The reason that futures markets have better volume (the contracts that survive over time anyway), trading liquidity, etc is due to the standardization of the contracts AND the fact that you have substantial credit benefits through the exchange ownership (or public companies today).

If someone brings me an oil futures contract for sale “at a discount” I could easily look up the price on the exchange and consider buying it or not buying it, but if someone brings me a structured note with odd terms I’ve never seen before and credit risk derived from some 3rd party I’ve never heard of, there’s no way to easily evaluate the offer, so there’s almost ZERO possibility I’d even look at the so called “asset”.

While I very much agree with the thrust of your post, only want to note that the Commodity Futures Modernization Act of 2000 was also a modifiction of the Commodity Exchange Act. Contracts executed on electronic trading facilities, and bilateral swaps, were effectively made exempt from most CFTC regulation. (”Enron loophole”)

So far as Amaranth, the size of its calendar spread bets were, well, extreme and, after NYMEX began trying to impose limits, the fund was able to offset through the ICE. (”London loophole”?)

My point? Commodities’ trade has been increasingly deregulated and de facto unsupervised rather than the contrary and that, in conjunction with reallocation strategies etc, this may well have contributed to the commodity price run up (which, IMO, was more interesting than the recent decline).

Also futures and the rest has a “volume” published for each contract, stock, etc.

A market maker is NOT an exchange, some amorphous obligation is not volume. If they could be traded, why weren’t they? The prices had to change over time, so there should have been a daily bid-ask.

Or perhaps we have different definitions of liquidity, and yours doesn’t require any trading volume.

Perhaps an exchange can handle large price drops maintaining liquidity (and having both longs and shorts). But a desk somewhere can’t deal with a million sell orders with no buy orders.

As we are now seeing opaqueness works ok untill ripples in credit markets appear and then few are interested in an opaque product that they cannot readily understand. Fear overcomes greed.

For derivitives to remain attractive in normal and roiled credit markets they need to be readily understood by all players…Like oil is oil (with differing grades), wheat is wheat (with differing grades), etc. Somehow, transparency will have to be introduced into derivatives products if they are to remain attractive in good times and bad.

River

STS-
Absolutely. Unfortunately, good regulation that works smoothly becomes so embedded in the woodwork that its presence is hardly noticed, while bad regulation causes problems and is always noticed. Thus, people get into arguments about regulation vs. no regulation because the only regulation that’s extensively noticed is bad regulation. Call it the squeaky wheel phenomenon…

Tom-
Thanks. Will try to stay away from claims of obviousness in the future

David-
I’m not a derivatives trader, so I’ll defer to your expertise. But I’d wager that a lot of the purposes served by customized derivatives can be adequately fulfilled by standardized instruments as well. For example, standardized stock options can be combined to execute some pretty specific strategies like collar spreads, butterflies, condors, etc. Similarly, while one standardized instrument may not fit your need exactly, a combination of several probably would.

At any rate, the loss of some flexibility and customizability is a small price to pay for the advantages of a more robust market (does any option trader really lament not being able to buy 3 year leaps that expire on April 23rd or something?)

Here’s the test. Try moving interest rate swaps to an exchange. They are pretty vanilla. If you can do that, then try swaptions, currency swaps, etc.

Try credit and mortgage derivatives later… I don’t think they will work in an exchange format because of the need for uniqueness in exposures.

Not a great fan of regulation but what you propose makes some sense.

The debate shouldn’t be “regulation vs. no regulation”, it should be “good regulations vs. bad regulations”. Not all regulations are alike.