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Derivatives regulation worries dealers
Gary Gensler, head of the Commodities Futures Trading Commission
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Kai Ryssdal: To paraphrase Benjamin Franklin if I might, I think we can safely add new financial regulations to death and taxes on the list of things we know are coming. Both Congress and the White House have promised as much. Especially for the largely unregulated but huge -- on the order of trillions of dollars -- market for what are known as derivatives. That's almost anything that's not a straight stock or a commodity.
Credit default swaps and AIG are a great example of derivatives gone horribly wrong. Today the head regulator for the futures trading industry proposed some new rules. Our Washington bureau chief John Dimsdale reports that that has prompted some worries about regulatory overreach.
JOHN DIMSDALE: Companies use derivatives contracts as insurance against dramatic swings in prices of commodities, say flour or oil. But with no oversight, these contracts became a new form of speculation as investors bet on everything from real-estate prices to interest rates.
At a Senate hearing today, the new chair of the Commodity Futures Trading Commission, Gary Gensler, said it's time to impose some rules.
GARY GENSLER: Such reforms must comprehensively regulate both the derivative dealers, those institutions that make markets in these products, as well as regulating the markets themselves.
Gensler wants all derivatives trading to go through a clearing house. Essentially, trades would be supervised. And banks and other financial institutions that trade the contracts would have to put up capital to guarantee payments. Financial institutions don't like that idea. They say that posting collateral would eat away their profits. And, they say, a regulated exchange would eliminate flexibility. Mark Lenczowski is a managing director at JPMorgan Chase.
MARK LENCZOWSKI: We think it would be a mistake to impose that kind of a one size fits all requirement on our economy.
But after today's hearing, Iowa Senator Tom Harkin, who backs regulation, said he still wants derivatives trading out in the open, so everyone can see their value.
TOM HARKIN: Price discovery is important and that's why I still come back to this idea of putting these on a regulated exchange.
Senator Harkin expects Congress to move on derivatives regulations in the fall.
In Washington, I'm John Dimsdale for Marketplace.
I wish someone in the media would begin to distinguish between credit default swaps and "naked" credit default swaps.
While there may be a place for and legitimacy to the former, "naked" CDS are exactly akin to you and i being allowed to buy a life insurance policy on my neighbor's life, and a fire hazard policy on his house. And while we're at it, might as well make it for ten times the value of the house, and get all the neighbors to do it as well.
That these instruments are allowed to exist is INSANE.
Clearly we had misuses and abuses of the various OTC products in the last 20 years (just as firms and individuals time and time again got decimated by trading exchange listed derivatives). Clearly dealers made massive amounts of money on OTC derivatives sometimes ripping off clients (similar to the way insurance firms profited from writing insurance). The knee-jerk reaction regulation is however not the answer. Clearing platform solutions, standardization, and disclosure to regulators are sometimes helpful but represent only a fraction of the answer. The key is sound margining procedures (such as the ones used by exchanges) and proper bank capitalization. Most banks already have such procedures in place and the Fed (as well as the OCC) should review and push for strengthening of these practices. The industry is already moving in this direction (see story on the letter from the dealers to the Fed and SEC). Destroying or restricting various risk management tools provided by dealers is unsound, even if it makes for great press coverage. If you want to understand rather than react, read a blog post called "Derivatives, the wrong war" on http://SoberLook.com
"Financial institutions don't like that idea. They say that posting collateral would eat away their profits. And, they say, a regulated exchange would eliminate flexibility. Mark Lenczowski is a managing director at JPMorgan Chase."
"MARK LENCZOWSKI: We think it would be a mistake to impose that kind of a one size fits all requirement on our economy."
It wouldn't be imposing a one-size-fits-all requirement on our economy, just on highly leveraged, and potentially highly destructive, derivatives trading. Too bad if it will limit flexibility. That's what got us into this mess in the first place.
How about this: If you're responsible for blowing up the world's economy, you don't get a say in how it gets put back together.
