As advocates for
shareholder rights
, we strive to make sure our members are heard on
important matters that affect all of our portfolios. That's
why
the White House asked for feedback from the Motley
Fool community
and agreed to answer your questions. Here is the fifth
installment of our interview with Austan Goolsbee, chief
economist for the President's Economic Recovery Advisory
Board.
The arc of progress has been described like this: First,
you have the innovators. Then come the imitators. And,
finally, enter the abusers.
The flow chart was followed nearly to the letter, with the
introduction of obscure financial products such as credit
default swaps (CDS). At first, companies used CDS and other
derivatives as protection against market fluctuations. The
behind-closed-doors trading tactic caught on and then morphed
into speculative gambling on a massive scale. Eventually,
these unregulated securities rained ruin on the likes of
Lehman Brothers and
AIG before they took their toll on the entire
U.S. economy.
There's no debate that derivatives such as CDS and
collateral debt obligations (CDOs) are mind-bogglingly
complex. If you want to understand them, here's an assignment
from Professor Warren Buffett:
I read a few prospectuses for
residential-mortgage-backed securities -- mortgages,
thousands of mortgages backing them, and then those all
tranched into maybe 30 slices. You create a CDO by taking
one of the lower tranches of that one and 50 others like
it. Now if you're going to understand that CDO, you've got
50-times-300 pages to read, it's 15,000. If you take one of
the lower tranches of the CDO and take 50 of those and
create a CDO squared, you're now up to 750,000 pages to
read to understand one security."
Before you ask, no, there's not a Cliff's Notes
version.
The White House's approach to derivatives
A major part of President Obama's
regulatory reform proposal(links to a PDF document) is to
make Wall Street do its bidding (and trading) of
over-the-counter derivatives and asset-backed securities in
public, so that the transactions will have to take place on
regulated exchanges and reported and traded under the
supervision of regulators.
Other key parts of the plan to regulate financial markets
include:
The problem with policing the next credit default
swap
Fool.com members had a lot to sayabout the use and abuse
of complex insider-ish financial products. Here are a few
comments David Gardner and I brought to the White House on
your behalf:
DavidInTXwrote: "My biggest concern is that we'll
'throw out the baby with the bathwater.' Let's not
discourage innovation. Credit Default Swaps aren't, in and
of themselves, bad. On the contrary, they are a decent
financial innovation that was badly misused. Let's focus on
limiting the potential for misuse, and not on restricting
innovation."
And here's the response to your questions from Austan
Goolsbee, chief economist for the President's Economic
Recovery Advisory Board.
Please enable JavaScript to view this
video.
Continued... |