|Regulating Derivative Markets
To Meet Real Needs: Beyond Toronto to Seoul
(c) 2010 by
Principal, Authentix Coaches
|Latest Revision: 100814
|What were the agendas for 100626-27 of the G8-20 leaders meeting in Toronto? They clearly were
various, and the idea of a financial transactions tax on speculative trading was far down the list.
Said Naoto Kan, the new Japanese PM, at the end of the meeting: "The bank tax was in focus before
the meeting, but it was not a major point of discussion at this meeting. In preparation for the meeting,
European countries were interested in the idea, but Japan and the United States were not necessarily in favor
of this form of tax. It was mentioned, but there was no deep discussion on the issue".
Will the discussions leading into the Seoul G20 Summit scheduled for November serve to channel
the energy and creativity of competent speculators away from greed and excess and playing
Russian Roulette with everyone's economic lives into contributing financial bets of net benefit to
everyone? As John Ivison of the Financial Post write, "the G20 deliberations may prove to be the
difference between the next financial meltdown coming in five years or in 50".
French President Sarkozy, speaking on behalf of all 27 leaders of countries in the Euro zone on
June 17, 2010, said EU leaders will call for a global tax on financial transactions and wanted the
United States and others to back a transaction tax at the G20 leaders' meeting in Toronto next
week. On September 19, 2009, Sarkozy had urged "fellow G20 leaders to introduce a special tax to
reduce risky behaviour by banks to be applied to every financial transaction". So at his lunch in London on
June 18, 2010, with British Prime Minister David Cameron, whose Tory party was about to
implement, rather than a transaction tax, a bank tax to pay for the bailout of British banks, he
undoubtedly would have spent some time working out a Euro-British approach to the upcoming
G20 deliberations on financial recovery and stability. The upshot in Britain's recent budget was
that a more modest than expected non-transactional bank levy was imposed, a decision that, in
my view, makes sense as leaving room later for a transactional tax to be added when practical
details can be worked out with other nations. In any case, the upshot for the Toronto G20 meeting
was also a letter to its host, Stephen Harper, informing him of the decisions of France, Germany
and the United Kingdom to press at the G20 for concerted introductions of a tax on bank financial
transactions. Will they be on the more extremely speculative ones?
Once the G20 meetings got started sentiment shifted towards Canadian Prime Minister Harper's
doctrinaire call for commitments to shrink deficits. The South Americans were appalled by this.
Argentina's President Cristina Fernandez said Europe's focus on cutting deficits is "absolutely
wrong," citing her country's searing experience with austerity which she said helped lead to a
massive default in 2001. "It all ended in an implosion and in default," she told Reuters in an
interview. Reuters also reported that Brazil's Finance Minister Guido Mantega said the budget
targets were "too tough.", and that Angel Gurria, secretary-general of the Paris-based Organization
for Economic Co-operation and Development, attempted to articulate a middle path by saying
that to ignore the debt burden could drive up borrowing costs, but cutting back too soon may
Simon Johnson, a professor at MIT, comments: "The (Toronto) G-20 declaration ... amounts to saying
‘assume a miracle’ for global growth” and reckons that Europe’s fiscal austerity plans will slow
growth. The scene is set for some innovative ways to raise money from unnecessary excesses.
Ellen Brown, in an Op Ed on 100702 in Truthout, reports that: "Two Green Party candidates for
governor, Laura Wells in California and Rich Whitney in Illinois, have included a state-imposed Tobin tax
(FTT) in their platforms. Both are also campaigning for state-owned banks in their states, on the model of the
Bank of North Dakota. People around the world look to the United States for boldness and innovation, and
California and Illinois are two of the hardest hit states in the nation. If those states manage to turn their
economies around, they could establish a model for economic sovereignty globally."
Regulators are unlikely initially to be very accurate in making the distinction between destructive
and constructive speculation but with some experience we can expect them to become much more
accurate. In that light, let’s recognize that a learning curve must be climbed and also that such
learning will only occur in the minds of people demonstrably committed to learning across the
divides of conventional left-right political thought.
Looking forward, the issue of how governments, after failing to supervise derivative markets, are
now going to address, in a period of generally slow economic growth and of aging populations
demanding expensive benefits, the deficits incurred by “bailouts and deliberately stimulative
program expenditures” will increasingly drive the debate over financial transactions taxation
between now and the Seoul G20 Summit in November. On 100713, President Obama, ever alert to
the value of praising even minor progress, congratulated three Republican senators, intriguingly
all ones from States nearest to Europe (Maine and Massachussets) for reaching across the aisle.
David Herszenshorn reported the words the President used in his New York Times article of
100714: “Three Republican senators have put politics and partisanship aside to support this reform, and I’m
grateful,” he said, adding “What members of both parties realize is that we can’t allow a financial crisis like
this one that we just went through to happen again.” Now he must face the growing doubts in his
policies by voters, especially logical but not rational ones, whose confidence in the US economy
is, according to Motoko Rich of the New York Times, taking a beating.
Toronto, June 5-August 14, 2010
Some pertinent research links:
Free Risk's extract from Wikipedia on the "speculative transaction tax"
House Financial Services Committee
Senate Banking, Housing and Urban Affairs Committee
Consumer Federation of America
Center for Responsive Politics
|"Europe must show the path for the bank tax. We will show the path and we will do it ... it's difficult to have
everybody go in the same direction. At least it (the concept) has been accepted". That was what
conservative French President Sarkozy told Reuters at the conclusion of the Toronto G20 Summit
on 100627. He also remarked that it was lonely pushing the (undifferentiated) Financial
Transactions Tax (FTT), which all 27 of his Eurozone colleagues had earlier endorsed.
Earlier in June media peole were reporting that the proposal to levy a tax on banks to insure
against a “rainy day” of credit instability such as brought the last speculative boom to a
frightening end was dead in G20 discussions. But now, recognizing that several problems remain
obstinately unsolved from the harsh fallout from derivative contracts traded in what amounted, in
hindsight, to self-and-other destructive speculation, much of it blatantly affrontive to conscience if
not downright dishonest, attention may be shifting toward consideration of the best form for such
One factor, political in nature, that is likely to play a part in solving these problems is the anger of
those who didn’t speculate recklessly but whose lives were nevertheless seriously disrupted by
the fallout. Anger is the emotion of most people in relation to those responsible for the much
tougher economic conditions prevailing over the last two years.
Another factor, more financial in nature, is the issue of how governments, having failed to
supervise derivative markets, are now going to address, in a period of generally slow economic
growth, and a recognized risk of deflation, of aging populations demanding increasingly
expensive benefits, the deficits incurred by “bailouts and stimulus program expenditures”. And
a third factor, one not often discussed, is the determination evidenced by many senior
government administrators to put an end to the intrinsic inauthenticity of those who facilitated
and promoted both ends of short contracts.
It was, I sense, this last determination which fueled year-old proposals to tax banks. Events in
Germany, France, the United Kingdom, and the United States tell us the determination has not
run out of gas, but differences in the economic conditions among the G20 countries are
precipitating differences in leadership perspectives. In Germany, a paragon of orthodox financial
rectitude while memory of its hyper-inflation of yore persists, Angela Merkel’s government has
banned short-trading of its currency. In France and the United Kingdom the population is so
angry with bankers that national leaders there know they have no choice but to tax banks. Indeed
the last UK budget did so.
And in the United States? The Obama Administration’s Treasury Secretary, another very
influential alumnus of Goldman Sachs, the biggest trader of derivative contracts, is on record for
over a year with public comments that leave no doubt of his determination for regulatory action.
Here’s what Anne Flaherty, an Associated Press writer, reported on July 10, 2009, of congressional
testimony being prepared by Timothy Geithner, then new as US Treasury Secretary. Geithner
said the ease with which derivatives were bought and sold in an era of easy credit encouraged
financial institutions and investors to take on too much risk. At the same time, government
regulators weren't given the proper tools to mitigate those risks and protect the American
consumer. The federal regulatory system "failed in its most basic responsibility to produce a stable and
resilient system for providing credit and protecting consumers and investors" was Geithner's summation.
On top of Geithner is a bold and persuasive, but congressionally hamstrung, president who's
shown his determination to accomplish many domestic and international goals dependent to a
significant extent on the availability of cash in US Treasury coffers. As Congress neared
completion of its overhaul bill, here's what Obama said before leaving for the Toronto G20
"Wall Street reform will also strengthen our economy in a number of other ways. We'll make our financial
system more transparent by bringing the kinds of complex deals that help trigger this crisis, like trades in a
$600 trillion derivatives market, into the light of day. We'll enact the Volcker Rule to make sure that banks
protected by the safety net of the FDIC can't engage in risky trades for their own profit. And we'll create
what's called a resolution authority to help wind down firms whose collapse would threaten our entire
financial system. No longer will we have companies that are "too big to fail."
Over the last 17 months, we passed an economic recovery act, health insurance reform, education reform, and
we are now on the brink of passing Wall Street reform. And at the G20 summit this weekend, I'll work with
other nations not only to coordinate our financial reform efforts, but to promote global economic growth while
ensuring that each nation can pursue a path that is sustainable for its own public finances."
The next day, in his weekly radio address, Obama pressed legislators to include in their financial
overhaul bill a tax on big banks. We now know that, divided along largely party lines, they failed
to respond positively.
How will all these paradigmatic energies get their satisfaction? My answer is that, in due course,
four authentic sources of political and regulatory energy will predominate: (1) the concern of
those now becoming worried about government deficits, (2) the concern of those planning proper
provisioning for the security of an aging, less gullible population, (3) the anger of the average
man or woman in the street who feels politicians have not in recent years been doing what they
are generally expected, and always claim, to do, which is to govern in the best interests of all their
constituents, not just those of their principal political benefactors, and (4) mounting frustration by
politically active progressives of all stripes that bankers and financial tycoons are running what
passes for thinking in many politicians' utterances.
What solution will emerge?
In the US, Congress appears to have agreed on legislation giving teeth to the power of regulators
to break up "too big to fail" institutions. It appears that virtually all legislators now accept that
the inability of the Bush administration and former Fed Chairman Greenspan to recognize the
necessity of the balancing factor of the value of responsibility to the value of freedom explains the
negligence Geithner highlighted. But the tendency of legislators to protect the sources of profit of
the financial institutions in their own domestic operations appears to be interfering with a swift
course to eliminate the kinds of trading which caused the boom/bust cycle from which we are all
now seeking a safe exit.
The solution proposed and heavily marketed by the Canadian government and its Central Bank
Governor, Mark Carney, is for each bank to issue debt earmarked as convertible to equity capital
in the event later that the Finance Ministry’s Superintendent of Financial Institutions should
determine that it was failing a solvency test (aka "stress" test). Unanswered in this solution is
“Who would want to buy such debt?” If the convertible debts were priced cheaply enough, of
course, someone would take that risk. But the idea appears to me more geared to protecting the
already more conservative practices and regulation of Canadian banks from "punishment" by the
bank taxes now on the verge of emerging in Europe than it is to solving the root problem of
The Canadian proposal is aimed at eliminating the "moral hazard" of big bank executives relying
on the existence of a fund to assure them a rainy day insurance policy equivalent to a government
bailout. But that would be only one purpose for a bank tax. Moreover, the deployment of always
scarce capital to support elements of conduct in short markets that often only the traders
themselves seem to want, and then only some of them, seems to me to be ignoring something
much more pervasively dangerous. Although Governor Carney asserts that, after raising that
extra capital from private markets, banks will “alter their business models and behaviour in that
capital presently held against trading books would be redeployed toward conventional lending”,
that is unlikely to become so unless speculative trading is deemed by bank leaders to be less
Before offering what I consider to be a more finely tuned solution to the problems posed at the
outset of this paper let me be clear that there is a role for speculative trading, and hence for
derivative trading. George Soros, one of the most successful speculative traders of all time, is
worth listening to here, I think. He is very clear that speculations fall into a spectrum in which
reflexive, destructive speculation is at one pole and intelligent, constructive speculation is at the
other. The criterion for a healthy financial sector is not that it be free of speculative trading but
that it be as free as possible of speculative trading that, prospectively, can rationally be expected
to be more likely to be destructive to the economy as a whole than constructive. Given, then, that
the terms “destructive” and “constructive” are meaningful when applied to speculation, the
practical issue becomes: how can regulators distinguish, prospectively, the destructive from the
Anticipating the inordinate growth of speculative bubbles, some economists have advocated
charging transaction fees on speculation. Traders and their banker sponsors have typically
distracted serious consideration of these proposals by political decision-makers on the grounds
that (a) such fees can never, they say, be implemented because that would require cooperation
among all 130 institutions managing national currencies and (b) no prospective distinction can be
made, they say, between "destructive" speculation and "constructive" speculation. Initially, the
IMF has been inclined to lend credence to point (a) but, in light of the fact coming to light that
already small taxes are imposed on certain financial transactions in the Austria, China, Greece,
Hong Kong, Luxembourg, Poland, Portugal, Singapore, the United Kingdom, and the State of
New York, amongst others, the IMF appears today to be relaxing that position.
Point (b) can be addressed by first noting five aspects of speculative activity that so far have not,
in combination, been widely discussed:
1. Some forms of speculation are in theory productive in that they facilitate prices changing at a rate that
correlates with the time horizon needed for intelligent planning of the supply of the real "good" at pricing
issue. Such forms of speculation facilitate, in theory, the utility to production planners of a market for
assessments of uncertain futures, and are therefore constructive and desirable
2. Other forms of speculation trigger price changes primarily because traders want to trade and think they
can make a "killing". Such forms of speculation are oblivious to the reality that good quality planning by
competent managers is rendered futile by wild price volatility such as occurred, for example, in crude oil
futures over the summer of 2009. In other words, such forms of speculation, if they can be prospectively
identified, engender "short-termism" and despair, and eventually cynicism and outrage, all of which
destroy social coherence, and thus are destructive and require active and currently intelligent moderation
3. In principle, longer-term contract forms have effects that are more of the first character (#1 above), and
shorter-term contracts have effects more of the second (#2 above). Thus length of contract term is a crude
proxy for distinguishing, prospectively, speculative transactions more likely to be destructive than
constructive for the economy as a whole. Length of contract is not a perfect predictive distinguisher,
clearly; but it is a crude one and therefore likely to be better than none
4. It follows from this that a tax on speculative contracts of #2 form would render them less profitable,
would be consistent with the mixed-economy free-market principles with which most people are
philosophically and practically comfortable today, would avoid rendering any form of production planning
futile, and thus, without affecting productive speculation, would diminish destructive speculation.
5. This theoretical argument is supported empirically, but with notable qualifications, by reviews of the
consequences of instances when changes in the transaction costs of capital transfers have been mandated
by various governments. For details please email me.
When one considers that these aspects of speculative activity are conceded by the more frank and
continuously successful of traders (traders such as George Soros), one begins to recognize that a
carefully-calibrated structure of transaction fees on shorter-term speculative capital flows would
not inhibit economically, socially, and financially desirable speculation but would be capable of
generating deficit-reducing revenue for governments whose debt to GDP ratios have in the last
two years been rising sharply. These features are, in my mind, far superior to the ingenious but
bank-centric notions of embedded contingent capital put forward by the Canadian government in
cahoots with Canada's banking establishment. The practical advantages may indeed prove to be
a swing factor for those G20 governments recognizing that they are entering a fiscally difficult
era. Moreover, the idea of curtailing the incomes of outrageously irresponsible traders and their
seemingly conscienceless sponsors is certain to assuage some of the anger that governments in
many advanced countries are now having to contend with by spending billions of dollars on
crowd control and VIP security.
Those segments of speculative activity that fall out of coherence with the general need to facilitate
good production planning – whether that be for solar electricity generating roofs, gasoline,
onions, electric bikes, entertainment, spritzers for senators, housing, education, news, comment,
or for any other commodity or service, including money supply, that is necessary to meet the real
needs for well-being of people with more than puerile consciences must clearly be restricted.
Later in this paper, I shall suggest how the G20 leaders can begin to institute a calibrated
structure of collectible transaction fees on selected categories of speculative capital flows as a way
to curtail such activity without throwing away the economic benefits of responsible speculation.
But first let's briefly address the objection that all 130 of the currency-issuing institutions would
have to sign on simultaneously. I think that is a significantly, but not entirely, spurious objection
-- for two principal reasons. First, the G20 economies comprise 85% of global economic activity
and an even higher percentage of global trading and agreement among 20 is, as the leaders of its
G7 and G8 predecessors recognized, much easier to get than agreement among 130. Second, it's
often said that certain governments -- particularly those whose currencies are used as reserves by
governments having weaker currencies -- will be eager to protect their own job-producing
financial sectors, and so will drag their feet. Well yes, but what's the point of protecting a sector
that is not only liable to self-destruct periodically but that,when indulging in destructive
speculation as inevitably it will, its "bubble-bursting pop" is going to take down a lot of other
economic activity with it? David Brown, former chairman of Ontario's Securities Exchange
Commission has, as John Greenwood of the Financial Post reported on 102026, this to say on the
issue: "If the rules are more robust in other jurisdictions then there is a possibility there will be a flight to
Canada because of lax regulations, and we don't want that reputation."
In summary, what appears to me to be required now is a steady and patient and politically
responsive global process for introducing a responsive and responsible structure of transaction
fees into derivative market regulations.
G20 decision-makers have a precedent to justify hope today that a steady, patient and politically
responsive and responsible introduction of a calibrateable speculative transaction fee would
emulate the slow, steady, and politically responsive global process that followed the Canadian
initiative of a generation and a half ago when the Canadian dollar was permitted to float, all on its
own, in international exchange markets. Since that bold and far-sighted initiative was taken by a
Canadian government forty years ago, the regulators of virtually all currencies of any
international significance have one-by-one in their own good (or bad) time followed suit.
As to some specific suggestions for designing a politically responsive transaction fee structure,
let's consider the following scenario:
|On 100721 President Obama signed into law a voluminous bill overhauling US financial
regulations. Amongst other things, it gives power to US administrators to wind down
troubled financial institutions that formerly would have been chapter 11 courts issues,
thus enabling government czars to act more swiftly in the future. But how will it match
what's happening in Europe, where German Finance Minister Wolfgang Schaeuble told his
country's parliament on 100702 that he would soon join with his French counterpart in
calling on the EU's executive Commission to draw up proposals for a Eurozone financial
transaction tax (FTT), and where analytics of stress testing are steadily restoring, as
they did last year in the US, confidence?
Angus operates an executive coaching practice with clients who include a manager of trading at a
major Canadian bank. His paper recognizes speculative trading as having mixed overall effects
on economies and proposes practical principles for winnowing out the negative effects of
speculative trading, and looks forward to preparations for the Seoul G20 Summit. A key
issue not addressed in the Final Toronto G20 Communique, Angus says, is whether the US,
BRIC, and Eurozone countries will work together to shape implementation of a direction
involving a tax on speculative transactions more likely to be destructive of the evolving
economic activities from which they are derived than constructive.