modern environment. Nassim Taleb, among others, points out that we are kidding ourselves when we think we "understand" the stock market. It's betting by another name. There's no possible way to do much better than guess, and the titans of these corporations take far too much personal credit for what has essentially been a run of good "luck" that has now come to a disastrous end.

We have bet not only what we own, but what we have borrowed from others -- especially China. We lost that bet.

We will no longer be able to simply print money to pay off our lenders, and all the other advanced economies seem to find themselves in the same trap.

It's really bad, and going to get a lot worse. The past models no longer apply because we have entered what Taleb calls a "Black Swan" era, where our past assumptions no longer work.

We're in for a helluva ride, and I'm not looking forward to it.

Thanks for the apologies Cox and Greenspan, but it's cold comfort considering the crisis we're entering.

Oct. 23, 2008

Response to post #1: As far as I know, "The essence of white collar fraud is contrived complexity" is original with yours truly -- several years ago. Best, Don Bauder

Oct. 23, 2008

Response to post #2: I hope it sums it up. Best, Don Bauder

Oct. 23, 2008

Response to post #3: Good analysis, Fred, but I want to add something scarier. You say the economy's good performance in the last couple of decades was a result of luck. I think it was a result of excessive leverage. Since 1983, debt has expanded by 8.9 percent a year while the economy has expanded by 5.9 percent annually. Everything is bloated: consumer spending, stock market, real estate values. Finally, the inevitable has happened: we can't add any more debt. We are deleveraging -- trimming debt, and rapidly. This means economic output will shrink dramatically. Asset values will come back to earth: stock and residential real estate prices are already doing so. Best, Don Bauder

Oct. 23, 2008

Response to post #7: He is a great writer and observer of the current scene. Best, Don Bauder

Oct. 24, 2008

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