Eugene Grygo, CCO for FTF News
It took a while, but CFTC Chairman J. Christopher Giancarlo and Chief Economist Bruce Tuckman have responded via a letter to the justified criticisms of derivatives and related activities that the Vatican with the blessing of Pope Francis released this past May.
To recap, a Bollettino published May 17 by the Vatican’s Congregation for the Doctrine of the Faith and Dicastery for Promoting Integral Human Development slammed derivatives particularly credit default swaps (CDS). (The actual Vatican paper is: “Oeconomicae et Pecuniariae Quaestiones: Considerations for an Ethical Discernment Regarding Some Aspects of the Present Economic Financial System” and can be found here.)
The Vatican document is interesting because one of its sections focuses on derivatives, the reasons behind their usage and the problems they cause when things go south. In fact, the Vatican censures credit default swaps markets because of three issues: “information asymmetries, speculation, and profiting from the ruin of others.”
By contrast, the Giancarlo and Tuckman letter “addresses the impact of derivatives on vulnerable populations, offering examples of how well-functioning financial and derivatives markets play a crucial role in feeding the world’s growing population, concluding, “[i]n many ways, the greatest beneficiaries of global derivatives activities may well be the world’s hungriest and most vulnerable. These are the people that Pope Francis has so powerfully advocated for by calling our attention to the ‘peripheries’ of the world. They would certainly suffer the most from the extreme price volatility in basic food and energy commodities that would result if derivatives trading were to suddenly cease.”
While acknowledging the Vatican’s position as “an important and caring commentary on modern finance,” the CFTC duo respectfully disagrees. “Yet, we also feel obligated to respond and defend derivatives and, in particular, credit default swaps, from various censures in the Bollettino,” according to their letter.
“The Bollettino’s criticisms have received outsized attention in the popular press, despite the fact that the relevant section of the Bollettino is limited to a few paragraphs,” according to the CFTC. (Actually, the Vatican document covers many other subjects and calls the LIBOR system scandals the result of “a criminal association.”)
So, in their letter, Giancarlo and Tuckman address three areas of concern for the Vatican:
- Information Asymmetries: “… This information contributes to a healthy financial system, which, in the words of the Bollettino, ‘requires the maximum amount of information possible, so that every agent can protect his or her interests in full, and with complete freedom;’
- Speculation: “Speculation contributes to the societally beneficial generation of information and the dissemination of that information to the public at large. Additionally, whatever uses of CDS are considered appropriate and unobjectionable require a counterparty on the other side of the trade, and speculators fulfill this role;”
- Profiting from the Ruin of Others: “Governments, for example, actually benefit from the availability of CDS on their sovereign securities, as research has shown that the initiation of CDS trading on sovereign bonds lowers countries’ cost of debt and increases the information efficiency of their bond markets” according to the CFTC letter. “Furthermore, it must be acknowledged that national governments do not always conduct their financial affairs in the best interests of their people or with the highest degree of fiscal competence or integrity, and the prices of government bonds, or of CDS on sovereign nations, are an important check on poor fiscal management.”
Giancarlo and Tuckman underscore why regulators are needed to police the derivatives markets “with the view, in the words of the Bollettino, of advancing liberty, truth, and justice,” according to the letter.
By the end of the letter, it’s clear that the CFTC and the Vatican are not that far apart on what has and could go wrong with derivatives.
“We do not claim that the CDS market is free from both economic and ethical challenges,” say Giancarlo and Tuckman in the letter. “We agree with the Bollettino in being skeptical of overly complex derivative products, like CDS tranches on mortgage-backed securities, which traded in great volume in the run-up to the 2007-2009 financial crisis. And we also agree that buyers of CDS protection, who stand to gain from defaults, must not be allowed to conspire to cause those same defaults or make them more likely. Such activity has recently drawn our regulatory scrutiny and censure.”
I remember at the height of the Great Recession when major banks and others were reporting horrific quarterly losses because of rotten derivatives, a fellow journalist suggested that the industry should just get rid of derivative instruments altogether.
While that idea seemed viable at the time, the problem is that the derivatives markets are far too lucrative for banks and others to walk away from. And it would take a major combined effort of the industry, multiple domestic and international governments and the culture to put an end to derivatives.
My guess is that even if derivatives could be banned, the energy behind them would be shifted elsewhere (crypto currencies, anyone?).
The bottom line is that, for better or worse, the industry needs its financial police no matter what form the crime takes.
The CFTC’s full letter can be found here.
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