Preface xiii
Acknowledgments xix
Introduction 1
PART ONE The Crises That Led to Derivatives Reform 15
CHAPTER 1 Seven Causes of the 2008 Market Crises 17
Ignoring the Warning Signs 18
More than Seven Causes of the 2008 Market Crises 20
An Incomplete Response to Problems Exposed in the Enron Bankruptcy 26
Enron Finance Used by Banks and the Lack of Regulation 29
The Absence of Effective Regulation 30
The Shadow Banking System 34
Development of an Unregulated Global Derivatives Market 39
The Rise of Credit Derivatives and the Credit Default Swap 44
Private-Label Residential Mortgage-Backed Securitization 45
U.S. Policy Fostering Home Ownership and GSE Mismanagement 47
Derivatives and Structured Products Accounting Practices 49
Notes 52
CHAPTER 2 The Crises and Reform Timeline 55
March 17, 2008: Bear Stearns Is Sold 57
March 27, 2008: Barack Obama Introduces Reform Principles 58
September 15, 2008: A Bankrupt Lehman Brothers 59
November 2008 to January 2009: American Leadership Ascends 60
March 26, 2009: Geithner Provides Testimony to Congress on Reform 60
May 13, 2009: Geithner Writes a Letter to Harry Reid 61
June 2, 2009: An Early Voice Speaks Out against the Clearing Mandate 61
June 22, 2009: American Corporations Lobby against Central Clearing Mandates for OTC Derivatives 62
July 22, 2009: Introduction of Legislation Favoring Exemptions to the Clearing Mandate 62
July 30, 2009: Introduction of Broad Outlines of the New Law 63
September 8, 2009: The Industry Demonstrates Commitment to Centralized Clearing 63
October 2, 2009: House Releases Draft of OTC Derivative Legislation 63
November 11, 2009: Senate Releases Draft of OTC Derivative Legislation 64
December 11, 2009: House Passes the Wall Street Reform and Consumer Protection Act of 2009 64
January 1, 2010: The New York Fed Publishes The Policy Perspectives on OTC Derivatives Market Structure 65
April 7, 2010: Financial Crisis Inquiry Commission Begins Hearings 65
April 16, 2010: Senator Lincoln Introduces the Wall Street Transparency and Accountability Act of 2010 66
April 22, 2010: President Obama Returns to Cooper Union to Speak on Reform 66
April 26 to 27, 2010: Senate Votes to Delay Debate on Derivatives Reform 67
April 27, 2010: The Goldman Hearing 67
April 28, 2010: Senate Votes Again to Proceed with Financial Services Reform 70
May 20, 2010: Senate Passes Its Version of the Legislation 70
June 30, 2010 and July 15, 2010: Congress Approves Legislation and Seeks the President’s Approval 71
July 21, 2010: President Obama Signs Dodd-Frank into Law 71
U.S. Rule Making in 2010 and 2011 73
U.S. Reform Blazes the Trail for Global Derivatives Reform 79
Notes 80
PART TWO Derivatives Reform 83
Introduction to Part Two 83
CHAPTER 3 Introduction to Futures, Margin, and Central Clearing 85
Three Crises and the Need for the Futures Model 87
A Brief History of Futures Contracts and Markets 92
The Commodity Futures Modernization Act of 2000 98
Introduction to the Futures Model and Basic Futures Concepts 100
Regulation of Futures 112
A Futures Contract in Action 114
Default by a Clearing Member in the Futures Model 117
Global Reform and the Futures Model 120
Notes 126
CHAPTER 4 U.S. Derivatives Law in Title VII of Dodd-Frank 131
Organization of Dodd-Frank 131
Introduction to Titles VII and VIII 134
The Approach to Understanding New Derivatives Law in the United States 136
Products 137
People 147
Taxpayers 153
Whistleblowers 169
Platforms 170
Notes 175
CHAPTER 5 Title VIII of Dodd-Frank 177
Opposition to Title VIII 178
Before Title VIII 180
What Exactly Does Title VIII Set into Motion and When? 182
What Is a Systemically Important Activity? 183
Practical Results of the New Law 184
Notes 186
CHAPTER 6 A Primer on Legal Documentation 187
Background 190
“Let’s Use an ISDA” 191
History of the ISDA 194
Basic OTC Architecture 195
The ISDA Documentation in Practice, and Problems in 2008 202
Glossary 208
Notes 210
CHAPTER 7 The Life Cycle of a Cleared Derivatives Trade 211
Step One: Legal Documentation 211
Step Two: Trade Execution via an SEF, SB-SEF, or DCM 215
Step Three: Alleging and Affirming a Trade; Reporting in Real Time 221
Step Four: The FCM Take-Up 222
Step Five: Trade Is Centrally Cleared 223
Step Six: The Trade Is Reported for the Second Time 225
Notes 226
PART THREE Trading Before and After Reform 227
CHAPTER 8 The History of Derivatives and Futures 229
The Earliest Derivative 230
Trees, Forests, and Wildfires 231
Did They Exist in Antiquity? 233
OTC and Exchange Derivatives 233
Back to Biblical Times 234
The Dark Ages and Medieval Europe 239
The Muslim Empire 240
Development and Early Use of the Bill of Trade or Exchange 241
After the Protestant Reformation 244
An Early Sighting of the Term Commodity Pools 249
Ten Wise Men 250
The Modern Era Begins in the States in 1848 258
Early-Twentieth-Century America 259
1907 Bankers Panic 260
S&Ls and Mortgage Finance Functions Well Before Abuses 268
The Creation of Fannie and Freddie 268
Disco, Dealers, Swaps, and Redlining in the 1970s 269
U.S. Regulators Formally Recognize Swaps 273
The Birth of the OTC Market 274
The Evolution of Options Markets 275
The Futures Trading and Practices Act and the 1993 Swaps Exemption 276
ISDA 277
The 1987 Crash and 1990s Crises 279
The Commodity Futures Modernization Act of 2000 286
Enron Loophole 287
The First Decade of the Twenty-First Century 288
Notes 289
CHAPTER 9 Market Structure Before and After 2010 299
Ancient Commodity Markets 299
Earliest Modern Exchanges 300
The Great Depression and Bucket Shops 301
Open Outcry and Pits Give Way to the Machines 302
Reform of U.S. Market Structure 305
Derivative Clearing Organizations (DCOs) 307
Swap Data Repository 308
Market Participants in the OTC Derivatives Trade 309
Notes 311
PART FOUR Continuing Education 315
CHAPTER 10 Survey of Derivatives 317
Overview of the Strategies and Trade Structure 319
Early Derivatives and the Beginnings of the OTC Market 320
Forwards versus Options 320
Option Basics 322
Options Pricing 324
Basic Option Strategies 326
Exchange-Traded Options 328
Swaps Follow Options in the Evolution of Derivatives 329
Credit Derivatives 330
Credit-Linked Notes and Other Securities 336
Total Return Swaps 336
Interest Rate Swaps 338
Equity Swaps 340
Currency Derivatives 341
Property Derivatives 342
Commodity Derivatives 344
Energy Swaps 345
Structured Products, Securitization, CDOs, and CDOs Squared 346
Exchange-Traded Derivatives: Futures and Other Listed Products 348
Additional Resources 349
Online Resources 349
Glossaries 350
Notes 350
About the Author 351
Index 353
