Barca beat Man United tonight in the Stadio Olympico 2-nil. Fittingly, United played as though they were in a Fellini movie. A huge disappointment of a match that was eagerly anticipated by all football fans. Sad.
Anyway, the issue we raised yesterday is a very real one; how does one regulate risk taken by non-financial institutions and which brings up the related question of who is the regulator? In reverse order, AIG is a very good, highly profitable insurance company. It was not the insurance business the got buggered, it was the financial subsidiary that was based in London. AIG's regulator was the State of New York as in this country, insurers are regulated in the state of their incorporation. NY State hadn't a clue about the business of the London subsidiary or at best, had only a notion. See the problem? The business being done across the pond turned out, because of the volume conducted to be in the nature of a "systemic risk" or at least it was in the minds of Our Hero who was running the NY Fed at the time and the then-Secretary of the Treasury, Hank Paulson. Problem was it grew like Topsy before anyone in real authority could put a stop to it. There are a number of similar situations in place as I write; just consider hedge funds and private investment funds not to mention trading subsidiaries of a number of otherwise non-financial corporations--both public and private--world-wide.
A great deal of derivative business being conducted is for entirely legitimate purposes, for example to hedge commodity positions , future price movements and interest rate movements as we have discussed. A great deal of this business is proprietary, i.e. knowledge of it can give a competitor a huge advantage as to a corporation's positioning, future views and strategy. Hence, a central clearing house, open and available to the public may not be in the best interest of the very parties directed to use the same. Further, clearing houses present their own form of risk; if everything is going through a few shops what happens if something goes wrong within one of the shops? The advantage of the availability of information in centralized locations is very possibly off-set by the additional risk being created. Some have advocated a special regulator and control functions for "systemic risk" be created. I guess systemic risk is like pornography; you know it when you see it. Problem is by that time everybody's got their clothes off and all you can do is prosecute it. Defining it is a topic for another day, but you get the idea. Before we all run out and do something it might be a good idea to first decide what we are about to do is a good thing.
I must confess, I am rapidly running out of my league here, but I just have a feeling that as the buzzwords of "regulation," "disclosure" and my all-time favorite, "transparency" dominate the conversation, we are likely to end up with a mish-mash of regulation that provides little of the above and a whole lot of hoops to jump through in order to maintain a very useful series of products that used properly do a lot more good than harm. If the industry allows congress and the administration to draft the rule, there's trouble ahead. Now is the time to be "proactive" (does anyone really know what the hell that word means?) and get out in front. An old friend and colleague once asked of me,
"Why do you get to a meeting early?"
"Don't know"
"So you can pick up all the chalk. That way you're the only one that can write on the blackboard."
Good advice even today, but I have no idea what the solution might be in the age of Power Point. Steal the whiteboard?
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