Household names like Apple, Caterpillar and Whirlpool are part of a coalition of companies lobbying Congress to allow Wall Street to escape tough new rules on derivatives trading, potentially sowing the seeds for another AIG-like disaster.
In a letter sent to senators late last week, the Coalition for Derivatives End-Users -- companies that ostensibly use derivatives to hedge future risks like rising interest rates or a depreciating dollar -- argue that the current bill pending before the Senate goes too far in regulating what famed investor Warren Buffett once called "financial weapons of mass destruction."
So the coalition wants exemptions -- lots of them:
Big banks like JPMorgan Chase, Citigroup and Goldman Sachs shouldn't be forced to have more cash to cover its derivatives deals; firms, including those financial behemoths, needn't be compelled to post margin to cover their bets; financial firms, save for the megabanks, should be treated like manufacturers and other industrial companies, and hence should be able to continue trading their derivatives contracts with little government oversight; and up to two-thirds of all over-the-counter derivatives trades should continue to be traded in the dark.
A close reading of the coalition's letter, and the accompanying suggestions for legislative fixes, reveals that the coalition doesn't really support the central aim behind reforming the derivatives racket: forcing the vast majority of now-unregulated trades that occur over telephone conversations and email onto central exchanges and exchange-like facilities.
"It appears to be a total evisceration of the bill," said Adam K. White, director of research at White Knight Research and Trading, an independent research consulting firm.
The benefit of derivatives reform, according to reformers on Capitol Hill, in the Obama administration, and outside Washington, is a less-risky system with more safeguards and more transparent pricing of these contracts, so firms that use derivatives to hedge against future risk get market prices rather than one determined by an oligarchical system.
The downside, according to the coalition, is "many companies across the country that had no role in the financial crisis and do not pose risks to the financial system will have to post billions of dollars in working capital to meet new regulatory requirements."
It's like gambling in Las Vegas for years with Monopoly money, and then all of a sudden being forced to front real cash.
"As it is, the end-user exemption will decrease the transparency and stability of the financial market, and in the current bill the end-user exemption definition is expansive to the point where lots of the wrong types of firms could qualify," says Mike Konczal, a fellow at the pro-financial reform Roosevelt Institute. "What the Coalition...[is] asking for is to radically make this regulation worse, by essentially saying that everyone gets to be an end-user and that everything gets to be exempt from regulation."
One of the signatories to the coalition's letter, the National Association of Manufacturers, did not respond to a request for comment. Another, the U.S. Chamber of Commerce, did not respond to an immediate request for comment.
"I don't think true end users want an evisceration of this bill because I don't think they want to go through another near-death experience like we did when the financial system almost collapsed," White said.
Among the coalition's requested carve-outs:
- Deleting provisions in the current Senate bill, authored by Banking Committee Chairman Christopher Dodd (D-Conn.) and Agriculture Committee Chairman Blanche Lincoln (D-Ark.), that call for swaps dealers, like JPMorgan Chase, Goldman Sachs, Bank of America, Citigroup, Morgan Stanley and Wells Fargo, to hold higher amounts of capital to support their derivatives bets;
- Deleting a term defining major derivatives users, which calls for higher capital requirements and mandates that they clear their derivatives deals through transparent venues that require parties to post margin. By deleting this provision, the coalition wants to exempt an entire class of derivatives users from having to post cash upfront to support their bets.
- Changing the definition of what constitutes true hedging. Derivatives are traditionally used to hedge future risk. Firms like Coca-Cola and General Electric use derivatives to hedge fluctuations in currency and interest rates. But they can also be used to make wild bets. The coalition wants to broaden the definition of what constitutes actual hedging to include transactions in which a firm -- like a hedge fund (Long-Term Capital Management) or large insurance company (AIG) -- seeks to hedge anticipated assets and liabilities, like a future purchase of a share of a collateralized debt obligation based on home mortgage-backed bonds. These kinds of derivatives contracts should continue to be traded with little government oversight, the coalition argues.
- Doing away with margin requirements that compel megabanks to post upfront cash on their derivatives deals with non-megabanks that reflect changes in the contract's value and guarantees the trades.
The net effect of these changes would keep between 60 to 66 percent of over-the-counter derivatives in the shadows and away from government oversight, according to statistics from the Bank for International Settlements.
"These changes would be worse than having no bill, as it would create the assumption that regulation has occurred when in fact nothing of relevance has changed," Konczal said.
The coalition's proposals are "loopholes that swallow the law," said Michael Greenberger, a professor at the University of Maryland Law School and former director of trading and markets at the Commodity Futures Trading Commission.
He added: "The American people are just going to have to decide whether they want to continue playing Russian roulette."