During the late 1990s, President Bill Clinton initiated public policy measures that brought our economy to its knees nearly a decade later.
Three measures were critical to this dynamic:
1. Housing and Urban Development policy to provide real estate mortgage loans based on parameters other than income and assets that would ensure proper debt service.
2. Financial Modernization Act of 1999, which permitted the consolidation of commercial banks, investment banks, securities firms, and insurance companies.
3. Commodities Futures Modernization Act of 2000, which allowed financial derivatives to trade without adequate capitalization and transaction disclosure.
The result was a massive increase in global financial risk that was transferred to the public. This was a key cause of the financial collapse.
As a result, financial institutions actively participated in the deregulated derivatives market, an undercapitalized system that did not disclose transactions. In fact, buyers and sellers were unaware of the price applied to the other: only the clearinghouse was aware of the price spread, which represented a significant revenue source.
The annual budget for the U.S. Commodity Futures Trading Commission (CFTC) doubled from $50 million in 2000 to $100 million in 2008.
However, during this time the notional (face) value of derivatives increased sevenfold, from $100 trillion to $700 trillion, according to the Bank for International Settlements (BIS). The CFTC wasn't adequately staffed to monitor this out-of-control system.
In fact, if these policies didn't exist, Bernard Madoff would have been required to disclose his fictitious Over the Counter (OTC) derivative trades.
This would have increased the probability of derailing his scheme earlier.
Since these derivative transactions may involve large, tailored positions between corporations and financial institutions, dissemination of the information may be disruptive to the market.
Therefore, going forward, I would suggest the following:
Establish an objective third party to verify and secure adequate capital
requirements and the agreed transaction price between parties without disseminating this information to the market until the transaction is consummated.
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