Reuters Pictures
Unregulated, shadowy derivatives played a key role in the 2008 financial crash—Warren Buffett called them “financial weapons of mass destruction”—and the Dodd-Frank financial reforms took serious measures to bring them out into the open. Even Matt Taibbi, a noted critic of the overall bill, said the derivative rules were the “biggest win of all.”
Now, Republicans—and some Democrats—on the House Financial Services committee are quietly trying to gut these key reforms. The committee reported out two bills recently that would make derivative transactions largely opaque once again and that would exempt large portions of the financial industry from further regulation.
Representative Barney Frank, the ranking Democrat on Financial Services, released a statement this week sounding the alarm about the two bills, which the House is expected to take up this month when it returns from recess. “Thoroughly hoping to take advantage of the fact that public attention is now focused on the budget and the healthcare bill, House Republicans are moving substantially to weaken the regulation of derivatives,” Frank said. “Democrats will be pushing for… two very important amendments to these bills, and if they are rejected by the majority, we will work hard against both bills and urge the Senate and the President to reject them.”
The Swap Execution Facility Clarification Act, introduced by New Jersey Republican Representative Scott Garrett—and co-sponsored by a leading Democrat on the committee, Representative Caroline Maloney—would kneecap the open-market derivative reforms established in Dodd-Frank.
Before the bill was passed, derivatives were mainly traded in the dark; neither regulators nor customers were privy to crucial price details. Only the traders, who have obvious motives for self-enrichment, knew this information.
Dodd-Frank directed the Commodity Futures Trading Commission to create rules to bring derivative trading out into the open. Already, traders now share trade and position details with federal regulators. Customers are still mainly in the dark, as most derivative trades are done over the phone, one-on-one, and so the customer is at the trader’s mercy. But in late 2010 the CFTC began pushing forward rules that derivative market participants must post prices on a “centralized electronic screen” that customers can easily access; one-to-one phone dealings would be barred.
Garrett’s bill is ostensibly meant to preserve the ability of firms to conduct phone trades—something the Democrats on the committee actually support. But as written, it would gut most all of the derivative reforms regardless of how they are conducted.
The second bill, the Swap Jurisdiction Certainty Act, was introduced by Democratic Representative Jim Himes, and co-sponsored by Garrett and would prevent the CFTC and the SEC from regulating derivative trades by overseas subsidiaries of American companies—even if the regulators determined those trades threatened the stability of the American economy or were being conducted purely to avoid regulation in America. If passed, financial firms would presumably be able to offshore a good deal of their derivative trading. Regardless of where its conducted, this sort of trading has clear potential to crash the market and even the firms themselves—which would no doubt be disastrous to the economy.
Combined, these two bills would defang much of the Dodd-Frank efforts to rein in dangerous derivatives. It’s truly astonishing—these instruments have already demonstrably caused massive harm to the US economy, and the negative effects continue to this day. Dark derivative markets benefit virtually nobody except financial traders; Representative Maloney, pressed by the New York Times last year to explain her position on the Swap Execution Facility Clarification Act, cited her concern about job losses on Wall Street.
It seems likely the Republican House will pass these bills in April, though unlikely that the Senate would approve them and less likely President Obama would sign measures that would hobble crucial elements of Dodd-Frank. But Republicans and their Wall Street funders are clearly eager to move the ball forward—and you can bet this isn’t the last attempt they will make to liberate the beloved, beleaguered derivative traders.