Oeconomicae et pecuniariae quaestiones on Derivatives


[Oeconomicae et pecuniariae quaestiones on] Derivatives

Letter #26 – Thursday, May 17, 2018

“Profit should be pursued but not ‘at any cost,’ nor as a totalizing objective for economic action.” —Passage from a new Vatican document issued today on the immorality of certain economic practices. Notably, the document warns against the use of “derivatives,” terming them “speculative” bets which can damage the underlying “real” economy. The document was signed on January 6, 2018, but was made public just today in a Vatican press conference (no reason has been given for the long delay between completion of the text and publication). Entitled Oeconomicae et pecuniariae quaestiones [“Economic and Financial Questions”]: Considerations for Ethical Discernment about Some Aspects of the Current Financial-Economic System, the document is the joint work of two Vatican office, the Congregation for the Doctrine of the Faith, headed by Archbishop Luis Ladaria Ferrer, and the Dicastery for Promoting Integral Human Development, headed by Cardinal Peter Turkson. The two offices turned to experts in the financial markets to help with certain passages of the text. (Note: In the phrase cited above, there is a typo in the English text published by the Vatican, which reads: “Profit should to bepursued but not “at any cost”, nor as a totalizing objective for economic action.” The words “to be” evidently should be simply “be”)


It is clear that applying excessively high interest rates, really beyond the range of the borrowers of funds, represents a transaction not only ethically illegitimate, but also harmful to the health of the economic system.” —from Par. 16 of the text, a condemnation of “excessively high interest rates,” that is, a condemnation of usury; but what an “excessively high rate” is, precisely, is not defined


26. Some financial products, among which the so called ‘derivatives,’ are created for the purpose of guaranteeing an insurance on the inherent risks of certain operations often containing a gamble made on the basis of the presumed value attributed to those risks. At the foundation of such financial instruments lay contracts in which the parties are still able to reasonably evaluate the fundamental risk on which they want to insure.

However, in some types of derivatives (in the particular the so-called securitizations) it is noted that, starting with the original structures, and linked to identifiable financial investments, more and more complex structures were built (securitizations of securitizations) in which it is increasingly difficult, and after many of these transactions almost impossible, to stabilize in a reasonable and fair manner their fundamental value. This means that every passage in the trade of these shares, beyond the will of the parties, effects in fact a distortion of the actual value of the risk from that which the instrument must defend. All these have encouraged the rising of speculative bubbles, which have been the important contributive cause of the recent financial crisis.

“It is obvious that the uncertainty surrounding these products, such as the steady decline of the transparency of that which is assured, still not appearing in the original operation, makes them continuously less acceptable from the perspective of ethics respectful of the truth and the common good, because it transforms them into a ticking time bomb ready sooner or later to explode.” —An almost impenetrable passage (Paragraph 26 in the text) attempting to explain the problem of financial “derivatives.” The passage does not really explain the problem. Still, at the end of the passage, the Vatican denounces as a “ticking time bomb” the mountain of financial “derivatives” that have been created in recent years. Derivatives are financial instruments designed to hedge against certain risks, like the effect of rising or falling interest rates on bonds (which increases or decreases the value of the underlying bonds); apparently, these hedges can themselves be hedged(!). After several iterations of hedging, the value of the underlying security evidently can become “distorted.” Notionally, these hedges should “zero out,” but evidently that may not apply in extreme situations, when certain instruments could become dramatically more or less valuable. In the end, the Vatican text concludes that “it is obvious” that such financial products, because they are so complicated and opaque, are “continuously less acceptable from the perspective of ethics,” that is, that they are immoral


A similar ethical assessment can be also applied for those uses of credit default swap (CDS: they are particular insurance contracts for the risk of bankruptcy)…

“The market of CDS, in the wake of the economic crisis of 2007, was imposing enough to represent almost the equivalent of the GDP of the entire world. The spread of such a kind of contract without proper limits has encouraged the growth of a finance of chance, and of gambling on the failure of others, which is unacceptable from the ethical point of view.

“In fact, the process of acquiring these instruments, by those who do not have any risk of credit already in existence, creates a unique case in which persons start to nurture interests for the ruin of other economic entities, and can even resolve themselves to do so…

“Therefore, it must be noted, that when from such gambling can derive enormous damage for entire nations and millions of families, we are faced with extremely immoral actions, it seems necessary to extend deterrents, already present in some nations, for such types of operations, sanctioning the infractions with maximum severity.” —The Vatican here denounces “credit default swaps” as “extremely immoral,” in part because the holders of the instruments can “start to nurture interests for the ruin of other economic entities,” that is, since they can profit when a company goes bankrupt, they can even be tempted to assist the bankrupting of a company(!)




Into the morass


The Vatican has just released a bold but nevertheless problematic document that attempts to bring clarity, and moral judgment, to bear on the murky world of global finance.


The central argument of the document is that the economic system should “aim above all to promote the global quality of life that, before the indiscriminate expansion of profits, leads the way toward the integral well-being of the entire person and of every person.”


The new document fleshes out some of the critiques Pope Francis has made of the capitalist system during his five-year papacy.


“The Vatican is denouncing offshore tax havens and financial instruments such as derivatives and credit default swaps as gravely immoral and unjust, calling them ‘ticking time bombs’ that hurt the world’s poor the most,” Nicole Winfield of the Associated Press reported. (link)


And Francis X. Rocca repeated in the Wall Street Journal: “The Vatican denounced the use of offshore tax havens and financial instruments such as debt securitizations that are seen as factors behind past financial crises, calling for new regulation that would ‘neutralize predatory and speculative tendencies.’” (link)


But the document falls short of explaining how, and by what authority, these financial ills can be faced and ended.


The Associated Press rightly notes: “Notably missing from the document was a call for a global political authority to regulate markets and tax financial transactions. The Vatican’s social justice office, which co-authored the new document, had recommended such an authority in a 2011 document that was widely dismissed even within the Vatican.”


And Philip Pullella, the Reuters Vatican correspondent, wrote: “The Vatican called for more regulation of markets and financial systems on Thursday, saying economic crises showed they were not able to govern themselves and needed a strong injection of morality and ethics… The document attacked the ‘economic cannibalism’ of some financial practices.” (link)


So the central fact is this: this document proposes no mechanism to enforce changes or reforms on wild, out-of-control, “cannibalistic” global financial markets.


“The recent financial crisis might have provided the occasion to develop a new economy, more attentive to ethical principles, and a new regulation of financial activities that would neutralize predatory and speculative tendencies and acknowledge the value of the actual economy,” the document says. “On the contrary, the response seems at times like a return to the heights of myopic egoism.”


The document does call for “ethical committees”(!) to be established in banks.


Concern for the common good


Presenting the document to journalists, Archbishop Luis Ladaria Ferrer, head of the Congregation for the Doctrine of the Faith, acknowledged that Catholic moral theology had in the past been more focused on “questions of sexual ethics than business ethics” but that, he said, did not mean that economy and finance are “outside the scope of Catholic moral teaching.”


Rooted in the principles of the Church’s social teaching, the document says an exclusive focus on profit leads to ethical questions being perceived as “irrelevant.”


But the pursuit of financial gain must be tempered with a concern for the common good and the needs of the poor, it says.


Businesses, the text explains, cannot simply follow a logic of benefitting shareholders but must also serve the interests of those who work for them, their consumers and the local community.


“Markets, the powerful propeller of the economy, are not capable of governing themselves,” the document states. “It is time to initiate the recovery of what is authentically human, to expand the horizons of minds and hearts.”


“No profit is in fact legitimate when it falls short of the objective of the integral promotion of the human person, the universal destination of goods, and the preferential option for the poor,” it states.


Toward the end of the document, almost as an afterthought, the Holy See speculates that “a minimum tax on offshore transactions” could “solve a large part of the problem of hunger in the world.”


That would be one very practical step to take. It could, in imitation of the “Tobin Tax,” be called “the Francis tax.”


(The “Tobin tax,” suggested by Nobel Memorial Prize in Economic Sciences Laureate economist James Tobin, was originally defined as a tax on all spot conversions of one currency into another. Tobin’s original tax was intended to put a penalty on short-term financial round-trip currency transactions.)


So, this document is useful and commendable as far as it goes.


But there is still a need for another document, perhaps not from the Holy See itself — whose true mission, to preach the Gospel of Christ, centered on His life, passion and resurrection, cannot be the arcane intricacies of global financial markets — but perhaps from an international study group, which might offer specific solutions to the dangerous problems that do, unfortunately, exist in these markets.




A Foundation to certify investments


A few days ago in Rome it was announced that a new Foundation was being formed to be called  “Quadragesimo anno” after the encyclical publiched in 1931 by Pope Pius XI.


Quadragesimo Anno was written by Pope Pius XI 40 years after Pope Leo XIII’s 1891 encyclical Rerun Novarum on the Condition of Workers. Pius wrote the encyclical to address the ethical challenges facing workers, employers, the Church and the state as a result of end of the industrial revolution and the onset of the Great Depression.


The new Foundation intends to develop a system to certify investments and companies whose characteristics and proedures are in conformity with the Social Doctrine of the Church.

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