Thursday, May 2, 2013

Caring About Derivatives Regulation

Caring About Derivatives Regulation

I’m willing to bet that most of you quickly move on to another story when the lead paragraph includes the word “derivative.”  Wall Street greatly appreciates the fact that you systematically ignore this kind of news item, because it enables them to continue to make gobs of money while putting you squarely at risk.  Much of the credit crisis was fueled by derivatives, and the Dodd-Frank law was enacted, in large part, to make the derivatives markets more transparent to participants and regulators.  In order to implement the law, regulators were required to issue rules.  The rulemaking process has given the banks an enormous opportunity to undermine any effective control of the derivatives markets.

Preventing Cannibalization (1999)

Now Gary Gensler, Chairman, of the Commodity Futures Trading Commission (CFTC), is in the bull’s eye of an industry attack.  Mr. Gensler should be one of your heroes, because he is almost single-handedly preventing the banks from gutting Dodd-Frank.  He has proposed rules to prevent banks from circumventing scrutiny of their derivatives business by conducting that activity overseas.  The rule requires disclosure and adherence to the CFTC standards if a derivatives contract has a US connection (such as a US client), even if it is booked in a foreign subsidiary.  The banks have responded by pretending that they are defending the prerogatives of foreign regulators. They’ve argued that they should only have to comply with the regulations of the country in which they house the contract. 

In other words, they want to do business in the country with the weakest set of regulations and in the jurisdiction that enables them to make the most money.  So what happens when those contracts blow up?  Your central bank, the Federal Reserve, your credit via the US Treasury, and your tax dollars will be committed to bailing out the banks.  If we allow the banks to get away with this, we are truly insane.  As Albert Einstein said, “Insanity is doing the same thing over and over again and expecting different results.”

Let’s be clear.  Chairman Gensler’s proposed regulation would drive down industry profits.  Frankly, that’s what regulation should do, particularly when those seeking to profit don’t bear the risks.

Even if you don’t understand the first thing about derivatives, you should be disgusted by the banking industry’s tactics as they try to defeat the new regulations and the CFTC Chairman.  And by the way, they are likely to win.  The first arrow in their quiver is character assassination.   Mr. Gensler is being characterized as “reckless” and “stubborn,” among the more polite terms.  His predecessor, Brooksley Born, another one of my heroes, was subjected to the same attack by the banks and the Clinton White House in the 1990s, when she tried to regulate the burgeoning derivatives market.  We should have listened to Ms. Born.

A second arrow is aimed at buying off politicians and their advisors.  As a result, the very politicians who voted for Dodd-Frank are now helping to defeat Dodd-Frank.  Here’s the most egregious example.  The New York Times reports that one of ex-Congressman Frank’s former aides, Michael Paese, an author of the law, now represents the banks.[1]  Mr. Paese is merely one member of a large army of former aides enlisted to kill what they created.

If personal attack and hired guns aren’t enough, the banks also have huge wads of campaign cash that they are deploying to convert both Republicans and Democrats to their cause.  As a result, Mr. Gensler faces a bi-partisan barrage and is even losing support from his fellow democratic commissioners on the CFTC.

In order to make sure that these proposed regulations fail, the banks have retained a vast array of lawyers and accountants to contest every passage and provision of the proposed regulations.  Once the proposed rules are suitably complicated, the banks will claim that the CFTC has proposed a convoluted and inconsistent approach, and that the rules are unworkable.

By the way, there’s a parallel fight occurring before the SEC.  For the past couple of decades, the banks have made sure that derivatives aren’t subject to one regulator.  As a result, the SEC oversees derivatives involving individual stocks and bonds, and the CFTC has jurisdiction over almost everything else, including derivatives based on stock or bond indexes.  This is just how the banking industry likes their regulators: divided and hopefully racing to the bottom where regulation is as lax as possible.

Whether you believe that we should be lowering taxes, spending more on defense, attending to our infrastructure, or addressing the needs of our poor, you should care about Gary Gensler’s battle.   If he loses, your taxes will be going up, and the pain of sequester will be a mere pinprick.


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