The Editor, the Guardian
Your leader, (Bonfire of the certainties Oct 14th) is dazzlingly clear and accurate in its diagnosis and prescriptions. You are right to say that new financial products must be approved by the regulators, in the same way as new pharmaceutical products must be approved. To take the analogy a step further, if the health service becomes aware that a new drug has toxic side effects, it is taken off the market. Derivatives, particularly Credit Default Swaps, have toxic side effects to the financial blood stream, not least in destroying trust. And they are infectious. If a corporation succumbs, out of its corpse crawls a Hydra of claims against the gamblers who made the wrong call on that corporation’s health. Ironically, given that some claim to act as insurance policies, they have the property of multiplying debt and magnifying risk. The magnification is so big that the total “value” of the derivatives sector is more than $596 trillion, which is about ten times the amount of foreign debt owed by every country in the world. This is an absurd amount, psychotic in the sense that it is a notion completely divorced from reality. It is unconscionable that the “products” of a tiny handful of financial gamblers and gamesters should endanger the livelihood of everyone in the world. The financial instruments that they have produced and profited from now threaten the banking system with a tsunami of odious debt. They must therefore be withdrawn from the financial market if that market is to survive. This is not going to be quite so easy as taking a drug off the market, but it can be done.
First, their legality should be carefully reviewed, both in general and also in particular instances. In general, the people creating these instruments have been behaving as companies, but have been operating outside of company law. Second, an institution, (Willem Buiter suggested it should be called a Toxic Asset Dump, TAD), should be set up, to act as a receiving and clearing house offering an amnesty for banks and institutions who have doubts about whether they still wish to hold them on their books. In this institution the value – or otherwise – of the “assets” can be analysed, and their legality – or otherwise – can be assessed. From what we learn in the TAD, ways and means can be devised to subject toxic derivatives to a controlled deflation.
Brown and Darling deserve credit in that their actions have stabilised the banks for a time. They must now use this time to take action to defuse the derivatives time bomb. We must burn the derivatives before they burn us.