This is a letter sent to my MP on October 17 2008.
"I am concerned that Government should use the breathing space that its bailout has obtained to take action to contain and if possible deflate the bubble of toxic assets created in the derivatives market.
In my previous letter I mentioned a figure of $1.14 quadrillion as the total “value” of the derivatives market, but on further research was unable to trace the source of this figure. However the Bank for International Settlements gives a figure of $596 trillion in December 1997*, which is about ten times the amount of foreign debt owed by every country in the world. The derivatives market may well have doubled in the ten subsequent months. This is an absurd amount, psychotic in the sense that it is a notion completely divorced from economic reality.
It is unconscionable that the “products” of a tiny handful of financial gamblers and gamesters should endanger the livelihood of everyone in the world. It is therefor an urgent necessary to examine these products in detail in order to verify that they are in fact based on valid and legal trading principles. One general point is that the people who created these instruments have been behaving as companies, but have been operating outside of company law. In particular, they must be examined to find out whether at least some of them amount to Ponzi schemes, which are illegal. If they are found to be illegal, the debts that they represent can be repudiated by the banks, which might help to stabilise the financial system and save billions of pounds of taxpayers’ money.
Mr Paulson is quoted as saying that he wanted to "kill the bad hedge funds and heavily regulate the rest." However, it is noticable that the “cash for trash” component of his TARP seems to have slid down the agenda, presumably because he recognises that the sheer magnitude of the TA problem would overwhelm the resources of the US Government.
Willem Buiter, inter alia, has suggested that a Toxic Asset Dump, TAD, should be set up, to act as a receiving and clearing house for institutions who have doubts about whether they still wish to hold them on their books. In this institution the value – or otherwise – of the “assets” can be analyzed, and their legality – or otherwise – can be assessed. From what we learn in the TAD, ways and means can be devised to subject toxic derivatives to a controlled deflation.
The details of the exact scope and powers of this institution can be finalised by the statesmen and their financial regulators, but the central principle is to bring the derivatives market to account. Some banks, unsure of the validity of their derivatives holdings, might be grateful for the opportunity to subject their holdings to an objective audit, especially if they thought that there was a chance that the debt implicit in them might be canceled if they were to be found to be illegal. At a second level of regulation, banks should be required to file the details of their holdings in specified derivatives, particularly the CDS. Confidentiality might be offered if there was a perception that knowledge of their holdings might endanger their standing in the markets. At a third level of regulation, all derivative holdings might be required to be registered with the TAD.
Given the globalised nature of the financial markets, it would seem best to set the TAD up at World Bank or IMF level, but the UK could forge ahead with a pilot scheme in order to speed up the process.
I would be very grateful if you would transmit this letter to the Treasury for an answer, or preferably ask a question about the Government’s plans to contain the derivatives market in the House.
