Orbital Matters

Saturn Smith
Editor’s Pick
MAY 14, 2009 4:13AM

A Finely Aged Regulation: Treasury Goes After Derivatives

Rate: 14 Flag

Also in the news yesterday (underneath the photo-release reversal madness, which I think Glenn Greenwald has pretty much covered) was the Obama administration's proposal to press for regulation of Credit Derivatives [emphasis added]:

The administration asked Congress to move quickly on legislation that would allow federal oversight of many kinds of exotic instruments, including credit-default swaps, the insurance contracts that caused the near-collapse of the American International Group.

The Treasury secretary, Timothy F. Geithner, said the measure should require swaps and other types of derivatives to be traded on exchanges or clearinghouses and backed by capital reserves, much like the capital cushions that banks must set aside in case a borrower defaults on a loan. Taken together, the rules would probably make it more expensive for issuers, dealers and buyers alike to participate in the derivatives markets.

The proposal will probably force many types of derivatives into the open, reducing the role of the so-called shadow banking system that has arisen around them. 

I know, not nearly as sexy as the legal intricacies of a fight against FOIA, but still important.  (Believe me, I tried for at least five minutes to think of a way to attach Paris Hilton's picture to this, too, but I've got nothing).  This is a dry topic, and if I didn't know Americans so well, I'd say the boring tedium of it all was one of the reasons no one took this up a couple of years ago when it might have actually made a difference.  Oh, wait, it turns out I do know Americans that well.  Anyway, now that the financial world is falling apart, suddenly everyone's concerned about the "shadow banking industry," so we might see some real change, since voluntary national alcoholism doesn't seem like a passable strategy to get through the days.  Like Andrew Leonard says, it is a bit like "closing the barn door after the derivatives escaped," but there are still plenty of derivatives in the barn that could use some supervision.

It turns out, though, there was somebody pushing for this exact strategy five years ago.  Wait, did you say five years ago?  I did, self, I did.  Who was this forward-thinker?

Waaait a second.  Where's his Darth Vader mask?

In 2004, Tim Geithner gave a speech1 on "Hedge Funds and Their Implications for the Financial System," in which he discussed, briefly, the need for credit derivatives to be traded more openly, and with some system of regulation.  Later that year, he convened the heads of the banks and got them to volunteer to update their tracking systems and get things onto a standardized computer system, instead of everyone running their own haphazard (think: sticky notes) show.  But the actual regulation of derivatives never went any further than that, whether because Geithner lacked the power, the resources, the guts, the inclination, the kickback, the conspiracy, or the political savvy or support (please remember who was running Treasury back then) to see that it did.

So, unlike PPIP and TARP and TALF and WTF (yes I made that last one up), this is a plan that someone's thought about for more than a week or two.  Consider this Revenge of the Government Servants.  The plan for regulating derivatives is... well, I won't risk putting you to sleep, but it's been in the works for a while -- we heard shades of it mentioned during Geithner's earlier Congressional testimony -- and it would consist, essentially, in rolling back big slices of the Commodities Modernization Act of 2000, which was adopted under the Clinton administration and, oh yeah, as both Andrew Leonard and the New York Times point out, with the full approval of one Larry Summers.

"Stop trying to help, Larry! Seriously!"

It would push for most "derivative instruments" to be traded openly, so that investors and regulators could actually get a look at the ways companies hedge themselves against risk.  And it would also require certain capital reserves to be on hand before banks could trade these things -- so an insolvent, constantly-borrowing-to-survive guy like Bear Stearns would have some trouble here. 

Openness?  What?  Accountability?  On Wall Street?  Surely you jest.

Well, a little bit, I do, because one of the agencies likely to be charged with overisght responsibilities is the Securities and Exchange Commission.  If you haven't read TPM's overview of the scathing GAO report on the SEC, well, that's ten minutes of appalled laughter and stomach-sinking dread that you really owe yourself.  The SEC is pretty much a dead agency.  Giving it new things to do will only help if the President and Congress are planning to staff it up -- and they'd better not be sending Summers over there.  SEC restructuring or, honestly, replacement is the biggest missing piece in this plan.

But overall, this is good news.  Yes, it comes too late, and yes, it's probably not a perfect plan, but it's complex with some pleasantly optimistic overtones and just a hint of bitter, bitter regulatory nuttyness.  Vintage government-label work, here.  I'll drink to it.

1 Should you ever have trouble sleeping, I really, truly recommend perusal of the New York Fed's speech archive.  Skip the lively speeches by the other guys -- Dudley's "May You Live in Interesting Times" is just no match for the somnia-inducing Geithner tome, "The Economic Dynamics of Global Integ..."  Wha?  What?  Oh, sorry, nodded off.
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Does this mean old Tim G gets a point in the "good" column from you this week?
You are now required reading for me, Saturn. I tried to follow this latest proposal within the folds of my soon-to-be-extinct print version of the NY Times this morning which, incidentally, had a fascinating article about how well Norway is weathering the financial storm. Of course Norway is a - wait for it - SOCIALIST country. Ahh, the irony.
Rollin' Rollin' Rollin'

Keep movin', movin', movin',
Though they're disapprovin',
Keep them doggies movin' Derivitaves!
Don't try to understand 'em,
Just rope and throw and grab 'em,
Soon we'll be living high and wide.
Boy my heart's calculatin'
My true love will be waitin', be waiting at the end of my ride.

Move 'em on, head 'em up,
Head 'em up, move 'em out,
Move 'em on, head 'em out Derivitaves!
Set 'em out, ride 'em in
Ride 'em in, let 'em out,
Cut 'em out, ride 'em in Derivitaves!

Move 'em on, head 'em up
Head 'em up, move 'em on
Move 'em on, head 'em up
Count 'em out, ride 'em in,
Ride 'em in, count 'em out,
Count 'em out, ride 'em in

Keep movin', movin', movin'
Though they're disapprovin'
Keep them dogies movin'
Don't try to understand 'em
Just rope, throw, and brand 'em
Soon we'll be living high and wide.
My hearts calculatin'
My true love will be waitin',
Be waitin' at the end of my ride.

Zumalicious! ...that was positively inspired. In particular, the whole "cowboy" meme really strikes the right note.
How stupid am I. It seems as though derivatives should have been the FIRST thing regulated. Go figure.
Geithner still scares me. The whole mess scares me. And yet, I can't help but read as much as possible about the mess that we're in. Thanks for being one of the clear and focused thinkers and writers whose words I value and trust. Not like Geithner.
They need to regulate CDS on national security grounds alone: any foreign state planning financial attacks on the dollar would need to hedge as much as they could by going long CDS on Treausuries, although there would be a limit because of counter-party failure.
That is how the Chinese tried it in my novel; through hedge funds that are fronts.
I have joked that when the time comes to hang capitalism, a capitalist will sell the socialists credit default swaps on their debt. Who knows.
Hey Saturn. Of course I found this over at the Tim Geithner fan site. They were so excited to finally have something to link to!
>> a fascinating article about how well Norway is weathering the financial storm. Of course Norway is a - wait for it - SOCIALIST country. Ahh, the irony.

Be careful what you praise, you just might get it. I read the article. Norway dumped a sovereign wealth fund just as the market did its bear market (short squeeze) rally. The issue is whether this is a fundamental rally, or a technical one. I'm betting technical. If Norway doesn't go to cash soon, they will be wiped out just like the rest of the world, only later.
Heh, well, he gets one good point and one bad, as the AIG bonus mess is heating up a bit and his role looks a bit more suspicious, mad_typist.

Thanks, 1WomansVu! I'll have to check out the Norway piece, so I can have a better response to you, Robert Young, too.

Nice work, Zuma! Now I have the tune to "rawhide" stuck in my head, though.

Thanks for the vote of confidence, Cartouche. I don't know quite what to make of Geithner, but skepticism is certainly a safe point of view here.
Thanks again Saturn, for distilliing it all down for me, and at just the right level of detail, with linked references too. All wrapped up in snappy writing that is a pleasure to read no matter how dry the topic.

I do care, and I do understand. But I can't spend the time on it, so you're a great help. I am just trying to sit tight, gold on, and hope for the best. So far, it's not too bad. Overall, I am pleased. I voted for Obama because I trusted him, and I am willing to give him the space and time to succeed. But I like to stay informed. So thanks again!
Well, if the Senate refuses to force banks to get out of loan sharking with their credit-card operations, I don't see much chance of the administration getting derivatives regulated. Credit swaps should not be regulated--they should be eliminated. It's not merely the fact that no capital was required to write them. It's that they allowed so-called risk managers to think they could go fishing instead of doing their jobs.

While it's nice that Timmy gave a speech five years ago about their evils, what did he do about it as head of the NY Fed in subsequent years? Squat, that's what. Still, if he and the administration do accomplish a meaningful regulation of that marketplace, I'll be the first to give him an attaboy.
I came upon this piece right after I wrote one myself about Nicholas Biddle. I tried to be funny (tried is the operative word) because this is all so freakin' serious. The more I read and hear about torture, and Pelosi et al the more I feel the heist continues in full sight. Our vision is being trained to look at everything other than what the financial industry is doing.
We have been hijacked and I am afraid that it is a fait accompli - no matter what these bastards say in public, in private WE have been packaged, tranched, swapped and sold. I do not fear China, Pakistan or any other such place. I fear Wall Street.
Great article.