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"Lure People Into That Calm and Then Just Totally F--k 'Em": How All of Us Pay for the Derivatives Market

Derivatives are a hotbed of abuses and bailouts. So why are taxpayers footing the bill?
 
 
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For the Wall Street reform package currently making its way through Congress to work, it has to accomplish two broad goals: It must take a huge bite out of banking profits and end the too-big-to-fail oligopoly that encourages megabanks to take megarisks and stick taxpayers with the tab. Neither of these goals can be accomplished without taking on derivatives -- the wild, unregulated market that brought down AIG. Right now, the U.S. government pays big banks for operating derivatives casinos. If we're going to clean up the derivatives mess, we have to move taxpayer money out of the market.

"The dirty little secret here is that the American government has been subsidizing the derivatives market through the Fed and other avenues since its inception," says Adam White, director of research for White Knight Research and Trading. "That's crazy."

What kind of business is the American taxpayer subsidizing? One with a history of deception and abuse that dates back to its earliest years. Back in 1993 when derivatives casino was first getting off the ground, a Wall Street titan called Bankers Trust Co. sold a derivatives package to drug and chemical giant Procter & Gamble. At the time, Bankers Trust was a powerful, well-respected financial player, which was how it scored big-time clients like P&G. But P&G ultimately took a huge loss on the deal with Bankers Trust, and took the bank to court, where it obtained more than 6,500 tape recordings of horrific derivatives strategizing.

The public release of those tapes was not enough to compel Congress to actually do anything as a matter of public policy, but it was more than sufficient to utterly ruin Bankers Trust. One quote from the tapes, in particular, has become infamous among the nation's financial establishment, but remains obscure to the general public. It's a Bankers Trust salesman, describing the Procter & Gamble deal:

"Funny business you know? Lure people into that calm and then just totally fuck 'em."

To this day, such techniques remain a central part of the derivatives business, as the SEC's recent fraud suit against Goldman Sachs has made clear. These operations are ugly enough as purely private-sector enterprises. But the real disgrace is that ordinary taxpayers are actually helping to fund it. That taxpayer payout, in turn, creates market distortions that encourage fraud, abuse and bailouts.

"In the fall of 2008, when the derivatives market-making of the five big banks lead to a systemic catastrophe, the banks all proudly walked back to the Fed window to get assistance to prop up their derivatives market-making," says Michael Greenberger, who served as the chief deputy to Commodity Futures Trading Commissioner Brooksley Born during her unsuccessful attempt to rein in the derivatives market in 1998. "The central question is whether we want this to be part of the basic business of derivatives. That seems insane."

As the Wall Street reform bill moves into its final stage of negotiations, the only proposal still on the table that would actually move taxpayer money out of the derivatives sinkhole comes from the unlikely source of Sen. Blanche Lincoln, D-Ark., a career corporatist who has never shown much interest in regulating anything. But it's a whopper of a proposal, one that comes free of any loopholes and goes straight to the heart of Wall Street's bubble machine.

The plan is simple: If you want to be dealing the crazy, complex financial products that toppled AIG, Enron and Long-Term Capital Management, then you can't receive any funding from the Federal Reserve. No bank can operate without access to the Federal Reserve's money supply, so the five megabanks would have to choose -- do they want to be derivatives houses or do they want to be banks? If they want to be banks, they have to move all of their derivatives operations to an independently capitalized subsidiary -- a company that raises money on its own and has no access to taxpayer perks.