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NY Times slams the bankers over “secretive” derivatives meetings

Derivatives market | NY Times slams the bankers over “secretive” derivatives meetings Anthony Harrington

We’re hunkered down wearing our hard hat writing this, since the writs are bound to be flying shortly. New York Times writer Louise Story has apparently taken the lid off a regular (“third Wednesday of every month”) meeting of nine top bankers, hosted by one of the new derivatives clearing houses, ICE. Their purpose? To discuss the quadrillion dollar global derivatives industry:

"In theory, this group exists to safeguard the integrity of the multitrillion-dollar market. In practice, it also defends the dominance of the big banks. The banks in this group, which is affiliated with a new derivatives clearinghouse, have fought to block other banks from entering the market, and they are also trying to thwart efforts to make full information on prices and fees freely available. Banks’ influence over this market, and over clearinghouses like the one this select group advises, has costly implications for businesses large and small…”

Three of the memorable bits of information that Story’s story provides are:

  1.  Bank of New York Mellon’s outrage at having its application to join three of the four new derivatives clearing houses rejected (you have to be okayed as a member to join). Story cites this as proof that the big banks are freezing out competition since Boney M is as good a candidate to trade the derivatives market as any.
  2. The banks do not reveal what they charge to set up a derivatives contract, the paper claims, so if you are a haulage company you can’t shop around for the most cost effective derivatives contract to hedge your fuel. And, tellingly, the bank fee is buried in the cost of the derivatives contract, so you’ve no idea what they are charging you.
  3. The third piece of information is that the Department of Justice has said it sort of fancies looking into what might be anti-competitive practices by the big banks in the derivatives space. If the DoJ fancies this, you can bet that the European Commission’s anti-cartel crew, who are hell on wheels when it comes to cartels and have a long and successful history of handing out enormous fines over cartel practices to companies right across the scale, from gigantic corporations to small builders, will soon start sniffing the breeze to pick up the scent of what would surely be the biggest cartel action of all time – particularly since European banks are said to be involved. No names, no pack drill…

Which reminds me, one of the funniest comments on Story’s scoop comes from Phil, of Phil's Stock World who points out that breaking a story like this takes real courage. He should know. As he puts it, ICE, the derivatives clearing house in question, “handed me my ass with legal BS” when he wrote a blog about them. “Fortunately they straightened me out and we now know that clearly there is no manipulation in the energy markets – can I have my Grandma back now?” he asks.

Story has a wonderful analogy to explain the bank’s practice as far as their charging on derivatives and the pricing of derivatives generally is concerned. It is as if when buying or selling a house, the estate agent is the only party who will ever know what both the buyer and the seller paid for the house. Their fee will be the difference between the two, but since neither party knows what the other paid, that fee could be whatever the estate agent deemed to be “reasonable”. In the real world this wouldn’t work because the buyer and the seller would both have a pretty shrewd idea of what properties in that area were going at, so they could work out the hidden fee. In the closed world of derivatives, there is no such price transparency, so there really is no getting at the bank’s fee, unless it chooses to disclose it, which, generally speaking, it does not so choose to do.

Story quotes Robert E. Litan, who helped to oversee the US DoJ’s investigation of Nasdaq trade pricing (which drove pricing down to reasonable levels):

“When you limit participation in the governance of an entity to a few like-minded institutions or individuals who have an interest in keeping competitors out, you have the potential for bad things to happen. It’s antitrust 101.”

Here’s Phil’s comment on Litan’s comment: “Better say goodbye to Grandma, Mr. Litan…”  Watch this space, this story will run and run…

Further information on banks, the derivatives market and the crash:

Tags: capital adequacy , central banks , credit rating agencies , derivatives , fair-value accounting , financial crisis , regulation , transparency
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