‘Abusive Swaps’ Would Be Banned Under Frank’s Derivatives Plan

[Joanne98]

Source: Bloomberg

Oct. 3 (Bloomberg) -- Legislation tightening oversight of the $592 trillion over-the-counter derivatives market would give regulators authority to ban so-called abusive swaps.

The Securities and Exchange Commission and Commodity Futures Trading Commission would get the power to “prohibit transactions in any swap” that regulators determine “would be detrimental to the stability of a financial market or of participants in a financial market,” according to a 187-page draft measure released yesterday by House Financial Services Committee Chairman Barney Frank.

Opaque financial products, including some derivatives, have contributed to almost $1.6 trillion in writedowns and losses at the world’s biggest banks, brokers and insurers since the start of 2007, according to data compiled by Bloomberg. Among fallen companies are Lehman Brothers Holdings Inc., the investment bank that filed for bankruptcy, and insurer American International Group Inc., which has been surviving on government loans.

“Lacking and lagging regulation of OTC derivatives was a major contributing factor to last year’s crisis, including the highly leveraged credit-default swaps at AIG that prompted government intervention,” Representative Melissa Bean, an Illinois Democrat who serves on Frank’s committee, said in an e- mailed statement.

The legislation offered by Frank, a Massachusetts Democrat, would require the most common and actively traded over-the- counter derivatives contracts to be bought and sold on exchanges or processed through a regulated trading platform.


Read more: http://www.bloomberg.com/apps/news?pid=20601087&sid=amik0fY5tT7c

[On the Road]

1. While the Government Needs More Leeway to Regulate

I would rather see regulations with very specific conditions on what is and is not allowable.

Not all administrations are going to use their discretion wisely or for the public good.

[Fire1]

2. Agree. Think I'll send an e-mail to that effect. n/t

[ArcticFox]

3. That is one of the problems

While regulatory reach does need to be expanded, when you seek to ban specific things, it inevitably leaves loopholes big enough to fly a 747 through. Those financial guys are pretty good at coming up with things that are just different enough to not be regulated.

[On the Road]

8. Yes, I Agree with That

The minute that specific regulations are drawn up, financiers and lawyers will start looking for loopholes and ways to avoid them.

In the case of credit default swaps, however, there are some reforms that pretty much cry out for implementation. cash reserves (which amazingly are not required today), publicly monitored exchanges, and so forth. To really clamp down, you could simply require that a party buying a derivative of this kind have a direct financial interest so that it is used for hedging, which is stabilizing, rather than speculation.

So some of it could be cut and dried, and the Tresury, Fed, and FDIC would have powers beyond that to deal with "innovations" and attempts to evade the letter of the law.

To do that, though, the government and private industry has to know a lot more about what's going on. Wired Magazine had an excellent article on issuing financial statements in XRBL markup langugage to provide "radical transparency". If that had been applied to credit default swaps, for example, some of the mortgage fraud and inflated values could have been reduced.

[unblock]

5. the practical problem is that they have no idea what they're dealing with

if they tried to spell out what should be banned, they'd most likely screw that up and ban legitimate stuff while leaving gaping holes for the crap.

they need a period of vague regulation to see what needs to be banned. then they're in a position to know better what to actually ban. whether that comes to pass given the state of the markets, the economy, and the politics at that point remains to be seen.

[On the Road]

10. It is True

that they don't know what the future will hold, but when the next wave of creative abuses hit, we don't know who's going to be in charge at the Treasury, Fed, and FDIC, or whether they will do anything at all. It could be during a Republican administration.

People lose interest over time, and the lessons of the current crisis are forgotten. That's why both specific regulations is needed as well as softer oversight.

[snot]

4. K&R'd. But Frank's bill doesn't go far enough.

If all we do is grant regulatory power, the regulator will cease to exercise that power as soon as Congress or the Executive Branch succumbs –– as they have in the past –– to cause the regulator to back off, either by appointing people who won't exercise it or by simply de-funding it to the point where it lacks the resources to do its job.

We need laws that prohibit the purchase or sale of uncollateralized credit derivatives and "naked shorts," and we need similar laws passed in other countries whose institutions are large enough to compete with ours.

Edited to add: Loopholes are not inevitable. The regulations enacted after the Great Depression worked just fine until they were repealed.

NYU professor Nouriel Roubini, who predicted the current crisis, mentioned in a recent talk that throughout recorded history, there's been a more or less regular cycle of economic bubble-and-bust every ten years, with only one exception during which we managed to prevent such crises from arising for a solid fifty years: the fifty years while Glass-Steagall and other post-depression securities regulation remained in effect. Then we allowed Republicans and "New" Dems, financed by Free Marketeers, to dismantle it. (The video of Roubini was formerly at http://www.theglobeandmail.com/servlet/story/RTGAM.20090408.wvRoubini_full0408/VideoStory/Business/News?pid=RTGAM.20090403.wrroubini03 but has been taken down and was not preserved on the Wayback Machine.)

[Fearless]

6. Excellent!

[Mark D.]

7. It's Not Complicated

This bill is helpful, and suggestions above could go farther. But the laws were in place, once. Glass Steagal and others were repealed, including a few in Reagan's era. They all need to be put back in. They were imposed after the Depression to prevent another from happening. Max Kaiser has well explained how the swaps ARE the 'new world currency' the more paranoid folks fear. They are in place now. Casino Capitalism that results in what Kucinich called "Casino Socialism" when the 'too big to fail' teeter due to that carelessness. The trouble is, this bill proposed by Frank, others Obama has proposed, none are in place yet. The under-regulated market is still in full swing. The party isn't really over. It took a few months off last year, but has been on an uptick since. The stock market is rising, while unemployment is also. Speculators pulled out of energy speculation amidst the crash (which is why gas prices fell when the economy tanked in 2008) but they're back in (notice prices are up again). Geithner, Summers, etc., are all deeply rooted, as Paulson was, in this corrupt banking industry. It's hard to expect them to bring the real change needed.

[AllentownJake]

9. I'm waiting for them to crash the system again

Which since they are accelerating the trading of these instruments with even less capital to cover losses than before, I believe they will do in the next 6-12 months.

[Ruby the Liberal]

11. Why is no one talking about reinstating Glass-Steagall?

That is the damn cornerstone of this mess.

Yes, we can tackle the outliers, but this to me should be a given.

[BumRushDaShow]

12. Don't reinvent the wheel. Reinstitute Glass-Steagall. n/t

[defendandprotect]

13. We need to put all re-regulation back in place -- Glass-Stegall --

and anything new required to control these freakish new means of stealing from

the public -- and without finally being accountable!!

[progressiveGI]

14. SEC Regulators

The Securities and Exchange Commission and Commodity Futures Trading Commission would get the power to “prohibit transactions in any swap” that regulators determine “would be detrimental to the stability of a financial market or of participants in a financial market,”

Would these be the same regulators who allowed the country to be pushed to the brink of financial ruins? Or would these be the same regulators who let Madoff ponzi scheme flourish for a decade?