President Obama’s Implied Future For Derivatives

If you’ve worked on economic policy formulation – or in any large bureaucracy – you know how to get your boss to make the decision you want.  The key is to frame the options in such a way that he or she feels that your preferred course of action is the only plausible direction.  Alternatives need to be undermined or discredited.Smart bosses know this, of course, and they seek out sources of information or analysis that are not managed by their subordinates.  The problem is that, traditionally, most such sources are not sufficiently well informed, at a detailed level, to be really helpful in the decision-making process.  The format of most mainstream media – 800 words for the general reader, 4 minute stories, etc – does not allow engagement at the technical level; and, to be honest, technocrats are very good at manipulating the information flow to even the best journalist (who is usually a generalist).  And while there are always outside technical domain experts, research papers appear with a lag and op eds usually have a broad brush (again, a format constraint).

Seen in this context, President Obama – on the face of it – has the role of blogs exactly backwards.  But perhaps he is instead telling us something more profound.

In Sunday’s NYT, the President is quoted as saying (at the end of the story),

Part of the reason we don’t spend a lot of time looking at blogs is because if you haven’t looked at it very carefully, then you may be under the impression that somehow there’s a clean answer one way or another – well, you just nationalize all the banks, or you just leave them alone and they’ll be fine.

Blogs relax previous format restrictions.  Length can vary, as can technical content.  Comments allow immediate feedback, clarification; debate is healthy for ideas.  Experts can now express a view or an endorsement immediately to a broader audience – and get pushback, as appropriate.

And, on the President’s point, experts can now talk directly to other experts at a very detailed operational level, and the results of that conversation are now public – and again attract public content (let’s be honest: sometimes experts are way off-base and they need to be told).  This is very threatening to official technocrats, both because their monopoly on expertise crumbles and because a broader set of people become skilled at criticizing their ideas.  These technocrats would much rather have their boss read newspapers and weekly magazines.

There is a good reason that the IMF is not free to speak candidly about the United States; it is full of experts who know what they are talking about.

But the President knows all this, which suggests another interpretation for his remarks.  Perhaps the financial situation – e.g., in and around derivatives – really is too complex for anyone to understand, unless they have the inside knowledge of regulators.  This would mean, of course, that going forward no one can question Treasury about anything important.

But that, in turn, makes congressional oversight impossible – even if we move to closed door hearings.  And it raises the question: if our financial system has become so economically complex that President Obama is right, then is it also too complex to be politically sustainable?

Big financial players now know they have a colossal potential put or bailout option.  They can also construct interconnected structures that no one can understand, except possibly the Treasury.  So every 10-20 years (or more often?) we will experience a crisis of current proportions?

There is a growing consensus that large banks should be broken up; no more “too big to fail”.  But the President’s implied point about economic/political complexity suggests that derivatives – for all their obvious potential benefits – are too dangerous to be allowed at anything like their current scale.  Who will be willing down the road to let Treasury, without outside comment or oversight, repeatedly provide massive amounts of resources to financial system insiders?

Derivatives have the potential to create a rent-seeking structure that is unparalleled in human history.  No society can afford to allow that kind of financial system to operate.  Either we figure out how to make it much more transparent – and amenable to outside review – or the re-regulation process currently in the hands of Senator Dodd and Congressman Frank needs to consider more radical alternatives.


Originally published at the Baseline Scenario and reproduced here with the author’s permission.

3 Responses to "President Obama’s Implied Future For Derivatives"

  1. george harter   March 10, 2009 at 12:48 am

    Two months ago, I was worried about the US and world economies. Nowadays I am frightened.Neither Obama nor his pet Geithner appear to be willing to acknowledge how serious our situation is. Yes, derivatives can create a nightmare economy, but I would be willing to give better than even odds that our present tangle of opaque financial instruments will be destroyed in a rather severe financial system meltdown. Chaos, illegality and disorganization will probably guarantee that most derivatives will become “Meaningless” as well as “Valueless”.More pseudo-wealth MIGHT disappear (if it hasn’t already) and contractual obligations in the WORLD OF HIGH FINANCE may generally be abrogated on a whim with little legal redress. In the USA we are like passengers on a low-budget Greek cruise ship which has caught fire. The first to run, of course, are the Captain and the Officers.Weather, does not cease to exist when we do nothing about it. The derivatives, their markets and market makers are simply headed for an abysmal resolution. Maybe Obama and Geithner, their fears and lack of resolution, don’t really matter at all!!George HarterBaghdadontheHudson, USA

  2. Morbid   March 10, 2009 at 7:05 am

    These criminal derivatives served up by the criminal banksters amplify losses – perhaps as much as ten fold, depending on how many side bets speculators weighed in with as well.REAL CHANGE you can count on – will happen when the ObamaNation of Desolation declares these FWMD null and void. Let all fail who dared to gamble to this extent. No Mercy.

    • Dan   March 13, 2009 at 7:14 am

      I agree!But why is it there is no popular revolt, uprising, we-are-the-world awareness of this issue? Oh, we put a $500K compensation limit on the executives who should have been fired long ago — boy, don’t we all feel better now? But to have Goldmine Sachs made whole on multi-billion dollar bets against bonds on Lehman (and soon, GM); when will the outrage begin?When will one congressman express the outrage against these?