Thank you for the link and for expanding your point.
I think a careful read of the document you link to shows that the only regulatory action that took place was the OTC becoming concerned in 2008 that AIG's previous derivative contracts had now become dangerous. They noticed nothing when the derivative contracts actually were issued.
Also note the comment in the text: "the level of review and amount of resources needed to asses a complex structure such as AIG's is vastly deeper and more resource-intensive than what would be required for a less complex holding complex", which is something of statement that OTS really wasn't up to very much supervision of this "vastly complex" enterprise.
But this is not really the main issue...
>> My impression is Alan Greenspan specifically nixed regulation of CDOs around 1999.
> Greenspan wasn't ever in a position to make that call.
He was indeed not a regulator of that but his testimony to congress influenced the resulting lack-of-legislation on the issue of derivatives when the official who would have regulated them asked for the ability.
> Yes, there are unregulated financial instruments. (Leases and ownership aren't regulated either.) However, the existence of such instruments does not imply that regulated institutions (such as AIG or its customers) can use them to escape supervision.
> For banks and insurance companies, regulators define what counts as an asset, how it is valued, and regulate exposure to different kinds of assets. That applies to all assets, whether they're "regulated" or not.
There indeed, is the rub. Being modeled as "very safe", my impression again, is that CDS were in fact often considered "off-balance-sheet-instruments". But that's again secondary...
Now that we have gotten into the details of these things, I should say "there are regulations and there are regulations". Bank deposits are and have been rightfully regulated actively in terms of explicit, apriori limits on deposits because deposit expansion and contraction can have a powerful effect on the economy as a whole. Derivatives have only been regulated in terms of one institution or another keeping loose track of what's happening and not particularly limiting anything until things seem worrisome - which now turns out to be long after the horse has left the barn.
What I am saying that derivatives should be regulated in a similar fashion to bank deposits, with limits to who can issue, how much can be issued, how much systemic risk they create and so-forth.
This is again consistent with state's necessary regulatory role. State regulation basically require apriori legislation to prevent private actions which can cause harm beyond the ability of a private actor to repay the victims of that harm. The OTS might indeed have looked at the risk of failure which AIG's actions involved for its depositors, its stock holders and even for Uncle Sam in his role as deposit insurer. The OTS clearly didn't look at the systemic risk which AIG's issuance of derivatives created.
What should be required, in the future, is such apriori limits on derivatives. Either no institution can take on risk beyond a certain multiple of capital or whatever other formula would work best. This is because, despite many claims to the contrary, unregulated derivatives have become what Warren Buffet calls "financial weapons of mass destruction" through their ability to first expand and then contract the money supply (or the velocity of money if you prefer).
> Did AIG screw up - yes. But there's no evidence to show that more regulation would have done better. More to the point, it is simply wrong to argue for more regulation on the theory that lack of regulation was a factor. It wasn't. If anything, regulation failed.
Consider that folks are not really concerned with a hypothetical failure of AIG in itself. By money-size, AIG wasn't "too big to fail". It is rather the systemic failure that would accompany AIG's failure that has people up in arms.
You could argue that the OTS or other bodies already had the authority needed to place limits on issuance of derivatives. This might be true but the real point is that neither the OTS or other bodies are charged with directly reducing systemic risk because they can't calculate systemic risk. Indeed, consider that Large modern economies (or, as another example, the world's ecology) are complex beyond all mathematical models - despite economists' earlier protests to the contrary (protests that look pretty shoddy now). Because of this, regulation must involve simply forbiding those actions which create unquantifiable systemic risk (including but limited to unlimited dervative issuance, unlimited deposit expansion or discharge of known polutants into the environment).
I saw an interview with Nassim Nicholas Taleb where he sketched a future version of capitalism where all investors put their money into either rather strongly regulated funds or very explicitly risky and unregulated funds, with only those who could show they could sustain the loss being allowed to jump into the risky funds.
> Being modeled as "very safe", my impression again, is that CDS were in fact often considered "off-balance-sheet-instruments". But that's again secondary...
That's wrong and the error is not "secondary". If something is "off-balance-sheet", it's useless to a bank. Banks need on-balance-sheet assets to match their liabilities. And assets are heavily regulated.
> Bank deposits are and have been rightfully regulated actively in terms of explicit
Deposits, the money that customers put in banks for "safe keeping" (and interest), aren't regulated and there's no reason to regulate them.
Deposits are liabilities, promises that the bank has made. Assets are what a bank keeps so that it can return deposits to customers, so it can satisfy its liabilities.
When you deposit $100, the bank books $100 in liabilities and $100 in assets. It can exchange the $100 cash that you gave it for assets of equivalent or greater value, but all that is regulated so that the bank can pay you $100 when you ask for it.
Yes, deposits are insured, but that's something entirely different. And, the way that deposits are insured is by regulating assets.
> The OTS might indeed have looked at the risk of failure which AIG's actions involved for its depositors, its stock holders and even for Uncle Sam in his role as deposit insurer.
AIG's problems had nothing to do with returning money to depositors.
> You could argue that the OTS or other bodies already had the authority needed to place limits on issuance of derivatives.
The problem with this argument is that the issuance is irrelevant. My standing on a street corner selling billion dollar cats isn't a problem.
The problem was that regulators said "sure, buy as many of those cats as you can find and hold them as assets". The unregulated firms saw that for the crock that it was.
We got hit by two problems. One was subprime loans, which were pretty much a creation of regulation and govt action. The other is bogus assets accepted by regulated institutions. Again, regulators failed.
Yes, the unregulated institutions have also taken a hit, but only to the extent that they counted on the regulated ones.
There's another thread in HN about folks driving more dangerously because they think that their cars have some feature that reduce the risk more than it does. (Or, as a friend of mine puts it, the folks with a winch are the ones who get stuck.)
Since Greenspan wasn't a decision maker wrt regulation, it's unclear why his opinion on regulation is any more relevant than his opinion on bubblegum. It's particularly interesting that his opinion is thought more important than the actions of congress critters who actually had a role in regulation.
I note that Dodd, Obama, Sen. Clinton, and Kerry all received significant donations from AIG and other investment houses and oversaw their regulation. Barney Franks was particularly vehement in telling us that Fannie and Freddie were perfectly safe and didn't need any regulation. (Which reminds me, Fannie and Freddie announced significant bonuses recently.)
Yet, we're talking about Greenspan.
The fact remains that there was significant regulation of AIG's biz. Any argument which starts from the assumption that there wasn't is fatally flawed.
"Since Greenspan wasn't a decision maker wrt regulation, it's unclear why his opinion on regulation is any more relevant than his opinion on bubblegum. "
Sheesh, it seems like you're just stretching your argument for the sake of it. By now, it's not like anyone else is even "listening" to this discussion, so neither of us have anything to prove.
Sure, Greenspan indeed had no official power in the matter but the press universally credits him with wielding sufficient influence to decide the question. I documented, as you requested, the fact that Greenspan testified against the regulation of derivatives. Now you say it doesn't matter. I would agree that the legislative branch was also instrumental in deciding derivative regulation BUT that discussion is pretty much irrelevant to the immediate question.
I simply criticized Greenspan, I didn't criticize-Greenspan-to-get-the-democrats-off-the-hook. I have no partisan axes to grind here, though I get the feeling you might. I would see the whole Washington establishment, democrat and republican, as enabling Wall Street's normal operations (which lead us to this crisis). Lots of folks can be blamed but Greenspan is very widely credited as being the articulator of the hand-off ("market fundamentalist") approach. Saying that he didn't have legal power over this or that is not a sufficient argument to challenge his status as architect of overall Washington approach.
Sure, I think by now I've acknowledged there has been plenty of regulation of AIG. As I think I've said, the point isn't regulation but what kind of regulation. Here, I would follow Doug Noland and others who see derivatives, CDOs and other entities as Wall Street devices for the creation of money-like-items - synthetic bonds with a AAA rating were the product was pumped out with the assistance of elaborate constructs like CDS's. This unlimited creation of money-like-objects ran part and parcel with a massive inflation of the value of assets - the bubble.
This process is ultimately equivalent the money-multiplier effect without any underlying capital requirement. Thus, it did not require just any-old-regulation but regulation like banks. The regulations on a savings banks is not simply to keep a single bank safe but to limit the money which banks as a whole inject into the system as a whole.
> I would agree that the legislative branch was also instrumental in deciding derivative regulation BUT that discussion is pretty much irrelevant to the immediate question.
To be clear, you're saying that Greenspan's influence over the legislative branch is relevant but what they actually did is irrelevant...
> I simply criticized Greenspan, I didn't criticize-Greenspan-to-get-the-democrats-off-the-hook.
You found Greenspan's comments important enough to criticise. You didn't find other people's actions significant enough to rate a comment.
If your comments don't reflect your priorities....
> Did I mention regulation-like-banks?
And for the ntheenth time, AIG was regulated as a bank - that's what the office of thrift supervision does. AIG was also regulated as an insurance company.
If you're going to claim that "regulation-link-banks" would make a difference, surely the fact that AIG was actually was regulated like a bank is relevant.
You keep bringing up things (unregulated assets and the like) that have nothing to do with AIG. (Banks and insurance companies get no benefit from unregulated/off-balance-sheet assets.) Perhaps you ought to be discussing institutions to which they actually apply.
Thank you for the link and for expanding your point.
I think a careful read of the document you link to shows that the only regulatory action that took place was the OTC becoming concerned in 2008 that AIG's previous derivative contracts had now become dangerous. They noticed nothing when the derivative contracts actually were issued.
Also note the comment in the text: "the level of review and amount of resources needed to asses a complex structure such as AIG's is vastly deeper and more resource-intensive than what would be required for a less complex holding complex", which is something of statement that OTS really wasn't up to very much supervision of this "vastly complex" enterprise.
But this is not really the main issue...
>> My impression is Alan Greenspan specifically nixed regulation of CDOs around 1999. > Greenspan wasn't ever in a position to make that call. He was indeed not a regulator of that but his testimony to congress influenced the resulting lack-of-legislation on the issue of derivatives when the official who would have regulated them asked for the ability.
> Yes, there are unregulated financial instruments. (Leases and ownership aren't regulated either.) However, the existence of such instruments does not imply that regulated institutions (such as AIG or its customers) can use them to escape supervision. > For banks and insurance companies, regulators define what counts as an asset, how it is valued, and regulate exposure to different kinds of assets. That applies to all assets, whether they're "regulated" or not.
There indeed, is the rub. Being modeled as "very safe", my impression again, is that CDS were in fact often considered "off-balance-sheet-instruments". But that's again secondary...
Now that we have gotten into the details of these things, I should say "there are regulations and there are regulations". Bank deposits are and have been rightfully regulated actively in terms of explicit, apriori limits on deposits because deposit expansion and contraction can have a powerful effect on the economy as a whole. Derivatives have only been regulated in terms of one institution or another keeping loose track of what's happening and not particularly limiting anything until things seem worrisome - which now turns out to be long after the horse has left the barn.
What I am saying that derivatives should be regulated in a similar fashion to bank deposits, with limits to who can issue, how much can be issued, how much systemic risk they create and so-forth.
This is again consistent with state's necessary regulatory role. State regulation basically require apriori legislation to prevent private actions which can cause harm beyond the ability of a private actor to repay the victims of that harm. The OTS might indeed have looked at the risk of failure which AIG's actions involved for its depositors, its stock holders and even for Uncle Sam in his role as deposit insurer. The OTS clearly didn't look at the systemic risk which AIG's issuance of derivatives created.
What should be required, in the future, is such apriori limits on derivatives. Either no institution can take on risk beyond a certain multiple of capital or whatever other formula would work best. This is because, despite many claims to the contrary, unregulated derivatives have become what Warren Buffet calls "financial weapons of mass destruction" through their ability to first expand and then contract the money supply (or the velocity of money if you prefer).
> Did AIG screw up - yes. But there's no evidence to show that more regulation would have done better. More to the point, it is simply wrong to argue for more regulation on the theory that lack of regulation was a factor. It wasn't. If anything, regulation failed.
Consider that folks are not really concerned with a hypothetical failure of AIG in itself. By money-size, AIG wasn't "too big to fail". It is rather the systemic failure that would accompany AIG's failure that has people up in arms.
You could argue that the OTS or other bodies already had the authority needed to place limits on issuance of derivatives. This might be true but the real point is that neither the OTS or other bodies are charged with directly reducing systemic risk because they can't calculate systemic risk. Indeed, consider that Large modern economies (or, as another example, the world's ecology) are complex beyond all mathematical models - despite economists' earlier protests to the contrary (protests that look pretty shoddy now). Because of this, regulation must involve simply forbiding those actions which create unquantifiable systemic risk (including but limited to unlimited dervative issuance, unlimited deposit expansion or discharge of known polutants into the environment).
I saw an interview with Nassim Nicholas Taleb where he sketched a future version of capitalism where all investors put their money into either rather strongly regulated funds or very explicitly risky and unregulated funds, with only those who could show they could sustain the loss being allowed to jump into the risky funds.