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
