The derivatives crises began as a mathematical formula, imported from physics where it was used to model heat transfer in liquids, to serve as a technique for valuing options (see the timeline). There's no conspiracy there.
The banking industry has lusted for decades after control of the accounting rule writing methodology. For a very long time this was solely the province of certified public accountants. The CPAs were challenged in their rule writing monopoly in the 1930s by the government, but this threat was cleverly beaten back by the best academic accountant in America, Henry Rand Hatfield (the subject of the blog author's master's degree thesis in 1978). The Nixon administrations wage price controls and fetish about financial instability caused the CPAs to give in during the early 70s and allow academic accountants and finance specialists to participate in the rule writing methodology with a new structure, the “Financial Accounting Standards Board.” This board produced FASB pronouncements for mandatory implementation throughout the accounting profession. This is political accomodation and professional cowardice, but hardly a conspiracy.
In 1996, the American Institute of Certified Pubic Accountants actively participated in the securities reform legislation that year which stripped individual shareholders of ownership rights. CPAs had entered political lobbying directly. They would pay dearly for swaggering around on Capitol Hill and retaining lobbyists.
When the derivatives crisis mushroomed in September of 2008, the Securities and Exchange Commission (SEC), without proper authority, prohibited the accounting profession from marking derivatives to market using FASB 157, a pronouncement dealing specifically with over-the-counter derivatives (using a principle which demands that unmarketable securities be marked to $0). The accounting profession lost control of its own professional rules, in spite of having dealt with derivatives in Financial Accounting Standards Board pronouncements FASB 119 and FASB 133.
Now, yes, this is a conspiracy by the hopelessly politicized SEC. Get it? It's a government conspiracy that will ultimately fail. It has ordered corporate auditors not to report the loss of valuation of their corporate clients' hedging instruments. The assumption is that the crisis – a group of instruments with a face (called “notational”) value in excess of a quadrillion dollars – can be managed and will not recur.
The present Treasury Secretary, Timothy Geitner, is on record saying that he seeks not to eliminate dangerous derivative instruments but to manage the risks with the instruments remaining out there in the over the counter computerland where they “live.”
Derivatives showed their true dangerous colors during the multiple failures in the 1990s (see the timeline). Bankers wanted to make money off commissions, and, in steps, they got the authority to merge with stock brokerages and with insurance companies (a forced separation legislated into existance early in the Great Depression by the Glass-Steagall Act), and then they got exemption from state regulation and from reserve requirements. These advances occurred even with a large hedge fund bankruptcy (by Long Term Capital Management, itself started by the living co-inventors of the Nobel Prize-winning formula taken from fluid physics!)
So a rump conspiracy developed to maintain the derivatives status quo as a money making machine for the banking industry, which status quo morphed into continuing those derivatives without any reserve requirements, with any failure leading to government underwriting. This is where we are now, in 2010.
It is tempting to say that a conspiracy isn't involved here, because commercial banks have been splitting their political contributions nearly perfectly between Republicans and Democrats. This is true, but a look at the smaller but more critical contributions by hedge funds shows explosive growth in lobbying and thus in political contributions, especially to the Democratic Party, whih gets most of the donations for 16 of the last 20 years. Yes, these are Democrats, the party of the people, the party of compassion, the party of the “little guy,” and the dominent party of New York State and Connecticut, the center of America's banking and insurance industries.
Political contributions from hedge funds are available on line at this link:
So, as the derivatives monster grew more important and more gluttonous, it developed a conspiratorial function which has saved it to date. But it didn't start as a conspiracy and it will end in a panic that also destroys the capital and existance of the conspirators.
The whole purpose of all of this all the way through was for the banks to make commissions on very large betting contracts, effectively insurance with no reserve requirements, on nearly-impossible events for which the banks would never have to pony up any capital as counterparties. That was the scheme. They were flirting with Fortune. The hedge fund executives and friendly bankers acting as counterparties forgot that Nemesis (vengeance) is a constant companion of the goddess they were flirting with.
Nemesis has already bankrupted nations such as Iceland, Hungary and Greece over these massive derivatives instruments.
