Market Sell-off
Jude Wanniski
August 24, 2005


You may not have noticed, but one of our West Coast clients spotted this Bloomberg story coming across the wire at 2:34 pm, with the DJIA immediately skidding 70 points. What we have is Tim Geithner, the NYFed President, seemingly proposing greater regulation of the derivatives industry on the grounds that there are too many confirmed trades piling up in back offices uncleared. Credit-derivatives are of course the best way the markets have of protecting themselves against the vagaries of the Fed and its floating dollar. If the dollar were again fixed to gold, that volatility would subside and the costs of "insurance" against risk would also fall. This would mean the cost of capital would fall and banks would be doing more banking and selling less "insurance." More regulation of the banks would damage those with smaller economies of scale and give more market share to the dominant players, but overall bites into the system`s ability to form new capital. Hence the market decline this afternoon, on this dark cloud on the horizon.

This is the equivalent of Sarbanes-Oxley, but from a different direction. Geithner, by the way, was a Bush appointee, but he was recommended by the Clinton people in the big banks, with recommendations from Bob Rubin at Citigroup and Larry Summers at Harvard, both of whom he worked for at the Clinton Treasury. He had to have been cleared by Alan Greenspan and we have been keeping an eye on him, as the forces of darkness never sleep. He`s now in the lead on this and we shall see what comes of it.

Fed Summons 14 Banks to Discuss Credit-Derivatives Controls 2005-08-24 14:34 (New York)

 By Hamish Risk and Justin Baer

 Aug. 24 (Bloomberg) -- The Federal Reserve Bank of New York invited 14 of the ``major participants`` in the credit-derivatives market to a meeting next month amid concern the $8.4 trillion industry is rife with unconfirmed trades.

The meeting at the Fed`s New York office on Sept. 15 will focus on market practices, according to an Aug. 12 letter sent to bank chief executives by New York Fed President Timothy Geithner. Fed spokesman Peter Bakstansky confirmed the letter`s contents and declined to name the firms invited.

The credit-derivatives market more than doubled in the past year, giving companies, investors and governments the ability to bet on or protect against changes in credit quality. A backlog of confirmed trades may undermine investor confidence, a group led by E. Gerald Corrigan, managing director at Goldman Sachs Group Inc. and a former New York Fed president, said last month.

The Counterparty Risk Management Policy Group, the banking industry group led by Corrigan that first met in 1999 after the collapse of hedge fund Long-Term Capital Management, said in a report on July 27 that "urgent" effort is needed to tackle the "serious" accumulation of trade confirmations. Banks should be prepared to consider reducing trading until the deals are confirmed, the report said.

JPMorgan Chase & Co., Deutsche Bank AG, Goldman Sachs Group Inc., Morgan Stanley and Merrill Lynch & Co. dominate the credit- derivatives market as the five most-cited trading partners, according to Fitch Ratings.

 'Senior' Executives

The Fed`s letter said "a senior business representative and a senior risk management person," should attend the meeting.

Credit derivatives are the fastest growing part of the $24 trillion derivatives market, based on the so-called notional value of the debts underlying the contracts. A derivative is a financial obligation whose value is derived from interest rates, the outcome of specific events, or the price of underlying assets such as debt, equities and commodities.

Investors use credit-default swaps to bet on a company`s creditworthiness or protect against non-payment. The contracts are the most common credit derivative. Like insurance, buyers pay an annual fee similar to a premium to protect a certain amount of debt against default for a specified number of years. In the event of a default, they get the face value of the bonds or loans.

The settlement process for credit-default swaps is resource intensive, and typically requires faxed signatures. Banks and companies risk getting swamped by investors seeking settlement on their contracts in the event of a corporate default, Corrigan`s group said.

Derivatives traders must ensure they have systems and controls in place to keep up with the growth in their business, the U.K.'s Financial Services Authority said in a letter to companies this year.