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Saturday, May 1, 2004

Shelve NYSE derivative plan


LOS ANGELES -- Deliberately injecting a new dollop of uncertainty into the already-shaky international financial system has got to be the white-collar dysfunctional equivalent of dropping a pair of terrorism car bombs on the steps of some nation's central bank.

Yet this, in effect, is precisely what leaders of the New York Stock Exchange are proposing, however unintentionally, if, as seems probable, they proceed to sanction derivative funds as official products of the exchange.

A final decision to do so would be morally inexcusable and in all probability injurious to global economic stability.

Derivative funds are a relatively new way to invest. Important as they have become, they are very difficult to define exactly, but (as one saying goes) you know them when you see them. They are sort of kissing cousins to giant hedge funds, sort of like very large insurance policies that are more or less constantly in motion -- a kind of radioactive hedge or insurance fund, say.

And they are the logical product more of the dazzling technology of our globalized age, with its lightning-fast computer transmission and instantaneous information-technology capabilities, than they are of a neatly rational, easily understood investment, such as buying a stock or government bond.

Moreover, as complex (and a bit mysterious) as they are, even the average small-time investor (like me), with his or her investment retirement account, mutual fund and what not, may unknowingly have put a small slice of their investment in derivatives. The global result is that derivatives funds tend to be of enormous size, with tremendous potential to generate great harm as well as massive profit.

Asia needs to be especially wary of the derivatives development after what happened during the 1997-99 regional financial scare. Western hedge funds of enormous magnitude, moving with the speed of light and the stealth of terrorists, exacerbated that unforgettable crisis by speculating against (in effect, serially shorting) weak national currencies and roiling national equity markets. The net effect was to turn a 4.5 earthquake problem into something like a 7.0 catastrophe.

Rocked to its core, Asia fought back by either accepting severely conditioned bailout billions from the Washington-based International Monetary Fund or, as with Hong Kong and Malaysia in particular, implementing their own radically protective responses. The region survived, obviously, but the experience was very scary, something that no one wishes to go through again.

But the derivatives development poses a new threat of a similar or greater magnitude, which is why this category of financial instrument has already drawn its share of critics.

Notable among them is billionaire investor Warren Buffet, who recently described derivatives as "financial weapons of mass destruction. . . . We view them as time bombs both for the parties that deal with them and the economic system, . . . carrying dangers that, while now latent, are potentially lethal."

Another widely respected financial figure, though he doesn't appear to share Buffet's negative view, has warned that especially diligent financial monitoring will be needed if derivatives are to become a healthy new coin of the investment realm. That very cautionary note came from none other than U.S. Federal Reserve Alan Greenspan.

The argument for officially listing derivatives on the NYSE, one presumes, is that it would simply recognize the growing reality of derivatives and provide a more regulated environment for the inevitable. But this argument would be far more convincing if those massive Western speculative funds that ravaged Asian currencies and stock markets just a few years ago hadn't had deep origins in, and direct links to, the very pristine sanctuary of the NYSE itself.

And this argument withers to near-hilarity when one considers recent history, such as the world's emerging sense of the true moral climate of the NYSE. Consider the global outrage when the world learned that nearly $200 million in compensation had been paid to NYSE Chairman Richard Grasso, now forced into resignation. Indeed, a deeply embarrassed NYSE is trying to get some of that compensation back!

Consider the collapse, like the proverbial house of cards, of once-magisterial Barings Bank, in part due to overexposure in speculative derivatives. Or the dirty side of derivatives revealed in the scandals of Enron (2001), Long-Term Capital Management (1998) and Proctor & Gamble (1994).

Even defenders of derivatives, who make the case that they are not inherently evil, have to admit that the amount of actual social good produced by them is difficult to discern. They exist primarily for the purpose of profiteering, and thus are driven largely by greed rather than social conscience.

Properly harnessed, human greed can produce great wealth that can ultimately become a powerful force for the common good. But derivatives are so complex that they are difficult even to define, much less harness or manage responsibly. Were it possible to contain the explosion of derivative investment within the United States, the NYSE's evident inclination to officially list them perhaps could be justified. But in an age of intimate economic globally interconnectivity, the NYSE has no right to inflict the risk of them on the rest of the world. America already has plenty of ways of making money without them.

UCLA professor Tom Plate is a member of the Pacific Council on International Policy.


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