Michael Greenberger’s paper on the ongoing opacity of Wall Street’s derivatives casino serves as a reminder why restoring transparency is so important.  Without transparency, bankers are free to gamble where they keep the gains and give the rest of us the losses.

He stumbles across the fact the Dodd-Frank Act is mostly smoke and mirrors that doesn’t make the financial system safer.  Mr. Greenberger concluded the Too Big to Fail banks

Specifically, he finds these banks are able to hide their derivative exposures from regulators.  For US banks, this involves booking their derivatives in off-shore entities who aren’t required to disclose any information to the regulators on the entity’s exposures.

Please recall derivatives are one of the primary sources of interconnectedness between the Too Big to Fail banks.  These opaque derivative positions were at the heart of the acute phase of the financial crisis and the regulators’ fears of contagion should one of these banks fail.

Since these banks were easily able to avoid all the complex regulations enacted in the decade since the acute phase of the financial crisis, it is clear complex regulations are not making the financial system safer.

The easiest and most straight forward way to deal with derivatives is transparency.  Banks should have to disclose their current derivative exposure details (regardless of where in the world their subsidiary is located).

With this level of disclosure, not only are regulators able to see what is going on, but so too can the market.  And it is the market that is capable of assessing how much risk the Too Big to Fail banks are taking with their derivative exposures.  It is the market that is capable of asserting discipline to reduce risk taking by even these behemoth banks.

Please keep in mind this comment:

“‘We didn’t truly know the dangers of the market, because it was a dark market,’ says Brooksley Born, the head of an obscure federal regulatory agency — the Commodity Futures Trading Commission [CFTC] — who not only warned of the potential for economic meltdown in the late 1990s, but also tried to convince the country’s key economic powerbrokers to take actions that could have helped avert the crisis.

‘They were totally opposed to it,’ Born says. ‘That puzzled me. What was it that was in this market that had to be hidden?’…

‘It’ll happen again if we don’t take the appropriate steps,’ Born warns. ‘There will be significant financial downturns and disasters attributed to this regulatory gap over and over until we learn from experience.'”

PBS Frontline, The Warning