Twofish- The trouble is figuring out how to represent those obligations in the balance sheet. For example, I agree to pay you $1 million if Martians land. How should I mark this on my balance sheet?

Well, if you’re a gaming concern, you would mark it as a contingent liability (recognising if and when it becomes more certain, eg when you hear reports Martians are broadcsating their arrival or you see Independence day scenes around you )and whatever betting fees/premiums you receive (what the counterparty pays you, since no one makes a one way transaction) would be revenue. If you’re not in the business , pretty sure you’ll be questioned by your boss or the relevant authorities soon.

Sorry people, not much humour since it’s pretty weird to be pondering such things on a sunday morning, any ludicrous parts must be attributed to the fact that I’m barely awake at 8/9 am

Banking is one of the most heavily regulated industries in the world, and this is a good thing since without effective governmental regulation, banks very, very quickly destroy themselves.

Regulation is hard because there are all sorts of tricky balances. For example, if you have someone with no banking experience then they just aren’t going be effective, because they will have no idea what questions to ask, what tricks people play, and where to look to find the bodies. On the other hand, if you have someone who is very experienced in banking, they will tend to see the world in the same way that the people they regulate do, and that might not be a good thing.

There’s also the problem that government regulators often don’t get paid enough. If private industry will pay $600,000/year for a securities lawyer while the government will pay $180,000/year, who are people going to go to? If you want effective regulation, it’s going to cost you.

The trouble is figuring out how to represent those obligations in the balance sheet. For example, I agree to pay you $1 million if Martians land. How should I mark this on my balance sheet?

RebelEconomist: The trouble is, however, that such regulators are regarded as dogmatic and obstructive, and tend to get squeezed out.

Regulators aren’t regarded as dogmatic and obstructive in the banking industry and aren’t squeezed out.

Derivatives really don’t have that much to do with the Anglo-Saxon model of corporate ownership. They’ve been around since the early-1980’s and personally I think that overall they’ve added a lot of stability to the financial system.

K: Countries like India which did not fall for the model or the derivatives have better financial stability.

Hard to say. Mexico hasn’t had particularly good stability.

K: There was indifference bordering on neglect on the part of regulators.

I don’t think this was true. The problem really is not so much in the derivatives market but rather on the collapse of the real estate markets that these derivatives were written on. Personally, I think that without derivatives, the situation would have been a lot worse than it has been.

In my view, the fundamental problem with off-balance sheet business was that it was not clear how detached it actually was. The investors in these vehicles considered that there was a high probability of the parent bank backing them, and the capital regulation assumed the opposite. What should have happened is that the responsible regulator should have declared one way or the other. The trouble is, however, that such regulators are regarded as dogmatic and obstructive, and tend to get squeezed out. I wonder if the greatest need for transparency lies in public service, because then the record would show who decided what, and on what basis, and make it harder to fudge such issues.

anonymous — i presume you were being ironic, or at least hope so. but i didn’t take any chances … so i deleted your comment.

Alan Greenspan admired them as “innovation” on par with the innovations in the IT sector. There was indifference bordering on neglect on the part of regulators. Now, the birds have come home to roost. More and more snakes are coming out of the pits (read monoline linked securities running to trillions of dollars). What has been Fed’s or Treasury’s response? Pump more liquidity, reduce interest to the bottom and feed the beast. When Asian countries faced a crisis, they were sheared to the bone and were asked to settle the loans. Their budgets were cut and welfare program stopped.

As a diversionary tactics, they are engaged in a war on SWFs. It will keep Senators happy. Unbeknown to Fed /Treasury, their distressed bankers are aligning with SWFs!

In the case of the banks, the Fed are the people that push for disclosure. None of the banks have too much choice as to when to disclose and how.

One problem is one of valuation. I will pay you between $1 and $100 based on what percent of fortune 500 companies default in the next ten years. What is the value of that contract?

The other problem is the sheer number of assets. Think of every account that a bank has. It’s not a matter of going in and saying, show me your worthless assets, you have to go through each account and try to figure out what every asset is worth.

The G-7 has lost influence.

And there should be a set of reforms that requires much more disclosure (and in ways that are useful) of off balance sheet exposure. it turns out all the problems were off balance sheet, and the banks had huge contingent liabilities and insufficient capital to support their off balance sheet activities, activities that didn’t stay off balance sheet in times of stress.

re: China’s 15% appreciation — too much of that came recently, and over the same time period china depreciated v europe. india’s move was comparable (tho with higher historic rates of inflation, the real move is larger), but the timing was different. most of it came in the spring of last year. since then india has been targetting a rupee level even more than china targets the rmb level, in part (I suspect) b/c of concern about rupee appreciation v the rmb.

It not only hedge funds that suffer from secrecy and opacity. Major banks like UBS, Credit Suisse, Citi, et al are disclosing burnt assets according to their own choice and schedule. Why doesn’t the Fed or IMF ask for total disclosure of all their assets and how much of it is detritus thrown up by the financial turmoil? For more than a decade, the IMF tried to prise open banks in all developing countries and laid down countless disclosure standards. Don’t these apply to big brothers in advanced countries? It is difficult to get lost if we pursue all these threads and how they were handled in the past.

Yes, I share the view that the US, China or India can limit investment avenues in their territories. It may also seem that presently US offers greater opportunities than other countries. This is a static (post Second World War) view and overlooks the newer opportunites which can arise in Africa and Asia. Ten years ago, who could have imagined the rise of Indian and Chinese giants in the global market? The pity is that the later day American version of capitalism is financial and has distorted the ‘real’ economy in the process. The current crisis may again decouple the two and, hopefully, one may see more growth in hardcore areas and not speculative bubbles.

On the US losing its leverage, one has to go deeper. The G7 was formed to contain the growing power of the US in the post war years. France led the battle. G7 began to have common purpose for some years. Now, G7 itself is riven with differences. In the current global context, G7 has become irrelevant. A time was when a whisper from G7 would tame other countries. They used to hold closed door meetings in European Palaces and chaperons will announce the decisions in single lines. No longer. It is the same kind of loss of US power or leverage that we witness. It is a welcome development for the world.

One last point Brad. I value your comment that the negotiations over “imbalances’ failed because, even as US corrected dits deficit (?), China or EM did not appreciate their currency. There can be, and indeed have been, serious divergence over which comes first. It ended in a stalemate. China has since appreciated Yuan by 15 percent and many emerging economies, including India, have done so in tandem. As the old cliche goes, it take two to tango. A tango fails if one partner turns aggresive - it will be a circus.