Instead of being pedantic and snarky why don't you enlighten us all instead of using acronyms for everything?
Okay, I'll try for a little bit. I should be programming. But a little bit of history. I apologize for sounding pedantic or snarky.
In the 1900s up until the 1970s, the Chicago Mercantile Exchange (CME) and Chicago Board of Trade (CBOT) traded mostly agricultural products. A similar market existed in New York (NYMEX). These exchanges were created so that (as alluded to in the beginning of the NYT piece) wholesalers, farmers, people with a heating oil business, etc., could hedge the risk associated with the price of their commodities (due to weather, circumstance, etc.). Eventually these contracts became standardized -- they referred to the same # of bushels, and they were backed by clearing firms and central clearing houses at the exchange that served as buffer between these hedgers (who would 'hedge their bet', if they were more interested in selling at a locked in price and not worrying about the changing prices of the market), and speculators (usually local traders, or 'locals'), who would assume this risk.
These standardized future contracts fall under the category of 'derivatives', because they 'derive' from the current price of the commodities (often called 'cash' or 'cash instruments'). It turns out that there is overlap in how you create other more complex derivatives related to these futures contracts. So you can create options on these contracts. The options 'derive' from the price of the futures, etc. Sort of similar to higher order derivatives in math (so blaming 'derivatives' in general usually irks people in the industry because that's like blaming 'acceleration').
But there are different cash instruments you can use, and different ways you can form these instruments. So in the early 1980s, due to tax incentives in Illinois, and a couple of other reasons, the CME introduces the Eurodollar future. This is the first major financial future. The cash product here is interest rates (usually the LIBOR rate -- hence, the 'Euro' -- a standard short-term interest rate used by banks). So now financial institutions are starting to see that they can do this same type of hedging of their bets (they're the 'farmer' or 'heating oil producer' in this equation). If they want, they can now hedge their exposure to interest rates.
But why stop there? Futures contracts have the benefit of different taxation (capital gains taxes in Illinois are lower than elsewhere -- I don't know how much this has changed, but, e.g., this is one of key things a good reporting piece could focus on -- the justification is that speculation and capital gains from trading is risky and deserves to be taxed less -- because of the good to the economy that it provides, etc. -- but I mean, that's worth debating). And futures contracts also have the benefit that they're standardized and accessible to anyone with a terminal. So before you know it futures on stock indicies are introduced (the largest volume contract in the U.S. -- is the S&P 500 family of futures contracts). And around this time -- in the early 90s, things start to go electronic for the first time.
Bond futures are also introduced (at the CBOT). And this allows large financial institutions to offset risk more easily with their treasury bond portfolios, etc.
The key thing here though is that all these instruments, all this financial futures -- and all the options on financial futures that created -- they're all regulated. They're all closely watched by the CFTC and other regulatory bodies.
Enter the problem. Credit Default Swaps. These are non-standardized contracts drawn up between bulge-bracket firms in New York and insurance agencies to deal with the risks associated with mortgage securities. This is a huge, multi-multi-billion dollar industry that isn't regulated because it's still in its infancy and the participants have never been truly brought into the light.
Financial engineers, having seen how derivative contracts can be used to offset or control risk -- decide to draft these contracts to deal with mortgage-backed securities. The problem with mortgage-backed securities -- I don't know for sure. But I know they've been problematic from the 80s onwards. The bundling of home loans by New York has just never worked out for everyone (and Warren Buffett bailing out Salomon didn't fix the core of the problem -- in fact, arguably it glossed it over and left it as a potentially hazardous situation for two decades later -- though that's highly controversial, and just my sense -- the rest of what I said is hopefully pretty well accepted).
So creating financial derivatives for CDSes doesn't work in an unregulated manner. So seeing things collapsing, and seeing an opportunity to be involved in a huge new market, Ken Griffin proposes that CDSes should be traded in a more open manner (in 2008). CME Group (which is a merger of all three major futures exchanges in the US -- CBOT/CME/NYMEX -- another thing a more targeted reporting piece could focus on -- there's a potential monopoly -- see their relationship with ELX, etc.), I'm guessing, correctly foresaw that they didn't want to be anywhere near CDSes with the political backlash coming. So they wisely turned down his idea. But I could be wrong there -- have no close familiarity with what really went on.
So that's a little history. I don't know the specifics of the ICE clearing house conspiracy meeting whatever. But there are hundreds of these 'working groups' for new types of derivative products. They're traditionally just large market participants voicing their concerns about how things are going to be traded (the software involved, the types of contracts, etc.). But...it's not a conspiracy.... Not any more than ISO / HTML5 working groups are conspiracies between tech companies to push their interests (I mean there's always going to be a little bit of that). But these are traditionally actually very good things -- people coming together to determine how to trade things in the open.
The problem is Goldman Sachs picking up the phone and creating a custom contract with AIG to insure themselves against a mess of mortgage-backed securities that they got themselves into. The problem is that (a) they could trade these to begin (see THE INSIDE JOB, etc. -- for the rationale behind Glass-Steagall, and the problems with its repeal) and (b) that this didn't happen in a free, open, accountable market and of course (c) that they got bailed out because they were so integral to the financial markets to begin with (which wouldn't happen if part (a) were addressed).
But I mean obviously if you're going to start regulating things more closely, it's good to figure out exactly what to regulate. But I suppose I really should get back to programming...
I'll preface this by saying that I work in electronic trading, so I have a dog in this hunt and my opinion should thus be viewed with some suspicion.
You make two points in the two posts that are related:
The key point that is missed in all this imprecision -- is that CDS derivatives markets are not like other derivatives markets -- which are regulated. They are contracts that occur between large financial institutions only. That is the 'secret'. The rest is just the equivalent of a high school tourist at the visitor's desk.
Eventually these contracts became standardized -- they referred to the same # of bushels, and they were backed by clearing firms and central clearing houses at the exchange
In the current state of affairs, the CDS market is not transparent and the participants who want to avoid transparency point to the custom nature of the contracts as a reason that they shouldn't be quoted electronically. However, this situation is similar to what existed in equity/index options before the products started to be listed by exchanges: customized contracts were traded through brokers. This sort of OTC trading still occurs, but it exists alongside a very large, very active market of exchange-traded options whose prices are very transparent and thus automatically force down the fees that can be charged in the OTC market because they provide publicly available pricing information on similar contracts. If electronic exchanges were to create standardized contract terms for CDSs targeting some of the more heavily traded debt instruments (sovereign debt be a good target at this point for obvious reasons) and then list these contracts electronically, I suspect that this would bring a great deal of transparency to the pricing of these products due to the participation of firms like Citadel (which already has a large and profitable group making markets in electronically traded options). Large players have resisted such transparency in the fixed income markets for years, and this seems no different.
Okay, I'll try for a little bit. I should be programming. But a little bit of history. I apologize for sounding pedantic or snarky.
In the 1900s up until the 1970s, the Chicago Mercantile Exchange (CME) and Chicago Board of Trade (CBOT) traded mostly agricultural products. A similar market existed in New York (NYMEX). These exchanges were created so that (as alluded to in the beginning of the NYT piece) wholesalers, farmers, people with a heating oil business, etc., could hedge the risk associated with the price of their commodities (due to weather, circumstance, etc.). Eventually these contracts became standardized -- they referred to the same # of bushels, and they were backed by clearing firms and central clearing houses at the exchange that served as buffer between these hedgers (who would 'hedge their bet', if they were more interested in selling at a locked in price and not worrying about the changing prices of the market), and speculators (usually local traders, or 'locals'), who would assume this risk.
These standardized future contracts fall under the category of 'derivatives', because they 'derive' from the current price of the commodities (often called 'cash' or 'cash instruments'). It turns out that there is overlap in how you create other more complex derivatives related to these futures contracts. So you can create options on these contracts. The options 'derive' from the price of the futures, etc. Sort of similar to higher order derivatives in math (so blaming 'derivatives' in general usually irks people in the industry because that's like blaming 'acceleration').
But there are different cash instruments you can use, and different ways you can form these instruments. So in the early 1980s, due to tax incentives in Illinois, and a couple of other reasons, the CME introduces the Eurodollar future. This is the first major financial future. The cash product here is interest rates (usually the LIBOR rate -- hence, the 'Euro' -- a standard short-term interest rate used by banks). So now financial institutions are starting to see that they can do this same type of hedging of their bets (they're the 'farmer' or 'heating oil producer' in this equation). If they want, they can now hedge their exposure to interest rates.
But why stop there? Futures contracts have the benefit of different taxation (capital gains taxes in Illinois are lower than elsewhere -- I don't know how much this has changed, but, e.g., this is one of key things a good reporting piece could focus on -- the justification is that speculation and capital gains from trading is risky and deserves to be taxed less -- because of the good to the economy that it provides, etc. -- but I mean, that's worth debating). And futures contracts also have the benefit that they're standardized and accessible to anyone with a terminal. So before you know it futures on stock indicies are introduced (the largest volume contract in the U.S. -- is the S&P 500 family of futures contracts). And around this time -- in the early 90s, things start to go electronic for the first time.
Bond futures are also introduced (at the CBOT). And this allows large financial institutions to offset risk more easily with their treasury bond portfolios, etc.
The key thing here though is that all these instruments, all this financial futures -- and all the options on financial futures that created -- they're all regulated. They're all closely watched by the CFTC and other regulatory bodies.
Enter the problem. Credit Default Swaps. These are non-standardized contracts drawn up between bulge-bracket firms in New York and insurance agencies to deal with the risks associated with mortgage securities. This is a huge, multi-multi-billion dollar industry that isn't regulated because it's still in its infancy and the participants have never been truly brought into the light.
Financial engineers, having seen how derivative contracts can be used to offset or control risk -- decide to draft these contracts to deal with mortgage-backed securities. The problem with mortgage-backed securities -- I don't know for sure. But I know they've been problematic from the 80s onwards. The bundling of home loans by New York has just never worked out for everyone (and Warren Buffett bailing out Salomon didn't fix the core of the problem -- in fact, arguably it glossed it over and left it as a potentially hazardous situation for two decades later -- though that's highly controversial, and just my sense -- the rest of what I said is hopefully pretty well accepted).
So creating financial derivatives for CDSes doesn't work in an unregulated manner. So seeing things collapsing, and seeing an opportunity to be involved in a huge new market, Ken Griffin proposes that CDSes should be traded in a more open manner (in 2008). CME Group (which is a merger of all three major futures exchanges in the US -- CBOT/CME/NYMEX -- another thing a more targeted reporting piece could focus on -- there's a potential monopoly -- see their relationship with ELX, etc.), I'm guessing, correctly foresaw that they didn't want to be anywhere near CDSes with the political backlash coming. So they wisely turned down his idea. But I could be wrong there -- have no close familiarity with what really went on.
So that's a little history. I don't know the specifics of the ICE clearing house conspiracy meeting whatever. But there are hundreds of these 'working groups' for new types of derivative products. They're traditionally just large market participants voicing their concerns about how things are going to be traded (the software involved, the types of contracts, etc.). But...it's not a conspiracy.... Not any more than ISO / HTML5 working groups are conspiracies between tech companies to push their interests (I mean there's always going to be a little bit of that). But these are traditionally actually very good things -- people coming together to determine how to trade things in the open.
The problem is Goldman Sachs picking up the phone and creating a custom contract with AIG to insure themselves against a mess of mortgage-backed securities that they got themselves into. The problem is that (a) they could trade these to begin (see THE INSIDE JOB, etc. -- for the rationale behind Glass-Steagall, and the problems with its repeal) and (b) that this didn't happen in a free, open, accountable market and of course (c) that they got bailed out because they were so integral to the financial markets to begin with (which wouldn't happen if part (a) were addressed).
But I mean obviously if you're going to start regulating things more closely, it's good to figure out exactly what to regulate. But I suppose I really should get back to programming...