Paul Jorion's Blog

My lecture at the Zermatt Summit, on the 16th of June 2011

Now online.

I defend my proposal of a prohibition of wagers on the evolution of prices (which was standard in the 19th century) within the framework of a Constitution for the Economy.

Paul Jorion

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11 responses to “My lecture at the Zermatt Summit, on the 16th of June 2011”

  1. With regards to FASB 133 can you please explain what you mean exactly with “it’s already there”?

    What is already there: the prohibition of wagers on the evolution of prices? I don’t think so.

    Here is the latest ammended text of FASB 133 “Accounting for Derivative Instruments and Hedging Activities”

    If you can please be so kind as to point out the relevant paragraphs or pages you are refering to it would help understanding your response to those who object that such a prohibition would be impossible to implement and control on a worldwide basis.

    Kind regards.

      • Granted, but how does such distinction in the US accounting standards get us to a worlddwide prohibition of naked positions on derivatives?

        btw, why not use the term “prohibition of naked positions on derivatives”‘ rather than “prohibition of wagers on the evolution of prices”? The former is very clear while the latter leads to a series of questions such as whether wagers on the evolution of prices which are inherent to the purchase of assets and wagers where one of the parties owns the asset are included or not in the prohibition.

        • I’m sure everybody in finance knows what a “naked” position on the markets is. The ordinary citizen is more familiar though with the way such things were expressed in the law in the 19th century : wagers on upside or downside moves of prices are prohibited. In the terms of art. 421 of the French penal code: “Les paris qui auraient été faits sur la hausse ou la baisse des effets publics sont punis des peines portées à l’article 419”.

          • The french penal code of 1810 you are refering to didn’t prohibit just any wager on the evolution of prices. Firstly, it limited the prohibition to public assets (eg government bonds), secondly, it felt necessary to specify unequivocally what type of wagers were prohibited, ie naked shorts (Art.422):
            « Sera réputé pari de ce genre, toute convention de vendre ou de livrer des effets publics qui ne seront pas prouvés par le vendeur avoir existé à sa disposition au temps de la convention, ou avoir dû s’y trouver au moment de la livraison »

            My point is that the term “prohibition of wagers on the evolution of prices” is far from being unequivocal, whereas “prohibition of naked derivatives” is.

            Your point is that the ordinary citizen will understand better what is meant with the former rather than the latter. I can relate to that but I also think the ordinary citizen in the english speaking world who is sufficiently interested with this subject matter as well as opinion leaders will grasp more easily “ban on naked derivatives”:

            – if you do a google search with the terms “wagers on the evolution/fluctuation of prices” you only get this blog as reference, with “naked derivatives” you get 1880 references, amongst which many popular blogs and websites.

            – “ban on naked derivatives” gets 370 references.

            At this stage we need to builld momentum around your idea of a worldwide ban on naked derivatives within the international community of bloggers and I don’t see how discussing the intricacies of the french penal code of 1810 is going to be of any help.

            At the end of the day the only thing that should matter are the merits of your proposal. Intuitively I think you are unto something huge, I am a strong supporter of yours willing to contribute time and money to make sure this gets the attention it deserves. So let’s get cracking.

            May I suggest the following, rather than discussing FASB 133 and the french penal code of 1810, can we start with building a counter argument to the American Council of Life Insurers’ statement on
            reform of the OTC Derivatives Market:

            Prohibition of “Naked” Derivatives Transactions Is Inappropriate

            There have been some proposals to ban or limit the entry into “naked” derivatives
            positions, most recently in the ACES bill, which would prohibit entry into a credit default
            swap transaction by a party that does not hold the underlying investment. U.S. life
            insurers generally enter into non-hedging CDS transactions only for “replication”
            purposes, an unleveraged and fully-funded conservative derivatives strategy permitted
            under insurance law for creating synthetic asset positions. While we are concerned that
            a prohibition of “naked” derivatives could affect this strategy, ACLI has broader concerns
            with this prohibition.
            These proposals reflect a potentially harmful misunderstanding of the dynamics of
            financial markets, particularly derivatives markets. A healthy, robust market is a twosided market, where both positive and negative views of a particular risk or investment
            may be taken. A buyer and a seller are required for every trade. The existing futures
            and options markets are a good example of markets in which “naked” derivatives
            positions are utilized to express investment views. In order for insurers and other
            hedgers to obtain the necessary protection or for OTC derivatives dealers to manage the
            6risk of protection they sell, additional market participants are needed to take the other
            side of the market.
            Prohibition of “naked” derivatives transactions could cripple the OTC derivatives
            marketplace by eliminating a necessary market segment. The counterparty risk of
            “naked” derivatives is properly controlled through appropriate margining and
            collateralization at the contractual or clearinghouse level and systemic risk regulation,
            not through wholesale prohibition of the activity. Credit default swaps are critical to life
            insurers in managing the credit risk of our investment portfolios. The Discussion Draft
            prudently avoids bans on naked derivatives transactions.

            What we need is a bullet proof presentation on why a worldwide ban on naked derivatives is the most important piece of reform that is required now.

  2. I love your reference to Moses on Mount Sinai – you make a really powerful analogy. For what indeed has made the greater contribution to a decent framework for human life in our communities and societies …???
    Is it waiting for people as individuals to come round “en masse” and more or less simultaneously to deciding to do the thing that is right, or is it outlawing and punishing that behaviour which is wrong and stigmatising it as criminal or evil ?

    Given the propensity of human beings to mimesis – the fear of losing out or of not getting as much as the next man/woman – behaviour that is harmful or destructive to the community must be clearly defined as such, and punished, or else we’ll never see the end of it.

    For if Jack does it, for kicks, and Peter sees Jack doing it and having a good time, then Peter too will jump on the bandwagon. And Tom, Dick and Harry.

    Financial investors, newspapers, even children are all crying out for “law” and clear rules : they are ready to stop behaving dangerously and badly, and by tomorrow, but only if everyone else is made to stop, too !

    We must use the “Law” to turn our instinct to imitate towards behaviour that is constructive and useful. If not, all our “gold” and wealth and T-bonds will turn to paper dust, and that’s all we’ll be left with to eat and drink.

  4. @Paul J

    I’ve added your proposal of prohibition of wagers on the evolution of prices to the Global Financial Crisis map on Debategraph:
    http://debategraph.org/Prohibit_wagers_on_upside_or_downside_moves_of_prices

    It could provide a synthesis of some recurring debates about it. If you don’t have time or are not interested by diagramming main arguments for your proposal on DebateGraph, I could try to map some (refering to the video for a start). Please advise.