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Frank Partnoy on Off-Balance-Sheet Transactions

A video definitely worth watching. Frank Partnoy – who wrote the excellent book “Infectious Greed” which I will review on another day – talks about how off-balance sheet transactions in derivatives have managed to pull wool over our eyes, not because of their size, but because they are allowed to be hidden as “off balance sheet”. The biggest culprits now are countries – Greece hid debt in a swap, the US is hiding debt under multiple headings, and even India has hidden it as “market stabilization bonds” and such.

Frank Partnoy on Off-Balance Sheet Transactions (MMBM) from Roosevelt Institute on Vimeo.

Partnoy makes a compelling case for disclosure. Any attempts to bring about disclosure, however, will result in major public consternation about some of the financial biggies. Some will instantly appear bankrupt (which they are, they’ve just been able to hide it well). Others will suffer from extreme leverage and thus will need to curtail themselves. And the few institutions that have done the right thing will also suffer from the general damage that deleveraging causes. That will impact everyone, everywhere; perhaps that’s why we aren’t seeing such disclosure requirements being pushed. If everything stays ok, we can continue to party, until the next, bigger crisis. But what if it doesn’t?

Partnoy also makes the point that the world is close to what it was in 1929. The markets most of their losses in 1930 (tick). We are speaking of resuming the party and that the recession is finally behind us. (tick) The figures show that recovery is indeed visible. (tick) Yet, the US markets crashed more than 80% after the 1930 highs. But then, a similar situation happened in 1987 when markets crashed a lot, and within a year, recovered. It stayed so-so for four years and then continued one of the biggest bull runs in history, till 1999. The formula used in the 2000 crisis (and even 1987) was to keep credit cheap, interest rates low, fudge figures and do “off balance sheet” business to the hilt. Today is no different, and everyone’s doing it including governments. Same table, higher stakes. But will we do 1987, or will we do 1929? Or is the 21st century going to be something else entirely? I wish I could tell.