..."If a Wall Street magician can conjure up any contract or security "derived" from the value of something real -- oil prices, mortgages, corporate debt, or literally anything else -- it's called a derivative. As a derivative, it doesn't have to be regulated the way other Wall Street securities are. Shockingly, after Congress passed landmark legislation in 2000 banning the regulation of key derivatives, the market absolutely exploded, with 95 percent of it concentrated at five too-big-to-fail banks.......
"Say I've got $10, and I want to bet on a stock. Turns out, it's a good bet, and the stock jumps 10 percent. I just made $1. Whoo-hoo. But say I borrowed $500 before I made the same bet, and the stock made the same 10 percent gain. I just made $51. That's a profit of over five times on my initial $10. Now we're talking real money.
But what if my stock loses 10 percent? I'm out $51. The trouble is, I've only got $10 -- everything else I borrowed. I just lost more than five times the money I actually had, and I don't have enough to pay back my $500 loan. If I were a corporation, I would be outrageously bankrupt.
That's what Wall Street just did.
The way to fix this is to require companies to have lots of cold, hard cash on hand to keep them from destroying themselves if their bets don't pay off. This cash is called "stock" or "equity." Obama, Congress and the Federal Reserve have all been tight-lipped about how seriously they want to rein in leverage, but at the height of the crisis, banks like Citigroup were leveraged at more than 50 to 1: for every $50 in borrowed money Citi bet with, it had just $1 of its own money on hand.
Saying what the right leverage ratio is can be tricky, but 10-to-1 is the traditional range of safety....."
"....If a major derivatives dealer like JPMorgan Chase or Morgan Stanley were to fail, it's almost impossible to determine what else would go down with them.
The best way to deal with the derivatives mess is to require that they be traded on an exchange, just like ordinary stocks. Exchange trading lets everybody know what everyone else is up to, and it requires a disinterested third party to sign off on the transaction. E.g., if a hedge fund wants to use derivatives to make a crazy bet on subprime mortgages with AIG, and the exchange knows AIG doesn't have the money to cover the bet, the exchange won't let the trade go through...."
"Say I've got $10, and I want to bet on a stock. Turns out, it's a good bet, and the stock jumps 10 percent. I just made $1. Whoo-hoo. But say I borrowed $500 before I made the same bet, and the stock made the same 10 percent gain. I just made $51. That's a profit of over five times on my initial $10. Now we're talking real money.
But what if my stock loses 10 percent? I'm out $51. The trouble is, I've only got $10 -- everything else I borrowed. I just lost more than five times the money I actually had, and I don't have enough to pay back my $500 loan. If I were a corporation, I would be outrageously bankrupt.
That's what Wall Street just did.
The way to fix this is to require companies to have lots of cold, hard cash on hand to keep them from destroying themselves if their bets don't pay off. This cash is called "stock" or "equity." Obama, Congress and the Federal Reserve have all been tight-lipped about how seriously they want to rein in leverage, but at the height of the crisis, banks like Citigroup were leveraged at more than 50 to 1: for every $50 in borrowed money Citi bet with, it had just $1 of its own money on hand.
Saying what the right leverage ratio is can be tricky, but 10-to-1 is the traditional range of safety....."
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