Gensler, Derivatives, and the Causes of the Crisis

A Times story brings up several critical points for coverage of Wall Street and reform

The New York Times profiles Gary Gensler, the Goldman alum and former deregulation advocate who’s now pursuing reform with the proverbial zeal of a convert.

It’s a good idea and mostly well-executed, but I want to look at a few subplots. Here’s one quote up high regarding Gensler’s push to regulate derivatives:

Conrad P. Voldstad, the association’s chief executive, said that derivatives were not the cause of the crisis. The problem was elsewhere, like subprime mortgages, he says, and those areas should be the focus of any new regulation.

This is one of the most-irritating PR lines of the crisis, and it’s one you see repeatedly with little pushback from the press.

First of all, saying that “derivatives were not the cause of the crisis” is like saying the arsonist’s gasoline didn’t burn your house down. Sure, fire is what literally turned it to cinders, but the gasoline was an accelerant that enabled it and intensified it.

Without credit-default swaps, you would have had much less securitization and, thus, much less leverage and much less bad lending. The takeaway from Gillian Tett’s book on CDS (and I’d say Tett is perhaps the top journalist on this issue) is that, contra Felix Salmon, they were pivotal in the crisis. Here’s one passage that rings particularly true:

Tett describes the thinking of Blythe Masters, one of the key creators of CDS, on separating risk from lending: “Doing so would overturn one of the fundamental rules of banking: that default risk is an inevitable liability of the business…. For the first time in history, banks would be able to make loans without carrying all, or perhaps even any, of the risk involved themselves.”

That was surely a key cause of the crisis, but it shows how incomplete our understanding of what actually happened still is. How much of the over-lending in the crisis was caused or enabled by CDS?

It’s a simple question that’s hard to answer. But it’s safe to say it was significant. Banks sold $503 billion worth of synthetic collateralized debt obligations (which are comprised of CDS) in 2006 alone. That’s not to mention the CDS that weren’t securitized.

Second, regarding Volstad’s spin, the idea that “X didn’t cause the crisis so we shouldn’t regulate it” has become PR boilerplate lately and it’s a red herring. We saw it yesterday with the payday-lending lobby’s statement in The New York Times:

Steven Schlein, a spokesman for the Community Financial Services Association, said the industry should not be dragged into the regulatory reform.

“The banks caused the financial meltdown, and they’re spending millions and millions to spare themselves from tighter regulation while throwing the consumer lending industry under the bus,” he said. “They’re trying to divert attention to us.”

We’ve also heard it ad nauseum in regards to Glass-Steagall and the Volcker Rule.

But the point of comprehensive reform is not just to patch up what broke last time; it’s to fix and prevent what might happen next time or what’s been festering for years (see payday lending).

The press needs to do a better job of pushing back on that.

Third, revisit that Voldstad paragraph quoted above and look at what the Times follows it with:

Public statements from the organization’s member banks, however, have been less critical of Mr. Gensler’s proposals.

We’ve seen this time and again, as well. The banks are mildly supportive or at least non-committal toward reforms in public but have their lobbyists doing their best to kill it in the back rooms. The Times is good to point out the discrepancy here, but I don’t think it goes far enough. It hopes you can read between the lines here, but most people can’t. Spell it out for people.

But perhaps most important here is this tremendous quote the Times pulls from Gensler:

“Wall Street’s interest is not always the same as the public’s interest,” he says now. “Wall Street thrives and makes money in inefficient markets, and I am creating efficiencies in the market.”

Print it out. Frame it. Tack it to your cubicle wall. Whatever. If you’re covering Wall Street-related issues, this insight is the core of your beat.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.