In the Public Interest: The Derivatives Casino
by Ralph Nader
The derivatives markets of today have become a high stakes casino of unimaginable magnitude. Wall Street’s bets have gone bad, and now the whole financial system is in peril. In a best-case scenario, it appears, the taxpayers will be required to rescue the system from itself. This is why Warren Buffet labeled derivatives "weapons of financial mass destruction."Amazingly, there seems to be some lingering sense that
current-day derivatives properly perform an insurance function.
Case in point: Alan Greenspan, the former Federal Reserve
Chairman. Greenspan says the world is facing the type of
wrenching financial crisis that comes along only once in a
century, but, reports the New York Times, "his faith in
derivatives remains unshaken." Greenspan believes that the
problem is not with derivatives, but that the people using them
got greedy, according to the Times.
This is quite a view. Is it a surprise to Alan Greenspan that
the people on Wall Street—said to be ruled only by the opposing
instincts of greed and fear—"got greedy?"
This might be taken as just a bizarre comment, except that, of
course, Alan Greenspan had some considerable influence in
driving us to the current financial meltdown through his
opposition to regulation of derivatives.
A series of deregulatory moves, blessed by Alan Greenspan,
helped immunize Wall Street derivatives traders from proper
In 1995, Congress enacted the Private Securities Litigation
Reform Act (PSLRA) of 1995, which imposed onerous restrictions
on plaintiffs suing wrongdoers in the stock market. The law was
enacted in the wake of Orange County, California’s government
bankruptcy caused by abuses in derivatives trading. An amendment
offered by Rep. Ed Markey would have exempted derivatives
trading abuse lawsuits from the PSLRA restrictions. In defeating
the amendment, then-Representative and now-SEC Chairman Chris
Cox quoted Alan Greenspan, saying “it would be a grave
error to demonize derivatives;” and, “It would be a
serious mistake to respond to these developments [in Orange
County, California] by singling out derivative instruments for
special regulatory treatment.”
The New York Times reports how the Commodity Futures Trading
Commission aimed for some modest regulatory authority over
derivatives in the late 1990s. Strident opposition from Treasury
Secretary Robert Rubin and Alan Greenspan spelled doom for that
Senator Phil Gramm helped drive the process along with the
Commodities Futures Modernization Act of 2000, which deregulated
the derivatives market.
Defenders of deregulation argued that sophisticated players were
involved in the derivatives markets, and they could handle
It’s now apparent that not only could these sophisticated
players not handle themselves, but that their reckless gambling
has placed the entire world’s financial system at risk.
It seems to be then a remarkably modest proposal for derivatives
to be brought under regulatory control.
Warren Buffet cut to the heart of the problem in 2003: "Another
problem about derivatives is that they can exacerbate trouble
that a corporation has run into for completely unrelated
reasons," he wrote in his annual letter to shareholders. "This
pile-on effect occurs because many derivatives contracts require
that a company suffering a credit downgrade immediately supply
collateral to counterparties. Imagine, then, that a company is
downgraded because of general adversity and that its derivatives
instantly kick in with their requirement, imposing an unexpected
and enormous demand for cash collateral on the company. The need
to meet this demand can then throw the company into a liquidity
crisis that may, in some cases, trigger still more downgrades.
It all becomes a spiral that can lead to a corporate meltdown."
That is to say, our current problems were foreseeable, and
foreseen. There is no excuse for those who suggest that present
circumstances—what many are calling a once-in-a-hundred-years
event—were unimaginable during earlier debates about
Some ideologues continue to defend derivatives from very strict
government control. As Congress moves to adopt new financial
regulations next year, hopefully the proponents of casino
capitalism will be given no more credence than those insisting
that the sun revolves around the earth.