The American Interest, July-Aug 2010 (online May 18, 2010) –
As I write this, the U.S. Senate is debating a major financial reform bill in which the credit default swap, a kind of derivative, plays a significant part. An amendment to that bill, proposed by Senators Carl Levin (D-MI) and Jeff Merkley (D-OR), would ban banks from proprietary trading. There are a lot of high-rolling bankers who do not want that amendment to pass, because it will mess up their plans to repatriate foreign profits into the United States, untaxed, by trading in derivatives on their own accounts. The clearinghouse ICE Trust U.S. forms a central part of these plans.
What is ICE Trust U.S., and who owns it? ICE US Holding Co., which was established in 2008 as the parent of ICE Trust U.S., is located in the Cayman Islands. Yet none of the owners of ICE US Holding Co. are based in the Caymans. Among the owners of the Cayman’s company are Citigroup, Goldman Sachs, J.P. Morgan, Merrill Lynch and Morgan Stanley, which are headquartered in New York. Bank of America, which now owns Merrill Lynch, is based in Charlotte, North Carolina.
One year ago, a group of financial institutions quietly launched ICE Trust, a new and theoretically safer way to trade derivatives, a key element of the financial crisis. As lawmakers debate reform, banks at the center of the storm are remaking the market—and stand to profit.
As the financial crisis exploded with full force in 2008, it was obvious that something was gravely wrong with the huge, unregulated market for derivatives.
Lehman Brothers had $738 billion of these contracts—which are based on the value of some other asset, such as a stock or a bond or a hog belly—on its books when it failed on September 14, 2008.
Lehman certainly wasn’t alone. Over the next few months, insurer AIG reported as much as $53.5 billion of derivatives losses—losses that were linked to nearly one third of its $182.5 billion federal
Congress has deftly avoided the real story of AIG’s collapse, which will make a few million in bonuses seem like peanuts.
Most legislators at a House Finance subcommittee hearing last week deftly avoided the real story of AIG’s collapse. Instead, they homed in on the public relations disaster of hundreds of top AIG officials and staff getting $165 million (later revealed as over $218 million) in bonuses.
The key issue ignored by the congressmen and women was the potential catastrophe represented by as much as $2.7 trillion in AIG derivative contracts and how AIG and the U.S. government are dealing with them. To put that number in context, we’ve so far provided the company only about $170 billion.