Free market efficiency does not work in the derivatives market. Free markets require a very large number of players to be efficient. When interest rates were deregulated in 1980's, no thought was given to how Banks and especially the Agencies, Fannie & Freddie would hedge their interest rate exposures. The free market came up with interest rate derivatives because they saw an opportunity to make money. We should give them credit for Financial innovation - free markets do work in this respect.
However, it has been thirty years since this innovation. Banks and Broker dealers have profited from this deregulation for all of these three decades. It is about time the patent on this simple product expired and the benefits of this product are distributed to all.
There is no point trying to limit Wall street wizards to smaller compensation packages simply by asking them to feel ashamed of their greed. The best way to beat them at their game is to join them.
These wizards are not making money on their really exotic products - this is the dirty secret that the media and lawmakers have completely missed. They are making money on really simple vanilla interest rate products. More disclosure in the Financial statements by actual product line would dispel any myths about their money-making abilities. They are making money from a basic financial product, an interest rate swap, which could be valued by a high school student after a couple of hours of training in simple interest calculations. If the government is really serious about going after Wall street, they should address the structure of the derivatives market. It does not make sense for the Agencies F& F to buy trillions of dollars worth of Mortgages from the public and then go to a small number of Banks, brokers and hedge funds, to offset their interest rate risk. Obviously, the few select providers of this product reap windfall gains, by overpricing it. The plutocracy (reference to Michael Moore's film) owns a monopoly that is fr@#king golden. The whole thing is smoke and mirrors, foisted on an ignorant public by vested interests.
There is a very good argument to allow interest rate derivatives for the retail public. Firstly, it is quite bogus to create a system where every one of our assets have a floating price and then to claim that only sophisticated investors can have access to the products that will hedge the risk of the basic products. Every one of us has exposure to floating interest rate risk through credit card balances, variable rate loans or ARM's. We should be allowed to go directly into the market and offset this interest risk. The main barrier to entry is the small size of our trades. The Fed should force Wall street to provide a channel where these small trades are also allowed equal access to the market. This will provide depth in the market and kill Wall streets' monopoly, and consequently there will be no need for a witchhunt to bring down paychecks.
Leave the exotic products to the wizards. None of those products make any real money. The only restriction should be that these products are confined to a non-banking entity, not commingled with any public money. Everyone should be forced to post collateral and all players in the market should have complete recourse to the assets of the promoters of each others' entitites. They should only be allowed to play in their own market where the public is not exposed to the results of their exotic experiments. That will cool the market for these products in a few short days.
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