From Jubak’s 9/23 article:
The global market for derivatives has a notional value of $455 trillion. The market for a single kind of derivative called credit default swaps (CDS) comes to $62 trillion. A single company, the recently rescued AIG, was counterparty to $422 billion in derivatives. That’s just a tad below the low-end estimate for the government buy-up plan as a whole. For a single company.
But the reasons that it will be harder to fix the derivatives market than the mortgage market don’t stop with size. There are three other very significant obstacles to a fix:
- There’s no political lobby to throw its might behind fixing the derivatives market. In the mortgage mess, the banks want it fixed, homeowners who are under water want it fixed, and elected officials who want to get re-elected want it fixed. The only dissenting voice comes from the taxpayers who will pay the tab, and we’ll get rolled as usual. On the derivatives side, the financial industry has successfully fought against regulating the derivatives market. In 2000, then-Sen. Phil “Americans Are Whiners” Gramm succeeded in getting the derivatives market declared off-limits to regulatory agencies in the Commodity Futures Modernization Act. When Gramm left the Senate in 2003, he went to work for Swiss bank . With that kind of cozy history, I don’t expect to see the financial industry take up the call for more regulation of the market.
- Derivatives are hard to understand. The reforms needed to fix the market are even tougher to grasp. One big problem, for example, is that most derivative contacts aren’t traded on any exchange. They are unique, one-off contracts between an individual buyer and seller. Without a market to act as a clearinghouse, there’s no way to know how many contracts any individual seller has written. Which, of course, turns out to be crucial to figuring out which sellers can stand behind which deals. And without a market, there’s really no way to price these contracts. So when a company such as AIG or Lehman faces a need for capital, there’s really no way to figure out what any nonmarket contracts are worth. Fixing this problem would require negotiating some degree of standardization into derivative contracts so that more of them could be tracked on existing over-the-counter exchanges. That would require tough negotiation by a politician with the smarts to understand the industry and the determination to see it through, although the political reward would likely be slight. You know anybody who fits that bill?
- And finally, it’s much easier to demonize the derivatives market than to fix it. Derivatives do allow traders to speculate on the direction of just about any price, and the high-profile presence of speculators in the derivatives market is enough to turn general opinion against the market as a whole. Who wants to reform the place when it’s easier to preach against it?
MIDD update: He is increasing his target for Middleby to $75 a share by October 2009 (I am long MIDD)