Bloomberg Reports Derivatives Regulatory Legislation Contains Large Loopholes

Hey kids! Were you holding out hope that someone might do something to robustly regulate the derivatives market that wrought such wrack and ruin to the global economy? Ha, ha, that's adorable! Tina Seeley and Dawn Kopecki report for Bloomberg today that "Legislation by Representative Barney Frank to tighten derivatives regulation contains an exemption that may let most financial firms escape new collateral and disclosure rules." Great!

Here's where the specific exemption lies:

A plan offered by the Obama administration would subject all swaps dealers and "major market participants" to new regulations for capital, business conduct, record-keeping and reporting. [Representative Barney] Frank's version would exempt corporations from that definition if they use derivatives for "risk management" purposes.

While Frank's proposal is a "step in the right direction," its "ambiguous" definition of risk management may leave a large number of corporations unregulated, Henry T.C. Hu, director of the SEC's new division of risk, strategy and financial innovation, told the committee.

Funny thing: the way the concept of credit derivatives was explained to me sort of made it sound like the daisy chain of "risk management" didn't actually diffuse the systemic risk in the derivatives market. (AIG was just one of the now bailed-out companies that used derivatives to "manage risk.") Well, Commodity Futures Trade Commission chair Gary Gensler thinks Frank should "eliminate the 'risk management' exclusion altogether." Frank says that he will "sharpen" the bill, saying, "I don't think what he says is accurate, but my view is why take the chance? So we agree with him as to the concepts and we'll make the language very clear." And Barry Ritholtz, over at The Big Picture, basically says: NO, NO, NO, YOU'RE DOING IT WRONG.

Any plan that seeks to reverse the unregulated wild west that derivatives have existed in since 2000 must have a simple beginning: Repeal the Commodity Futures Modernization Act.

This ruinous and corrupt legislation, pushed through by the Bonnie & Clyde of derivatives, Enron Board member Wendy Gramm, and her astonishingly clueless ideologue husband, former Texas Senator (and current UBS member) Phil Gramm, lay at the heart of the current derivatives debacle.

Ritholtz offers further prescriptives: "In addition to the full repeal of CFMA, derivatives should be 1) Traded on exchanges ONLY; 2) counter parties must be adequately capitalized and transparently disclosed; 3) appropriately reserved for; 4) Where derivatives are acting as insurance, state insurance commissions should have oversight and audit capability."

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Comments

[TJCole]

LOL..! Let the Bribe Taking Begin..!

We have a system of legalized bribery..!

A bribeocracy...no longer a democracy...

Schumer my Senator already got his $1.64 million from Wall St...

It's gonna be Health Care Reform all over again...but maybe even more mullah for our mullahs the pigs at the trough...alright Arianna..

[research]

Bingo!

Outlaw Derivatives,

Leave Wall street no choice but to invest in Main Street.

Prosecute the Banksters for Fraud.

[Gernuser]

Congratulations to to Obama for winning the Nobel Peace Prize

If you like finance & econ news you'll like: http://pie.im/af30

Obama needs to carry out more reform. Needs to get things done instead of just talking and planning.

[Soulsurfer]

To have these guys (Congress) deride them (The Corps) in public sessions, then take their money, must really piss the bankers off. But Barney pays off in the end, with this kind of toothless legislation.

[loki]

this is the kind of thing Im afraid will happen if we ever see a public option health care bill. The title will make them look as if they are keeping the promise, but the details will do the opposite.

[Gernuser]

More work needs ot be done

Good articles: http://pie.im/af30

[strangelet]

I am not, customarily, a big defender of corporations, but I spent my life working for various ones and I must say that there are legitimate risk-management uses of first-level derivatives. Corporations may have large amounts of cash. They don't put it in the bank; they buy US Treasuries, or perhaps some other nation's bonds. Those that do business internationally are affected by currency exchange rate variations. To avoid a situation in which the a corporation's financial performance is determined by fluctuations in bond prices, or exchange rates, it will often use derivatives to hedge against unfavorable changes. Risk management is pretty easy to recognize -- the total amount of money spent on the derivatives is a very small fraction of the corporation's total budget. It isn't trying to MAKE money off the derivatives; it's more like buying insurance, where you spend a small amount of money to protect against a big, bad surprise.

That said, I agree with everything Ritnoltz says, except maybe for (4), which I consider ambiguous. What does "act as insurance" mean? If it means "hedge against unfavorable currency fluctuations", I would seriously question whether any state insurance regulator would have the expetise (or interest) to be involved.

I'd rather see a hard limit, say 0.1% of revenue, that can be spent to purchase derivatives in any financial period.

[research]

good ideas. Derivatives used to be about 10% of the market, about 10 years ago. Once CDS was unregulated, derivatives grew to 10 Times the rest of the market. see my profile for more detail. I think we just plain outlaw derivatives to force Wall Street to invest in Main Street.

[MyTalkRadiou]

Obama needs to do actual reform instead of just talk & plan

good articles: http://br.st/tU

~~

[Veri]

Keep dreaming. Barney Frank knows how to write loopholes. What, you think this is an accident? Those loopholes are designed to allow Citi, JP Morgan, and Government Sachs to operate such as they currently do while hobbling their competitors.

[WashingtonEd]

I have a hard time understanding why credit derivatives should exist at all, and particularly why they should be available for purchase by lenders. Why should a lender be able to avoid "risk" on a loan it makes (same goes for bundling and selling the loans in a securitized package). Where's the social contribution there -- does it not instead lead to avoidance of responsibility by a lender to make an intelligent loan decision.

Exempting lenders that use derivatives for "risk management" purposes is itself a mistake. I'd love to enter a "no lose" business.

[PhilipTaylor]

Robustly Regulation of derivatives market = WHO OWNS CONGRESS? WALL STREET!

Until Congress is DELINKED from Wall Street expect CONTINUED CORRUPTION!

Campaign Reform addresses the "HEART" of WHAT IS WRONG WITH AMERICA!

[RomeoMD25]

O was Big Finances top recipient in 08 to the tune of $40 million. Might explain
why 9 months later there has been virtually nothing done to reign in Wall St's excesses.
http://www.opensecrets.org/industries/recips.php?ind=F&cycle=2008&recipdetail=A&mem=Y&sortorder=U

[NeoconGal]

Can't go upsetting the very people who bankroll our campaigns can we?

[CarmanK]

It is good that people are willing to offer constructive criticism and off solutions to some of the problems cratering Wall Street. These suggestions sound pretty good to me and perhaps come in time to let Frank review the suggestions for impact.

[FreedomCorpse]

Of course the legislation has loopholes. All the legislation has to say is it is a felony to do this anymore