Too few derivatives?

[toomuchtime_]

Yep, that's what Geithner says got us into this recession. From the Fact Sheet the Treasury Department released in conjunction with Geithner's Financial Stability Plan speech yesterday.

While the intricacies of secondary markets and securitization – the bundling together and selling of loans – may be complex, they account for almost half of the credit going to Main Street as well as Wall Street. When banks making loans for small businesses, commercial real estate or autos are able to bundle and sell those loans into a vibrant and liquid secondary market, it instantly recycles money back to financial institutions to make additional loans to other worthy borrowers. When those markets freeze up, the impact on lending for consumers and businesses – small and large – can be devastating. Unable to sell loans into secondary markets, lenders freeze up, leading those seeking credit like car loans to face exorbitant rates. Between 2006 and 2008, there was a net $1.2 trillion decline in securitized lending (outside of the GSEs) in these markets.

http://www.financialstability.gov/docs/fact-sheet.pdf

So Geithner appears to be saying that the derivatives were not the instruments of our destruction, as many of the most outspoken critics of the banking industry have claimed, but we got into this mess because the banks did not create and sell enough of them. In effect, Geithner is saying the creation and sale of these derivatives did not only provide a positive service to our economy, but an essential service. But if Geithner is correct about this, how can it be that the deregulation bills passed in 1999 and 2000 that allowed these derivatives to be created and sold were the root cause of the financial crisis as so many have told us? If we are to believe Geithner, I guess we have to conclude these deregulation bills were the right thing to do.

Well, I just have to ask him, "Look here, Tim, if the derivatives were essential to our economy and the bankers who created them were performing an essential service to our economy and the deregulation bills were necessary, then how in the hell did we get into this mess? Who's to blame for all this?"

I feel like he was speaking just to me when he said:

Investors and banks took risks they did not understand. Individuals, businesses, and governments borrowed beyond their means. The rewards that went to financial executives departed from any realistic appreciation of risk.

There were systematic failures in the checks and balances in the system, by Boards of Directors, by credit rating agencies, and by government regulators. Our financial system operated with large gaps in meaningful oversight, and without sufficient constraints to limit risk. Even institutions that were overseen by our complicated, overlapping system of multiple regulators put themselves in a position of extreme vulnerability.

These failures helped lay the foundation for the worst economic crisis in generations.

TG-18: Secretary Geithner Introduces Financial Stability Plan

"You mean everyone's to blame?" (Except, of course, the House and Senate banking committees he will have to crawl before to ask for money.) "Where's the fun in that? Come on, Tim, give us one banker to blame, one really evil derivative, one outrageous deregulation."

I'm waiting, Tim.

I'm waiting.

Don't let me down here.

 

[Toro]

I interpret what Geithner is saying is that derivatives are positive but were taken to an extreme and people did not understand the instruments in which they were invested.

Derivatives, used positively, are very beneficial. However, people made incorrect assumptions about how the securitized assets would behave, and levered up too much debt on their balance sheets. There was also no transparency.