Opacity's Child

“Regulation of derivatives transactions that are privately negotiated by professionals is unnecessary.”

-Alan Greenspan

 

Some of the financial ideologies born out of the Clinton Administration’s second term are something for sore eyes this morning. With ex-Goldman CEO and czar of all things Greek Philosophy, Robert Rubin, at the helm of the US Treasury, there was no stopping Alan Greenspan and Larry Summers from de-regulating us into oblivion.

 

Now some may argue that is too aggressive a stance to take on America’s Wizards of Oz (after all, they are “professionals”), but one of those people isn’t President Bill Clinton. Clinton made 3 explicit comments about his Treasury Secretaries (Rubin and Summers) on ABC’s “This Week” program yesterday:

 

  1. “I think they were wrong and I think I was wrong to take their advice.”
  2. “Their argument was that derivatives were expensive and sophisticated and only a handful of people will buy them and they don’t need any extra protection.”
  3. “Sometimes people with a lot of money make stupid decisions and make it without transparency.”

Now whether you are political or not doesn’t matter this morning. This Tiger Woods like PR nightmare for Goldman Sachs is political in principle and global in reach. In the UK, Gordon Brown is staring down an election on May the 6th, so don’t think his rushing out to the cameras to call this a “moral bankruptcy” was ironic in its timing.

 

Don’t think for one second that the Clintons don’t have a plan here if President Obama fumbles on the opportunity either. Hillary’s husband admitting he was wrong in the face of Blankfein reminding the world that he thinks he is smarter than you, opens the fences for one of the biggest political softball pitches in US history.

 

History is what matters this morning, not the semantics of a Goldman VP and the volcanic ash that has become him. On December, 15th of 2000 Congress took Robert Rubin and Larry Summers word for it and declared law that derivatives and swaps were free and clear from regulation and/or oversight by the CFTC (Commodities Futures Trading Commission). Then in 2004, Hank Paulson and Dick Fuld lobbied hard to have the SEC removed their leverage ratios (great for a derivatives business, if you have one).

 

Taking a step back, most people in America are becoming familiar with the name Brooksley Born. She was the chair of the CFTC who tried to regulate the swaps market early in Clinton’s second term. This was after Orange County’s derivatives bet blew up (1994) and before Long Term Capital Management imploded (1998).

 

I know, how dare she try to regulate the Goldman boys (she was elected President of the Stanford Law Review in 1963) when, according to my favorite financial historian Roger Lowenstein, “most of the women in law firms were still pouring coffee.”

 

Brooksley Born resigned in 1999 and the rest, as they say, is history. In Lowenstein’s latest book, “The End of Wall Street” you can get up to speed on the history of derivatives de-regulation in literally 7 pages (pages 57-63). On page 62, Roger quotes Greenspan when he was asked about the topic of derivatives regulation again in 2002: “Regulation is not only unnecessary in these derivative markets, it is potentially damaging.”

 

What’s really going to be damaging here is the deepening global perception of American financial markets being opaque. When the President of the United States pipes his message of ‘Transparency, Accountability, and Trust’ into CNN, some people out there actually take his word for it.

 

I think this Goldman case is going to be much larger in scope than those who “bought GS on the dip” on the technical merits of the SEC fraud case on Friday think. This is going to be a global debate about transparency versus opacity. Goldman will be opacity’s poster child.

 

The risk manager in me obviously asks about the downside before I start accepting the narrative fallacy of perpetual upside; particularly after Thursday’s closing YTD high of 1211 in the SP500 (which was +79.1% higher than where most of people were right freaked out by the fears that the likes of another Goldman beauty, Hank “The Market Tank” Paulson, helped perpetuate).

 

Not unlike Hank Paulson’s grossly miscalculated risk that Lehman filing for bankruptcy was going to equate in a “cleanup day” (Lowenstein’s “The End of Wall Street”, page 198), the idea that re-regulation of the entire swaps and derivatives market is going to equate to a 1-day selloff in stocks from their nosebleed highs is reckless in its historical assumptions.

 

We shorted the SP500 on Thursday April 16th, then issued a slide presentation on Friday outlining why our Hedgeyes see the risk outrunning the reward at SP as we head into May. No, we didn’t know that the SEC was going to make this move. No, we didn’t purport to not know how opaque our financial system was prior to the announcement either. Managing risk doesn’t happen in the vacuum of Opacity’s Child. If you are going to play this game, just know who you are playing against.

 

My immediate term support and resistance levels for the SP500 are now 1175 and 1214, respectively.

 

Best of luck out there today,

KM

 

Opacity's Child - BL