Wallace C. Tubeville, a former Goldman Sachs VP and former CEO of derivative broker VMAC, has done us all a service. In a post on New Deal 2.0, he lays out the over-the-counter derivative trader’s view of why financial reform is a bad thing.
A level playing field is anathema to the trader. Successful traders must have advantages over their counterparties. This is the job description. While a trader may emphasize his or her superior intellect and courage (and therefore individual responsibility for profits, especially useful in compensation discussions), these are far less important than institutional advantages. The best traders deploy those advantages effectively to secure higher trading profit.
He is describing here the negative effect that exchanges will have on trader profits if the financial reforms pass. Under the leading Senate proposals, all derivatives trades by financial companies will have to go through transparent exchanges, which will function like major stock exchanges. Participants will know how much the last guy paid for the same, or a similar, product, taking away the trader’s ability to make bigger margins based on their knowledge advantage of a secretive marketplace.
Tubeville goes on to discuss the trader’s aversion to new clearinghouses, which are also likely to be required under the current Senate proposal for financial firms. A clearinghouse would require parties to a derivative transaction to post margins in real time to ensure that they can pay off their bets. But this takes away a chunk of profits from traders who profit now by extending credit in lieu of margins:
It is widely known that deployment of credit capacity to trading with a company is far more profitable than conventional lending. . . . This mechanism for allocating finite credit capacity in the economy is questionable, to say the least. A trader at a bank derives an advantage from this preference. To access credit capacity allocated to trading, the company must transact exclusively with the trader. The additional profitability is baked into the trade, and thus into the performance of the trader and his or her compensation. Trader control of the extension of credit is not a recipe for long-term efficiency in capital utilization for either party to the transaction.
As I explained a couple of weeks ago in a piece for the print magazine, Jamie Dimon at J.P. Morgan estimates that the proposed changes could reduce between $700 million and $2 billion in annual revenue to his company alone. As Gary Gensler, the nation’s top futures regulator and another Goldman alum told me for that story, “Information is money for Wall Street.” In other words, financial reform is, as currently devised, aimed directly at the compensation of the traders. They have good reason to worry. To wit:
A trader views these advantages as central to his or her livelihood. Fairness, a level playing field and social utility are not important considerations to a trader. In fact, for a trader to perform the functions that are desirable, such as accurate pricing of commodities, this is appropriate. They “eat what they kill,” which makes them ruthlessly efficient.This is not necessarily a bad thing. Robespierre is reported to have said, “First, we behead the speculators.” Demonizing traders for doing what comes naturally similarly distracts from the real problem. Traders, perhaps more than almost anyone else, must be constrained by external rules. However, if financial institutions continue to be primarily trading entities, the incentive to secure short-term profits by dominating markets will ascend over the need to preserve long term bank lending and investment banking relationships. Behavior that damages society as a whole must be controlled by regulation, since the leadership of the financial institutions will not curb it.
Read Tubeville’s entire piece here. (H/T Rortybomb.)
