Today’s Senate assault on Wall Street was a sure sign of the disconnect between American politics and modern capitalism.
It became clear as the hearing unfolded that the panel convened by Senator Levin of Michigan does not even understand what a market maker does. Senator Collins of Maine hinted that market makers should owe investors a fiduciary duty similar to that imposed on investment advisors. Of course, if that were the case the markets would collapse. By definition market makers stand in between buyers and sellers and cannot be a fiduciary for one party in a transaction without acting adversely to the investor on the other side of the trade. The Dow is down today and I would not be surprised if Snowe was in part responsible.
The confusion of the Senate panel deepened when they tried to understand synthetic CDO’s. Granted these are complex transactions. But they are really not substantially more complex than shares in Google or IBM. If investors think shares in publicly traded companies are less complex it is only because they do not understand what is at stake when one buys stock in technology companies!
Again and again the Senators seemed (almost) willfully to ignore the fact that someone must go long on a synthetic CDO and someone must go short. In the deal at stake in the SEC complaint against Goldman, one can be sure that the two big banks – IKB and ABN Amro – that went long on those deals were HAPPY that Paulson was willing to be on the other side of the deal as a short. Otherwise they would not have been able to buy into the deal, one of many similar deals they invested in.
The Senate also seems to think that synthetics are of no value whatsoever to modern capitalism and Senator McCaskill of Missouri kept claiming these were like betting operations run by the mob. But in fact synthetics like many other derivative instruments are a vital hedging instrument allowing a price to emerge for assets found within the economy where markets have not previously been available. Senator Tester called himself a farmer – one wonders if he thinks the presence of a futures market is valuable to capitalist agriculture. That, too, is a derivatives market – in fact, it’s the original derivatives market. One can criticize the nature of a capitalist market – which I do all the time – but to try to deny that such a market exists and is effective at what it does isn’t “common sense” as the Senators said, but nonsense.