Tuesday, August 10, 2010

so, if christie romer is out, then...

A nice story about Larry Summers. Thanks to 3Qd for this amazing piece. Fitzgerald quotes in an article economics? My my.

Bucket shops were once operated in many large American cities. Outfitted with a New York Stock Exchange ticker, each shop would post quotations as they came in. Customers, rather than buy stocks, would bet on the tape—for example, 20 shares of sugar at $100—and the shop would take a commission. If the stock went down, the customer lost. Customers could also short a stock. Edwin Lefèvre’s 1923 book, Reminiscences of a Stock Operator, vividly describes the turn-of-the-century bucket shop. They were partially blamed for the Panic of 1907, and states outlawed them soon after that. The New York Stock Exchange, where customers bought the underlying assets, continued to be legal.

The “synthetic” collateralized debt obligation is a revival, 100 years later, of the bucket shop. Could anyone defend the return of gambling shops? Well, yes, President Obama’s principal economic adviser, Lawrence Summers, did. In July 1998, as deputy treasury secretary in the Clinton administration, he explained to Congress that the derivative market “in just a few short years” had become “highly lucrative” and a “magnet for derivative business from around the world.” The market, Summers continued, is developed “on the basis of complex and fragile legal and legislative understandings.” It was true, he said, that “questions have been raised as to whether the derivatives market could exacerbate a large, sudden market decline.” But he didn’t think so, noting that the derivatives supported “higher investment and growth in living standards in the United States and around the world.” There was no reason for concern, he said, since:

the parties to these kinds of contracts are largely sophisticated financial institutions that would appear to be eminently capable of protecting themselves from fraud and counterparty insolvencies and most of which are already subject to basic safety and soundness regulation under existing banking and securities laws.

Summers explained that the market was based on an “implicit consensus that the OTC [over the counter] derivatives market should be allowed to grow and evolve without deciding” the legal issues—i.e., whether derivatives violated laws prohibiting bucket shops, gambling, and trading in unregistered securities, not to mention doing so outside the regulated options exchanges, such as the Chicago Mercantile Exchange. “At the heart of that consensus has been a recognition that ‘swap’ transactions should not be regulated . . . whether or not a plausible legal argument could be made” that the contracts are “illegal and unenforceable,” Summers said.

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