A Timely Lesson From the Commodities Pits

It's a recurring theme: Wall Street creates an excess and experiences a crisis, and Washington rushes in late to regulate an area of finance that's already too far gone to benefit from any regulation.

But in the midst of the ongoing credit crunch, we need to take a hard look at the expertise and value the commodity exchanges can deliver to help us get through this crisis quickly and cleanly. Here's an effort Washington can get behind that will help us now.

A major source of all the woe we're experiencing in the equity and credit markets is the prevalence of unregulated and frankly unfathomable derivative instruments. Whether they are CDOs or CDSes or other varieties of securitized debt obligations, it's been impossible to get a handle on how deep the problems really are, in no small measure because it's been impossible to understand what many of these instruments are really worth.

These instruments have proven themselves to be the "financial weapons of mass destruction" that Warren Buffett warned us about. Created in the minds of the investment banks' top rocket scientists from the MBA programs of Harvard and Yale, these derivative products were packaged inside the financial engineering backrooms of many now-defunct mortgage and insurance firms, sent back to the investment banks to be repriced and sold by the best (and best-paid) traders and brokers in the business. At every tier of this process, fees and excess spreads were siphoned off from the securities to handsomely pay all of the geniuses involved.

But at the heart of the problem with this process is the lack of transparency. Modelers, brokers and traders of newfangled derivative instruments created in the closed financial world of investment banks can run all the simulations they like, but in the end they cannot ever be sure of the prices they apply to them, because they are being done in a vacuum, by them and by their minions in the closed financial world. Avalanches of paper, traded back and forth solely by the closed-knit group of engineers and brokers who have created them, gave a biased, uninformed and ultimately wrong value to most of these instruments, and we are all paying for that now.

---

At the time of publication, Dicker had no positions in stocks mentioned, but positions can change at any time.

Dan Dicker has been a floor trader at the New York Mercantile Exchange with more than 20 years' experience. He is a licensed commodities trade adviser. Dan's recognized energy market expertise includes active trading in crude oil, natural gas, unleaded gasoline and heating oil futures contracts; fundamental analysis including supply and demand statistics (DOE, EIA), CFTC trade reportage, volume and open interest; technical analysis including trend analysis, stochastics, Bollinger Bands, Elliot Wave theory, bar and tick charting and Japanese candlesticks; and trading expertise in outright, intermarket and intramarket spreads and cracks. Dan also designed and supervised the introduction of the new Nymex PJM electricity futures contract, launched in April 2003, which cleared more than 600,000 contracts last year alone. Its launch has been the basis of Nymex's resurgence in the clearing of power market contracts over the last three years. Dan Dicker has appeared as an energy analyst since 2002 with all the major financial news networks. He has lent his expertise in hundreds of live radio and television broadcasts as an analyst of the oil markets on CNBC, Bloomberg US and UK and CNNfn. Dan is the author of many energy articles published in Nymex and other trade journals. Dan obtained a bachelor of arts degrees from the State University of New York at Stony Brook in 1982.