Yesterday, just about 15 years after the General Accounting Office warned it was necessary, Treasury Secretary Timothy Geithner sent a letter to regulators expressing President Obama's interest in regulating the market in Over the Counter Derivatives.
The news spent a few hours on the front of New York Times' web page before being relegated to the nation and the business sections, but it was arguably bigger news than the death of William Seidman, the long time Republican financial and political operative who, as head of the Federal Deposit Insurance Corp., created and ran the Resolution Trust Corporation to clean up the Savings and Loan scandal in the early 1990s.
Seidman's RTC-which Seidman (along with other worthies such as Paul Krugman) advocated as a model solution to our present troubles-is now regarded as a triumph. The government unsentimentally nationalized the failed thrifts and banks, closing many of them despite their claims of profitability ("we knew they were lying," says the chief investigator from that simpler time). The bad assets were parceled off at fire-sale prices to investors (many of whom were connected and corrupt, but whatever). The cost to taxpayers was about $130 billion-or about three-fourths the AIG bailout so far.
The RTC is remembered as calm wisdom today, but in the early 1990s it was seen differently. Critics on both the left and right howled about the scams shrouded by the fast-moving, hugely expensive program. The cartoonist Mark Alan Stamaty posited that FDIC stood for "Free Dough If Conned."
In hindsight it appears that Seidman got it mainly right, even presciently so. In his 1993 memoir he advised: "Instruct regulators to look for the newest fad in the industry and examine it with great care. The next mistake will be a new way to make a loan that will not be repaid."
Which brings us back to Over the Counter (OTC) derivatives.
Derivatives are just futures contracts and insurance policies written up so that their issuers do not have to do the things (have money, for example) that insurance companies are supposedly obligated by regulation to do. "OTC" just means they're private contracts, unmonitored by any central regulator or clearinghouse. So, OTC derivatives are secret futures and insurance contracts.
Though often (incorrectly) regarded as inscrutably complex, derivatives are easy to understand in principle. The contracts serve as betting slips, and can be used to ameliorate risk or to secretly magnify it, and they magnify the apparent amount of money in an economic system. (See my "Murray The Drunk" illustration here).
Geithner's proposal is just that-a toe dipped in political waters to check the temperature. It bears noting, then, that it was no secret among those who make their livings trading this kind of paper. The Times' story covers the ground well enough, but its story misses a few points, such as the historical significance of the 2000 Commodity Futures Modernization Act. The Times tells us: