The rise of the Electronic Communication Network (ECN) and Alternative Trading System (ATS) radically changed equities markets and exchanges in the 1990s, although many people interchanged the abbreviations to the point where often times what was technically an ATS got labeled as an ECN, and sometimes vice versa.

Financial reform has now given birth to a new three-letter entity, the SEF, which stands for Swap Execution Facilities and which could radically alter the derivatives market not to mention challenge exchanges. And just like an ATS probably didn’t necessarily appreciate being categorized as an ECN, those who see themselves as SEFs already are feeling misunderstood.

During the debate leading up to financial reform many a wise pundit pointed to the provision in the legislation that would bring dangerous derivatives out of the shadows and on to exchanges where the lights of transparency shine brightest, supposedly.

But it’s important to note that reform requires most swaps to trade either on an exchange or on an SEF. Not only should SEFs not be overlooked, they should be viewed as a key part of the equation as the swaps markets digest this brave new world.

GFI Group’s Chris Giancarlo, the interdealer broker’s executive V.P. in charge of corporate development, is also chairman of the 14-month-old Wholesale Market Brokers Association Americas (WMBAA), a trade organization that during the reform debate represented the interests of GFI, as well its rivals—ICAP, Tullet Prebon, Tradition and BGC Partners—all better known as IDBs but who stand poised to rise to the fore as SEFs.

Firstly, since SEF spells something closely resembling a word let’s go ahead and agree that we will not call these “ess ee effs,” and instead get our heads around the idea of referring to these entities, collectively, as “Sefs” (rhymes with refs).

Secondly, let’s establish a handy way of explaining what SEFs are. “Think of it as eBay for financial instruments that don’t trade on exchanges,” Giancarlo explained. “We already provide this service to the wholesale market.”

GFI is not officially registered as an SEF yet, and defining what constitutes an SEF, who gets to be a SEF, is something the Commodity Futures Trading Commission is going to have to figure out, but for all intents and purposes GFI and the other IDBs (or wholesale brokers) are already, what going forward will be, SEFs.

IDBs/wholesale brokers are best positioned to be SEFs because of their eBay platforms already in place.

(Quick sidebar from Giancarlo re the term IDB versus wholesale broker: “We have been called wholesale brokers for at least several decades since at least when we formed the Wholesale Market Brokers Association in London at the request of the Bank of England. IDB refers to that subset of the business of a wholesale broker that intermediates only among dealers, hence “interdealer” broker. Wholesale brokerage is where we serve not only dealers but also other large non-dealer counterparties, as we do in many markets, such as energy and equity derivatives.”)

Back to SEFs: Explain again why we need yet another three-letter financial services entity?

“The reform legislation was written to reflect the derivatives market as it existed,” Giancarlo said. “SEF is a new term, but not a new concept.”

What is a new concept is that swaps trades will have to, by law, be intermediated. Mandated intermediation means that OTC traders at a big bank can no longer call a client directly and sell them some merchandise; an exchange or SEF must be used. So while IDBs already serve as the eBay for OTC products, banks still have had the option of not selling something over eBay, so to speak, rather just directly to someone they know would be interested, just a two party, direct transaction.

“Think of it like this,” Giancarlo said. “You have a used car in your driveway. You could try to sell it on eBay and see who hits the offer. Or you could sell it your neighbor, or the guy down the street, without going to eBay.”

So now, by law, and sticking with this analogy, neighbors (traders) can no longer sell each other cars (derivatives); they need to use eBay (SEFs). Or trade on an exchange.

Because exchanges intermediate trades and have arms that clear trades, there was some concern that the SEFs would be at an unfair disadvantage because while they intermediate they don’t clear. And since the new law requires that derivatives trades, in addition to being intermediated, also be centrally cleared, SEFs could be shut out of the market in the event that clearing venues required or heavily incentivized buyers and sellers to use them for both intermediation and clearing, the so-called single silo model.

Lawmakers, recognizing that there are basically just a handful of exchanges in the world, and sensing that eventually there will probably one day just be one (called the NYSEEURONEXTLIFFECMEICE) went to the trouble of creating a playing field that did not discriminate against SEFs, requiring exchanges to provide SEFs with non discriminatory access to clearing services, hence fostering competition between exchanges like the CME and SEFs.

But GFI’s Giancarlo recognizes that SEFs are going to have a hard time competing with exchanges that transact and clear; it’s just a fact of life. That said, he is not discouraged because the things that GFI and rivals do in order to differentiate themselves in the IDB/wholesale broker market will help them in the new playing field.

“Depth of liquidity, product expertise, relationships, trust, knowing where to find the other side—these are all things that will make SEFs a viable alternative to exchanges,” Giancarlo said.

So the next time a pundit talks about how derivatives now have to trade on exchanges remember what they really mean is that they have to trade on exchanges, and SEFs, which are kind of like the same thing, only different. Like ECNs and ATSs. Sort of.

Publishers Clearing House began on Long Island as a way to sell bulk magazine subscriptions through the mail. Today, it’s a direct marketing web site peddling all sorts of items to people who presumably are hoping for a shot at a sweepstakes grand prize.

While it won’t be coming in the form of an oversized cardboard check for $50,000, a potential windfall has been laid at the door of U.K.-based LCH.Clearnet courtesy of the financial reform law signed last week by President Obama.

When it comes to over-the-counter derivatives, a clearing house exists not to bundle magazine subscription pitches or to sucker people into thinking they have a chance at an encounter with a prize patrol, but to give investors, whether the portfolio manager at a hedge fund or the head of a pension fund, some backup protection in the event they enter into a swap trade and their broker goes belly up. It’s a straightforward strength-in-numbers premise. Members of the clearing house kick in some cash that sits in escrow to be tapped in the event one of them gets clobbered by some unforeseen blowup event or daisy chain type failure of another counterparty. With the passage of Dodd-Frank, OTC derivatives now have to be cleared centrally. This is, in and of itself, central to reformers’ ostensible goal of averting another destabilizing financial crisis.

The biggest clearing house of OTC derivatives currently is London-based LCH.Clearnet. The company has been operating a clearing house with 32 large swaps dealers as members, for which they are charged an annual fee that has remain unchanged for several years, explained Andrew McGuire, vice president of SwapClear services for the U.S. office of LCH.Clearnet. According to McGuire, who is responsible for delivering SwapClear’s OTC clearing services to U.S. buy and sell side customers, SwapClear manages roughly $224 trillion dollars in open interest represented by 14 currencies (of which $85 trillion is in USD).

Customers who currently want transactions cleared by a clearing house, as opposed to transactions being cleared their broker, do so specifically as a risk reduction precaution, especially in the wake of 2008 failures, and not because they are mandated to do so by law.

Of course, going forward, funds and dealers will have no choice but to have swaps trades cleared.

Not surprisingly, LCH.Clearnet is now readying a 24-hour clearing service and will reinvent itself in the U.S. and offer a Futures Commission Merchant (FCM) model, so as to be subject to U.S. bankruptcy laws.

Currently, LCH.Clearnet members consider themselves as an “SCM” which stands for swap clear member, and which is not subject to U.S. bankruptcy law.

It is worth noting that SCM (”Ess See Em”) sounds a lot like FCM (”Eff See Em”), so there’s that added bit of confusion, but like the new laws, LCH.Clearnet and the rest of the industry will just have to roll with it.

Memorandum

To: Congress
From: Sherlock Holmes
Re: The Financial Crisis
CC: President Obama

The financial crisis highlights the need to improve oversight of leverage at financial institutions and across the system.

Memorandum

To: Sherlock Holmes
From: Anyone who has been Paying Attention to the Financial Industry These Past Few Years
Re: Your Memo

No shit.

“Financial Crisis Highlights the Need to Improve Oversight of Leverage at Financial Institutions and Across the System” was actually the title of written testimony delivered on May 6, 2010, before the House Committee on Financial Services’ Subcommittee on Oversight and Investigations by Orice Williams Brown, director of financial markets and community investment at the United States Government Accountability Office. It is worth reviewing O.W.’s leverage meditation on the day President Obama signed financial reform into law if only to underscore the idea that while Obama may be claiming with a straight face that “because of this law, the American people will never again be asked to foot the bill for Wall Street’s mistakes” we’re all still looking at a system that, for the most part, remains free to choke on its own vomit.

The quick summary of O.W.’s testimony:

“In 2009 GAO conducted a study on the role of leverage in the recent financial crisis and federal oversight of leverage, as mandated by the Emergency Economic Stabilization Act … as Congress considers establishing a systemic risk regulator, it should consider the merits of assigning such a regulator with responsibility for overseeing system-wide leverage. As U.S. regulators continue to consider reforms to strengthen oversight of leverage, we recommend that they assess the extent to which reforms under Basel II, a new risk-based capital framework, will address risk evaluation and regulatory oversight concerns associated with advanced modeling approaches used for capital adequacy purposes. In their written comments, the regulators generally agreed with GAO’s conclusions and recommendation.”

O.W. goes on to explain something elementary, but which bears repeating, that is, how the crisis revealed limitations in regulatory approaches used to restrict leverage.

Because I happen to be the last man on earth who still buys music CDs, and because on Friday afternoon as I crossed 57th and Park Avenue I felt like I was about to spontaneously combust, I found myself ducking into an air conditioned Borders to pick up a re-issue of The Beach Boys’ classic, “Pet Sounds,” for which I recently had a hankering.

That’s when I saw it: Display copies of Randall Lane’s book, The Zeroes, chronicling the rise and fall of Doubledown Media, defunct publisher of the glossy, “Forbes-meets-GQ” magazine Trader Monthly, of which I was a senior editor, and which is considered by some to be among the most obnoxious magazines in history and which went down like the Hindenburg in February 2009.

I had no intention of reading the book, and had already received a few emails from ex-colleagues describing the various parts that mentioned me.

Nevertheless, as it was sitting right there in front of me and as I have never been mentioned in a book before, I picked one up, flipped to the index, looked up my name and proceeded to check out each one of the handful of references. As someone had already alerted me, I’m first in there mentioned as being “gruff and barrel-chested” and as someone who carried himself “like a trader,” which I suppose is, or is not, accurate, depending on the kind of trader stereotype to which you do or do not subscribe. If I carried anything like anyone, it was Trader Monthly, on my back, like a Himalayan Sherpa, but more on that later.

One passage had me emailing Randall about an at times combative editorial assistant named Teri Buhl. Supposedly, I was complaining to Lane, my boss, the editor in chief and CEO of Doubledown, that she was pestering me about not running some of her online scoops. I’m going to assume I sent the email and that Randall has a copy of it, but as I read this part I quietly shook my head, and could not help but wonder why any nonfictional narrative of any genre would ever reference for any reason an email from an editor at a trade magazine seeking advice on how best to handle an unhappy intern, but then again I do realize Randall and Teri have had their differences. For what it is worth, while I had misgivings about some of her pitches and ability to play well with others, following her departure I did enlist Teri to help me research our annual list of the highest paid traders, and in this regard she did some good work. It’s one thing to have a hedge fund PR handler whisper that, yeah we more or less have the income estimates right on, but it’s another to have the actual traders confirming (not for attribution) we were right on the money. Teri, in a number of cases, was able to do just that.

Producing the T100 list every year was a sick amount of work, a five-month siege, to say nothing of what it took (blood, sweat, tears, did I mention blood?) producing every issue of the magazine. That I was left to rely on inexperienced interns to aid me in the bulk of these endeavors tells you much of what you need to know about the way Doubledown was run, or at least as much as a brief leaf through of the book. The Zeroes could very well refer to Lane’s editorial staffing policy. He took running lean to a level not seen since Karen Carpenter first recorded “We’ve Only Just Begun,” and believe me—I have.

The only thing more perplexing than how/why the company ever tried to function without even a single full-time experienced financial writer on staff besides myself is why I ever went along with it. I suppose the reason owes to the company’s original startup mentality, though looking back, Brian Dawson and Ty Wenger, who handled front-of-book and lifestyle content, respectively, and myself (handling everything else) were really suckers disguised as gluttons for punishment masquerading as can-do soldiers.

Also perplexing, to which anyone who has perused the DD bankruptcy filing can attest, is the mountain of debt the company ran up, considering, again, there was no real editorial staff and what freelancers we did use were often not paid for months, or at all. God Only Knows what the fiscal mess was actually about, but I Know There’s An Answer. Wouldn’t it Be Nice if we all figured it out.

The least impressive figure in the Doubledown saga is not Lane, but Jim Dunning, the diminutive private equity mogul who after becoming involved as owner (buying much of Magnus Greaves’ stake) would come by the office once every few weeks to blow smoke up all of our asses. Patronizing to an almost Monty Python-like point of absurdity, Dunning was convinced that he was building a company that would one day be valued at $1 billion dollars or more, hence the ill-fated launch – with no staff – of Dealmaker, billed as Trader Monthly for bankers, and the doomed acquisition of Private Air, and the royal debacle that was the launch of a single doomed issue of the Players Club with top-shelf collaborator Lenny Dykstra.

To me, Dunning was like G.E. Smith, the showy, blues-guitar-styling musical director of Saturday Night Live. For those who recall watching SNL in the ’90s, Smith would come on before and after commercials, simply to fill some space, busting out some seemingly amazing but in actuality ballachingly indulgent solo, commanding respect without it ever being clear why exactly he should.

For three years after Doubledown formally launched, myself and the aforementioned senior editors tried to get our equity stakes put down on paper, officially. I had always hoped/foolishly assumed my stake would be no less than 1-2 points. Like I said, we tried to get this in writing. I realize I should have done so before ever showing up for the first day of work, but at the time I never thought we would publish more than a few issues before folding, and so early on I agreed to have ownership codified at a later date. Soon enough, two years had gone by, and then three, and by then I was in too deep, committed for the long haul because Trader had gotten some traction and I had worked too damn hard to walk away. Randall kept stalling.

Still, I always trusted my sweat equity would be rewarded. In the end, I was granted a stake that did not add up to even one half of a point, and soon even this pathetic stake was diluted to some fraction of a percentage incalcuable without a special software application.

Not long after the dilution but before the company went to hell, in a sitdown meeting with Randall and Dunning, I voiced my disgust at what had gone down with the ownership stakes. Dunning started barking at me, something about me not understanding the math, and he promptly ordered me to write down some figures. He was trying to make a case that a smaller percentage of a larger sum was better than a larger percent of a smaller sum but his calculus depended on the company selling for hundreds of millions of dollars and it was clear by this point that was never going to happen.

Him instructing me to take down the figures like some rented stenographer was the straw that broke the barrel chest. I took my pen and my notebook and threw them at him, snapping, “you write it down” prompting Dunning to scowl and for Randall to say, “hey Rich that was not cool!”

I later settled down, and apologized, but looking back I wished I had thrown a pen, a notebook and a Bloomberg terminal, but then Doubledown would never have thought to pay for a Bloomberg terminal. Another editor, Ty, had the presence of mind to snag that notebook for posterity. Hopefully, he still has it. It should remain as a lone symbol of the one shred of my dignity that survived that shitshow.

I just had to get that off my barrel chest. Sorry to be so gruff.

No, actually, I’m not sorry. And, incidentally, if Hollywood ever turns The Zeroes into a movie, I want to be played by the fat guy from “Lost.”

If you are an investment manager with a position, long or short, in British Petroleum, you owe it to yourself to listen to this King World News interview with Matthew Simmons. In it, Simmons says BP is lying when it claims the cap on the oil well riser has stopped the flow of oil into the Gulf of Mexico. That’s because Simmons believes, based on his 40 years as an investment banker to the oil industry and information he’s receiving from various sources, that the real oil gusher is not the damaged riser, but a hole in the ocean floor nearby that is spewing crude oil and methane gas. This oil and gas is suspended in a giant lake-blob 4,500 to 5,000 feet below the surface in the cooler water there. His main concern with this is that if a tropical storm or hurricane stirs the Gulf waters and brings that cool water layer, with the oil and gas, to the surface, the methane will blow inland on the wind and sicken or kill many living along the Gulf.

“Peak Oil” theorists love Simmons because he has been saying for years that the Saudi oil fields are in decline and that we need to face up to a future with less oil. Because of his views on Peak Oil, and other stances he has taken, he is also dismissed by some in the oil and financial industries as some sort of crackpot.

BP’s stock price was down was down about 4.5% this afternoon to $35.40 per share. If Simmons is right, BP should be worth $0 and its executives should be headed to jail. Listen to King’s interview with Simmons, and decide for yourself.

News headline: “Goldman will pay $550 million to settle SEC charges”

“The SEC accused Goldman of creating and marketing a debt product linked to subprime mortgages without telling investors that a prominent hedge fund [Paulson & Co.] helped choose the underlying securities and was betting against them.”

From the Huffington Post: “Jack Lew: Obama’s OMB Pick Oversaw Citigroup Unit That Shorted Housing Market”

“Though Lew is a longtime public servant who’s spent nearly 30 years in various positions throughout government, it is his few years at Citi—in particular the one year he spent at its then-$54 billion proprietary trading, hedge fund and private equity unit—that’s likely to raise the most eyebrows in the coming weeks as Lew faces a Senate confirmation hearing.

“Especially his unit’s investments in a hedge fund [Paulson & Co.] that bet on the housing market to collapse—a reality suffered by millions of American homeowners.”

So the SEC approves a $550 million settlement with Goldman Sachs—an amount well below what many suspected Goldman would have to pay to make the civil fraud charges go away—shortly before President Obama’s pick to head the Office of Management and Budget faces a confirmation hearing at which he’s likely to be questioned about Citigroup’s involvement with Paulson and Goldman during his tenure there.

And they say there are no coincidences.

Actually, anyone involved in shorting the housing market during the bubble years deserves credit for being smarter than just about everyone else. Who can argue with putting smart people in important positions?

So the big financial system overhaul bill has finally passed. It seems like legislators, lobbyists and lawyers have been working on this thing forever. In reality they have been working on it in one form or another pretty much since someone taped that two dollar bill to the revolving door at Bear Stearns.

A lot of friends who are not in the financial industry have asked me what I think of the legislation. As if I’ve read all 2,300 pages. Most of the people who just voted on the bill haven’t even read all 2,300 pages … or even one-tenth of that. But I still offer my quick take, which is that it’s a large and complicated bill designed to try to rein in a large and complicated industry, the excesses of which over the years caused large and complicated economic problems.

It is going to be years before we understand the full effect of this legislation. Some winners and losers are easy to pick out. Others will take some time. One big winner for sure is lawyers. This bill is going to create a lot of work for lawyers and compliance departments, figuring out what the bill actually says and how to implement specific provisions firm-by-firm. Some law firms may create entire departments just to figure out which pieces of this affect their clients and how.

For hedge funds, the new rules mean registration, and higher compliance costs. But administrators, prime brokers and accounting firms are already developing and deploying middle- and back-office systems designed to automate many of the compliance functions that will be required by greater regulatory oversight. In the end, the new rules will probably not be a large barrier to entry, even for an industry that could probably use a slightly bigger one. Financial regulation reform will not result in the dismantling of the hedge fund industry as we know it, nor will it likely affect returns.

Even the supposedly greater regulatory oversight to which hedge funds will be subject may in reality never materialize. Subjecting hedge funds to more regulation will only be effective insofar as the regulators can handle the added workload. In recent years there has been little to suggest the SEC is equipped to identify, understand or address the kinds of risks that forced the global financial system to its knees—including counterparty risk and leverage.

And subjecting the hedge fund industry to greater regulatory scrutiny, while it may help discourage the kind of outright fraud we’ve seen, it won’t totally prevent it. Nothing will. You can’t legislate morals.

As we choke down and digest this thing over the coming months and years, one thing that will stick in my craw is how financial regulatory reform is a shining example of the way the American legislative system works. What I mean by that is this is a bill that was written by lobbyists, not legislators. The whole lobbying process is distasteful to me, but I harbor no illusions about why it exists: the complexity and nuances of many aspects of the world today—finance, health care, energy policy, to name three—are beyond the ability of most elected officials to comprehend.

That’s not necessarily meant to be a knock on politicians. They are, after all, politicians; they are not bankers, doctors or energy experts. But they are also not like everyday people. Many members of Congress may not know what a gallon of milk costs at the store and are years removed from calculating how much gas to put in the car to make it to work the rest of the week while still having enough money left over to buy food, pay the rent and shop for clothes for the kids. Put simply, politicians are not equipped to understand the complexities on either end of most legislation. Enter the lobbyists. Banking lobbyists, environmental lobbyists, organized labor lobbyists, gun lobbyists, tax lobbyists, abused spouse lobbyists, renters’ rights lobbyists, auto safety lobbyists, auto industry lobbyists…. All have a story to tell, a change to suggest, a meal or trip to pay for.

I was talking the other day with an executive at a hedge fund administration firm. The conversation inevitably came around to financial regulation. He said he was in favor of financial regulation that gave investors confidence. The old way of doing business wasn’t sustainable, he said. I was dismayed, but not surprised, when he told me nobody connected to drafting financial regulatory reform had ever asked him what he thought might be needed, nor had they asked anyone he knew. Industry lobbying groups—the Managed Funds Association, in particular—had spoken on behalf of the industry.

Apparently the lobbying is only just beginning, even now that the bill is about to become law. Regulators themselves appear to be the next targets as they determine how to implement this new rule book they’ve been given.

Although the banks and others may complain about the additional costs of complying with these new rules, they’re not going to be the ones ultimately paying for it. They’ll pass those costs on to their customers and clients.

Which it could be argued is a fair thing to do. We as consumers have benefitted from the financial wizardry that led to credit default swaps and collateralized debt obligations and we should probably be responsible for paying to make sure things don’t get out of hand again.

Not that this legislation will necessarily do that. When it’s all sorted out, it probably will have some positive effects, but only if its implementation is carried out by intelligent, competent people of integrity. Like the Zen master says, “We’ll see.”

“It just lays there like a bad pierogi on the plate, both of you pretending it ain’t there.” – Major Stan Valcheck (from HBO’s “The Wire,” Season 4)

I own a tiny, cottage-style house in Ulster County, New York, in a valley hamlet called Big Indian, not far from Woodstock. It’s not much, but it’s a terrific spot, in the heart of the Catskill Mountains. There’s a creek in the back. That, the mountain air and a fire-engine red Coleman cooler filled to capacity with Budweiser longnecks on ice — there’s really not much more I need. Every time my girlfriend Meryl and I head up there, which is every weekend or so in the summer, some new project awaits me: A tree limb has smashed a deck railing; the local black bear has destroyed my fence or ripped apart the peach tree; the roof has sprung a mysterious leak, or carpenter ants have staged a reenactment of the Battle of Gettysburg in my attic.

My handyman, John Spriggs, has a saying whenever he sees me become hesitant about going the extra distance on a proposed remedy. He screeches: “Hey, you fix problems!” (Which usually means what might have been a few hours work suddenly turns into a three-part episode of “This Old House.”)

Neither Democrats nor Republicans seem to truly want to deal with Freddie Mac and Fannie Mae, those twin Government Sponsored Elephants which are 79.9 percent owned by a conservator (us) with the rest of the companies’ stakes in the hands of the public. There’s a big, terrifying reason why the conservator does not hold 80 or 81 or 82 or God forbid 100 percent of the ownership stake, and considering the publicly owned shares of Freddie and Fannie were just de-listed … well, isn’t it time to end the charade? Maybe it isn’t. Therein lies the inertia.

Both GSEs spent the better part of the past 30 years lining the pockets of both political parties and intertwining themselves in the global power structure/financial system, so it’s understandable that no one in any position of authority is leaping at the chance to pull the plug. There’s an argument to be made that without Freddie and Fannie, the housing market would be in even worse shape, and no one wants to veer toward the dreaded double dip recession. Understood.

Still, one has to wonder how much longer these housing market subsidy providing zombies can continue to stagger around, running up a tab that by some estimates is closing in on $1 trillion.

Maybe now is the time to put them down, after the Midterm, but by year’s end.

Let’s just play it out calmly.

Thirty-year mortgage rates are at levels not seen since the Eisenhower era. Many areas of the country have seen home prices decline drastically. Yet housing sales are down. That’s because there are tens of millions of under- and unemployed people who obviously can’t afford to buy a house right now, and many of those who can probably took out a second mortgage or are carrying $30,000 in credit card debt. Now is the time to euthanize. The stock market is on a six-day tear, possibly signalling a sustainable rally and Wall Street is said to be hiring again, possibly signaling a rebound in the economy.

Sure, I understand that if we take away the trillions of dollars that Freddie and Fannie throw around to guarantee mortgages and mortgage backed securities there will be a spike in mortgage rates and artificially inflated home prices will fall some more, but man, so be it — rates have nowhere to go but up. Turn the game board over. Let the houses and hotels fall where they may. If the housing market caves in, that’s strong, tough, badly needed medicine.

And if the roof springs a leak, I have a handy man I can recommend.

Ask a Stupid Question …

Well, I hoped for a robust response from readers when I put the word out the other day that I was interested in learning about investment strategies that could generate some form of positive return every month, but in hindsight I realize now that I wielded a pretty misguided premise. It’s not that I’m not interested in strategies that can generate even a half of a percent per month, but as readers pointed out – I failed to grasp the reality about the lack of a free lunch in investing while completely blocking out the most notorious consistent monthly positive return provider in all of history.

Loyal reader Pietro chimed in:

“Bernard Madoff will give you the answer. Last I heard he is someplace in N.C. I’m sure you can find him.”

Another reader added:

“A good fund manager will provide a good return over the long term but if anyone offers a guaranteed positive return every month call in Markopolous.”

I suppose I’ll settle for some form of positive return every quarter. Or maybe I can stumble upon on an early stage Ponzi scheme and figure a way out prior to its unraveling, like, say, Social Security.

A Texas endowment executive (who oversees multiple billions) told me a few weeks ago that a brand-new strategic allocation in 2007 to absolute return hedge funds—which were supposed to produce some form of positive return in any market conditions—proved extremely disappointing in 2008, when just such a strategy was most needed. He wasn’t so jaded that he bagged hedge funds altogether, but he did come to appreciate how correlated supposedly non-correlated strategies could turn out to be.

This year, through the first six months, the Hedge Fund Research HFRI Fund Weighted Composite Index is down slightly (-0.18). For what it’s worth (not a whole hell of a lot, let me tell you) each of the half dozen equity and balanced mutual funds in which I invest (Fidelity, American Funds, OppenheimerFunds) are all down for the first half of the year.

Wait. Scratch that. A short-term cash equivalent fund I parked some money in is up, but something in the neighborhood of less than one-tenth of one percent.

So as an investor, and columnist, I’m on the lookout for funds and strategies that can achieve some form of positive return, every month. Not sure they exist, and maybe it’s too much to ask with the world choked by so much debt, but I would like to hear back from readers on this topic.

I had a chance to go through my notes following a financial reform analysis session with a derivatives industry lawyer who insisted I not quote him, and who bluntly agreed with my assessment that the over-the-counter derivatives trading business is far more radically impacted by the Dodd-Frank legislation than most people seem to recognize.

Regulatory overhaul stemming from the crisis of 2008 is hardly the gift basket to the banks many are making it out to be.

Below are some notes from a conversation with a “senior derivatives industry attorney” who has followed the reform process closely and who asked not to be named.

Hollowed-Out Bullet Point: OTC, RIP?

Lawyer: “Banks ostensibly get to keep most of their swaps dealing businesses. But new central clearing and exchange trading rules mean new game-changing standardization and collateral and Futures Commission Merchants registration requirements.”

Chicago drinks New York’s milkshake?

Lawyer: “Yes that could be the name of the bill.”

Aren’t all big banks also FCMs already? Isn’t Goldman the largest FCM?

Note re: why FCMs—there is supposed to be a bankruptcy reason.

Lawyer: “FCM makes clear that CFTC has insolvency jurisdiction over the failed dealer.”

Couldn’t this easily have been done without whole-hog FCM status?

Counselor: “FCM status besides accomplishing back-door push-out also clobbers the banks’ ability to net down their cleared and uncleared swaps or to net cleared exposures against other financial contracts. It whacks ICE Trust clearing and LCH clearing and positions the CME clearing as the market leading structure.”

Singapore Singing a Happy Tune

“Singapore, not Switzerland, could become the international beehive of non-exchange/clearinghouse swaps dealing activity previously transacted in New York and London,” said the lawyer, citing industry people supposedly buzzing about this.

Wow. Credit derivatives trading maybe moving to a jurisdiction where most forms of mischief carry stiff punishments, such as being beaten with a rod or life imprisonment. We shall see.

Section 716, Not Great

Sen. Blanche Lincoln (D-Ark.) backed off requiring banks to spin off derivatives dealing businesses, so most people thought Wall Street won that match point decisively. However, “the push out provision should not be underappreciated,” the lawyer said.

Banks can still deal credit default swaps by the trillions, notionally speaking. But the transactions need to be centrally cleared, meaning margin accounts, held in escrow, by FCMs. But banks are FCMs. What changes?

What really sank AIG exactly?

It was some transactions into which AIG lovingly entered, and which then went really bad. And they triggered some collateral calls to Goldman and other counterparties. The ultimate fiddler’s invoice had come due, and it could not be paid, not without causing shockwaves.

If such potential future hell-tabs are more aggressively prepaid, ahead of time, before oh-come-on-that-will-never-happen, worst-case scenarios are allowed to play out, such groundwork could prevent the next AIG debacle or at least help to mitigate it.