Derivatives Reform Update- The Wall Street Profit Bubble Will Collapse

We have written a handful of times that the vast majority of derivatives should be banned. That financial innovation is, at its roots, nothing more than legalized fraud. Derivatives serve no purpose other than to provide income at the expense of counterparties. They create no economic wealth. To the contrary they destroy wealth. Effectively, one could look at derivatives as a form of hyper-consumption or tax in its effect. Derivatives aren't proper risk-hedging instruments. In fact, they are a major source of risk. Concentrated within a handful of major Wall Street firms, they become a source of systemic risk. Eventually that income generation achieved through the losses of a counterparty will create another Wall Street collapse. It's a mathematical inevitability compounded by the amount of income transfer and the muted state of capital creation in the underlying economy. This isn't some great epiphany to anyone who understands basic mathematics. Yet we don't get meaningful reform because of Wall Street's fraudulent involvement in government policy decisions via legalized bribery better known as lobbying.

We wrote some time ago in a lengthy derivatives post that deregulated derivatives are actually a design point sought by Wall Street. That such an environment lacking in transparency and asymmetric access to information in counterparty arrangements is necessary for outsized profits. This dynamic allows Wall Street firms to rip off society including our schools, municipalities and companies who are acting as counterparties. We have witnessed this in countless lawsuits and stories of fraud. We the People are left with the bill for this fraud.

While most derivatives should simply be banned given their design point was actually the legalization of fraud, transparency has a very powerful effect as well. Advanced Trading has an article with an introduction as follows:

Congress is looking to bring transparency to the OTC derivatives markets. While buy-siders are in favor of central clearing and exchange trading, dealers are concerned that reform will threaten their profits.

Indeed this is the dynamic we wrote about quite some time ago. That transparency itself will reduce profitability and more than likely make their usage undesirable. Wall Street fears transparency because it will threaten their profits. In other words, when all counterparties to a derivatives contract have access to the same information, profits will be squeezed very, very substantially. Possibly even making the use of many derivatives an endeavor of futility and losses. Competition does in fact cause Wall Street much consternation. For when everyone has access to the same information, Wall Street's fraudulent money machine will fail.

Future profits of Wall Street are very, very overestimated. The Federal Reserve and government cannot keep the bubble from eventually popping.