|Derivative Market Oversight:
How might a "smart" FTT work?
(c) 2010 by
Principal, Authentix Coaches
|Angus operates an executive coaching practice in Toronto with clients who include a trader
with a major Canadian bank. In the 80s his firm delivered the world's first electronic trading
system built with open-system components -- to a Toronto-based bond trading house.
|In his leader of June 28, 2010, New York Times DealBook Editor Andrew Ross Sorkin wrote: "So
amid all the back-and-forth over this bill, keep in mind one of the most important aspects of the act: it would
give Washington policy makers a powerful tool to mitigate the next too-big-to-fail blowup, however that
blowup manifests itself. For the first time, Washington would have what is known as resolution authority,
that is, the power to wind down a giant financial institution that runs into trouble. If policy makers had had
that power during the tumultuous autumn of 2008, they might have averted the catastrophic failure of
Lehman Brothers. They might have placed the teetering American International Group into conservator
ship. And they might have taken over Bank of America and Citigroup, and possibly even Goldman Sachs
and Morgan Stanley. Senior management would have been tossed out."
Mr. Sorkin was summarizing the Financial Overhaul Bill. In other words, it will not prevent
overexcited horses from "bolting from the stable" but it will give more "tools to the stable boys
to round up and return many, if not most, of the horses who escaped".
Can we prevent the horses from kicking down the stable doors limiting their animal instincts for
freedoms that, if available to them, would endanger the rest of us? If that sounds a tall order,
let's consider whether ethically managed derivative trading operations, sensible trading, and
fully informed insuring broke the stable door -- because I believe we can substantially lessen
dysfunctionalities of competence and/or morality in those constituent parts of what we call the
derivative economy if we focus on the reality that, amongst other factors, it was outrageously
imprudent speculation and/or unconscienable/irresponsible market-making in derivatives and
synthetic derivatives that broke down the stable door. In other words, it was only outrageously
silly, greedy, incompetent, dishonest – put whatever label you want on it – derivative trading
activities that led to TRANSACTIONS DYSFUNCTIONAL TO THE ECONOMY AS A WHOLE
that broke the latches on the stable door and let the horses get out and indulge their animal
instincts to eat their neighbour's apples.
From the trial of Societe Generale trader Jerome Kerviel we can see how incompetent or
unscrupulous, but in any case dangerously unfocused internal supervision failed the trading
houses and their sponsors whose job it is to make sure overexcited trader horses don't kick
down their stable doors.
Telling trading house managers how to do that job seems to have been the major focus of the
bill President Obama signed into law for overhaul of financial regulations. But that focus seems
to me to have missed the primary objective of correcting the ROOT dysfunctions of the financial
industry, which is to find and implement a practical way to make extremely dysfunctional
futures contracts PROSPECTIVELY much less profitable, because, of course, sometimes they
can be exploited to be extremely profitable. In the stable analogy that would mean feeding less
oats and more hay to the horses, for it is the oats/hay mix which determines their excitability.
Can we do that with a differentiated financial transactions tax -- that is, one targeted at the
transactions that are least likely to be constructive contributions to the real part of the economy
and most likely to be bubble makers and bursters in the derivative part of it?
Traders and economists agree that the most troublesome transactions are always the shorter-
term futures and the more wildly synthetic derivatives. Longer term futures and ones not
mixed into synthetics are less likely to trigger boom/bust cycles. Because of this, a
differentiated speculative Financial Transactions Tax (dsFTT) -- one that has not, to my
knowledge, ever before been proposed -- is likely to be the way to go. I like the concept for the
1. It's NOT the "Robin Hood" tax. The undifferentiated FTT, now called the "Robin Hood" tax
by marketers whom I think may have been too clever, was first proposed, I understand, by
Maynard Keynes in the 1930s. It went nowhere. Sixty years later in the 1990s James Tobin
resurrected the idea and it took on with some academics, but never affected the thinking of any
2. A differentiated speculative FTT (dsFTT) addresses the ROOT problem: irresponsible
transactions in derivatives. It does NOT tax authentically responsible trading in derivatives (or,
of course, small current trades in stocks or bonds); but, by refraining from doing so, its
proponents would demonstrate an insight into the issues of brokers, traders, and
managers/sponsors/insurers of traders and brokers that recognizes their contribution to the
real economy. Such insight would be reassuring to those politicians who, like Scott Brown
(until recently?), are more inclined to believe the established experts, i.e. senior bankers and
central bank gurus, than to do the really hard cognitive work of thinking independently
3. An implemented dsFTT would obviate much legal work. Legal processes continue, even
with the descent of "banksters" to the position of society's most hated professionals, to be the
object of much frustration and anger by the more conscientious of us -- because once a matter
becomes legally controversial, progress tends to be slow, animosity is evoked, and the trauma
of a lose/win result is always experienced. In other words, a dsFTT is not just libertarian-
friendly, but intelligently circumspect in being so
4. A dsFTT is eminently calibrateable to changing conditions. For more on the dsFTT idea,
and in particular for a sense of how it can be calibrated to reflect the interests conscientiously
honest and competent people in both the trading-banking-insurance community and the
community of real-economy executives, as well as of people at large, please take a look at the
paper entitled "The Need/Capital Cycle"
5. Lastly, a dsFTT would minimize, and perhaps obviate entirely, the additions of capital
proposed in some quarters to protect banks from failure. Because a dsFTT would directly
attack the main problem, namely grossly imprudent speculation, rather than merely protect
against it, a dsFTT is a much more economic solution than the proposal for, for example,
contingent embedded capital.
* * *
If we must keep calling the serious work of moving capital to where it's needed a playing field,
let’s be sure the players who are likely to endanger their own and everyone else’s well-being
have less financial rope. That presents temptation with which to get further addicted to their
chaos-and-pain-causing shenannigans. A smart FTT can be an intelligently automatic referee!
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