Treasury is today issuing a Notice of Proposed Determination providing that central clearing and exchange trading requirements would not apply to FX swaps and forwards.
The basis for Tim’s big decision was made clear in the Treasury announcement:
In contrast to other derivatives, FX swaps and forwards always require both parties to physically exchange the full amount of currency on fixed terms that are set at the outset of the contract.
Okay! Got that? Interbank FX is excluded from D-F because it requires a settlement. Unlike FX futures that have zero expectation of actual cash settlement (AKA: A bet) the FX spot and forward market requires that the parties exchange the currencies.
I think many people will like this distinction. The thinking is that if actually delivery of a commodity or currency is required, then it is a commercial transaction and not a
Tim Geithner knows how it works inside and out. He worked on the Fed desk in NY. Therefore he knows that the basis for his decision is flawed. The simple answer is that only a small fraction of interbank FX spot and forward transactions are actually settled for cash. They are netted out and settled by an outfit called CLS.
What’s CLS? A good description comes from Tim’s former employer, the Fed:
Is CLS a big deal? Does this outfit settle the lion’s share of all interbank spot and forward settlements? You bet it does. The Feb. numbers were a Multi-Trillion dollar blow out:
As a result of CLS 98% of all FX spot and forward transactions are netted out and settled with no delivery of the underlying currencies. So the argument that Tim has put forward in defense of his big choice is actually bogus. And he knows it.
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Take the mid point of each of the swaps/rates for one year AUDUSD. Those numbers are:
Swaps = .0505
AUD Euro deposit = 5.43%
USD Euro Deposit = 0.83%
Spot AUDUSD = 1.0970.
Put this together.
The interest differential is 4.60% (5.43 - .83).
The swap differential is .0505, divide that by the spot rate of 1.0970 and you get 4.60%. Bingo!
Some observations on this:
-All forward swaps are = to interest differentials.
-All forward swaps are interest rate derivatives.
-All forward FX swaps have just been carved out of Dodd-Frank.
-One can make a bet on interest rate changes through the swaps market.
-The swaps markets are highly liquid. Forward swaps are available for virtually all currency pairs.
-If a financial institution wanted to make a derivative bet on interest rates AND avoid the central clearing requirements of Dodd-Frank they could do it with no problem.
-Sharpies will figure this out. (they already have)
Ergo: Dodd-Frank has no teeth.
Ergo: We’re living in Joke Town.
"Joke Town"
Posts
Bruce:
ReplyDeleteThis is amazing information!
I would love to hear a reply from someone near the Treasury secretary.
Have you tried to contact these people in the past?
Don Levit
This is pretty absurd. The FX market had absolutely nothing to do with the most recent credit bubble and collapse. It shouldn't have been included in Dodd Frank in the first place.
ReplyDeleteDon Levit: I send my all my stuff to the Agency that is under my thumb. I will never hear from on this. For some reason, I don't think they like me.
ReplyDeleteWalter S.
ReplyDeleteI agree with you. FX should never have been included. But it was so this is a Uturn of some significance. Me? I'm just busting Tim's balls...
For what it is worth I think that Dodd-Frank was just an over reaction by DC.The whole thing should be shit canned in my view.
Hi Bruce, why do you think: :Dodd-Frank was just an over reaction by DC.The whole thing should be shit canned in my view" ?
ReplyDeleteIlene:
ReplyDeleteWhen Enron happened we got Sarbanes Oaxley. That was a terrible bit of legislation. It was an over reaction to what happened with the crooks at Enron. Enron cost tens of billions. SB cost hundreds of billions.
We had a massive crisis in 2008. The result is Dodd-Frank. Basically the same result in my view.
Were derivatives and forward swaps the problem in 2008? No, they may have contributed to the problem but the real issue was how DC managed Fannie and Freddie. It was also a function of the Fed. Interest rates were very low in 2007. The our boy Greenspan jacked them up fast just before he left office. Put those two errors together and you have a mega crisis.
DC can't legislate markets and have a happy ending. They should stick to their own knitting and leave markets alone.
So what would you do/change the financial markets with the goal of market's having a happy ending? What regulation/laws would you want to exist and be enforced?
ReplyDeleteI thought I saw this story posted on ZeroHedge.com and then I went back and it wasn't there. Am I seeing things?
ReplyDeleteDave Harrison
www.tradewithdave.com
Ilene:
ReplyDeleteI want equity in deals. All of them. Home mortgages to CDS swaps. You name it.
No more funny money. That would help. But I want more. I want accountability.
I want perp walks for folks. Not insider trading stuff, that's easy. I'm talking Lehman type stuff. There was none of that in 2007-10. Five years in the slammer for fudging numbers or securitizing junk would wake up WS.
Skin in the game, downside risk. That might work. Legislation, by itself, won't work. As I tried to describe, the markets will just find a way around the roadblocks.
"the real issue was how DC managed Fannie and Freddie."
ReplyDeleteYes.
"Five years in the slammer for fudging numbers or securitizing junk would wake up WS."
No.
No more funny money. That would help. But I want more. I want accountability....
ReplyDeleteI want perp walks for folks. .... Five years in the slammer for fudging numbers or securitizing junk would wake up WS.
That would be good. Are the laws now sufficient (if enforced) or do you think there needs to be more - how do you get rid of the "funny money"?
What a pile of horseshit coming from BK today. 'No regulation for financial markets!' he cries! You complain about Enron which completely destroyed the financial lives of many thousands of innocents, and yet Enron was the result of no/lax regulation! Like duh, give your head a shake. You then say you want Equity in every deal, completely contradicting yourself because it would be a regulation! Finally, perp walks, five years in the slammer for 'securitzing junk', where of course 'securitizing' and 'junk' would have to be defined by regulations! Complete and utter rubbish.
ReplyDeleteIlene, I think there is too little equity today. Yes, rules could address that. But it does not come cheap. Say we make a rule that to buy a home you have to have 20% down payment no second liens. We would not have another mortgage crisis anytime soon if that were to happen. But the housing market would tank. How much would that cost? Plenty.
ReplyDeleteSame with options and swaps. If you increase the required equity that the banks have to have on this it will result in a drop in liquidity. That's a risky outcome.
But I think that is the price that has to be paid if you want a system that is not subject to blowups.
I don't think the laws and penalties are clear on this. The folks at Fannie gambled the countries money and we lost. I want someone to go to jail. Do that a few times and the bad acts won't happen as much.
Anon:
ReplyDeleteIf you want to say I am rubbish you're welcome to do so. But you ought to put your name to it. I do.
If sarbanes oaxley was in place before Enron went bust it would not have mattered. If someone is willing to lie and there is a conspiracy of people willing to cover up the crime there is no regulations that work. Sooner or later it all goes bust. But regulations don't solve the problem. Bad eggs don't follow the rules.
Some folks did some time for Enron. Many did not. I would have liked to have seen a much wider net. Anyone who was part of the cover-up would go to jail.
There are and were very clear laws regarding Madoff. It still happened. Now he is going to jail for the rest of his life. This will make some think different who are contemplating a ponzi. We just have to do the same for a lawyer/banker who securitizes junk.
Regarding Anon's comments: What a pile of horseshit coming from BK today. 'No regulation for financial markets!' he cries!
ReplyDeleteFreedom of speech does not mean speaking profanities at 2am off your rooftop. I heard former President Clinton once got on his NY rooftop, don't know if its true, and started giving speeches, and they called on the police.
In George Soros' new book, he talks about the lassiz faire from the Reagan era that caused our problems, as business was held to no rules, no standards. While we may not necessarily conclude as he does about his solutions, it should be obvious that lassiz faire has caused a lot of problems.
Men by themselves in their greed and lust for power and domaniance need regulation. Natural law dictates economies are in pyramids. See Freakonomics on economic pyramids found in the ghettos among the cocaine dealers; it's not just Wall Street. The sun comes up every day, and we live under natural law.
Seems you live by some fantasy thinking that somehow man does not need to live fair and square in cooperation with one another.
Who is out of sync? Not BK, but you.
Whoever posted the last comment, I agree with you.
ReplyDeleteMan needs a Regulator, call Himn God, etc., internally.
We also need an external Regulator.
That's why the Jews consider the Torah to be like a fence, setting boundaries, which we need, that we will not cross.
Particularly when people are overwrought emotionally, an external Regulator is vital.
If you don't think so, your arrogance will eventually get you into trouble.
Don Levit