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The ghastly dangers of unregulated derivatives trading

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According to NY Times economics columnist Gretchen Morgenson and Fed chief Ben Bernanke, using credit default swaps in a way that intentionally destabilizes a company or a country is counterproductive, and Bernanke says the SEC will be looking into it.

Credit default swaps, you will remember, are securities that are supposed to offer insurance-like protection. They are also the instruments that helped tip over the American International Group (AIG) in 2008 when it lacked enough money to make good on the massively mounting claims coming from the huge numbers of insurance contracts of this kind that it had so brazenly sold.

Now there are fears that the use of these insurance policy instruments or "swaps' may also help propel entire countries -- like Greece -- to the precipice and possibly over it. With the able assistance of Wall Street bankers, Greece employed such insurance policy swaps to mask the amount of its indebtedness. And now it appears that some traders are using such insurance policy "swaps" to bet that Greece won't be able to meet its debt payments and will as a result default on them.

Mr. Bernanke is undoubtedly an intelligent man, but his seemingly naive comment that it's merely "counterproductive" to use credit default swaps to crash an institution or a nation exhibits a certain willful blindness--or selective inattention? -- as to how the titans of finance operate these days.

Big bank high-octane trading is counterproductive to taxpayers, for sure -- but not to the speculators who win big when such transactions pay off. And let it not be forgotten: in the case of AIG the speculators got their winnings from the taxpayers!

The certainty that Mr. Bernanke expressed about the coming SEC inquiry into credit default swaps is willfully blind as well. The fact is that credit default swaps and other complex derivatives have proved to be instruments of mass destruction -- yet they still remain entrenched in our financial system three years after our economy was almost brought to its knees.

Derivatives in general are responsible for the collapse that cost taxpayers hundreds of billions of dollars for bailouts. Yet credit default swaps have been largely untouched by financial reform efforts. This is not surprising, given how much money is generated by the big institutions that trade these instruments. Nor is it surprising that these institutions are showering many millions of dollars on members of Congress as a means of protecting their very lucrative, taxpayer-protected gambling operations. (The Office of the Comptroller of the Currency reported that the revenue generated by the credit derivatives trading of America's biggest banks totaled $1.2 billion in just the third quarter of 2009 alone.)

Thanks to very generous campaign contributions from these big banks, congressional "reform" plans for credit default swaps are full of loopholes, guaranteeing that another derivatives-fueled financial crisis awaits us. And the banks can certainly afford to be generous when carrying out this kind of bribery where astounding amounts of monetary value are in play: According to the Bank for International Settlements, credit default swaps with a face value of $36 trillion were outstanding in the second quarter of 2009.

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Several years after receiving my M.A. in social science (interdisciplinary studies) I was an instructor at S.F. State University for a year, but then went back to designing automated machinery, and then tech writing, in Silicon Valley. I've (more...)

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