Hope And Cave: SEC and CFTC Fold on Regulating “Financial Weapons Of Mass Destruction”
Remember that financial crisis we had four some odd years ago – the one that brought America and the world economy to its knees – a crisis that so shook the foundations of America’s faith in the system that millions voted for Change? Well one of the primary catalysts for the epic meltdown was a financial instrument known as a derivative. Or rather unregulated derivatives. So not surprisingly many Americans – experts and non-experts alike – demanded derivatives be regulated and given the outrage and fear the federal government almost seemed like it would side with the people over moneyed interests, almost.
Rather than real reform, the country got another dose of kabuki theater with Swiss Cheese legislation, known as Dodd-Frank. In theory Dodd-Frank would put the lid on what Warren Buffett called “financial weapons of mass destruction”. In practice the bill left the fine tuning and consequential decisions to federal agencies long captured by Wall Street.
So what happened next is really no surprise.
Corporate America, with help from the Obama administration, has struck yet another blow against the scary financial regulations it claims will hurt the economy.
On Wednesday they undercut new regulations on derivatives, which the detail-obsessed among us might point out didn’t just hurt the economy but nearly destroyed it. Just a few years ago.
Under heavy pressure from the energy industry and other corporate interests, the Commodity Futures Trading Commission and the Securities and Exchange Commission are retreating from a plan to regulate many reaches of the U.S. trade in financial derivatives known as swaps, including the credit derivatives that nearly brought down the financial system.
Yes, because why learn from your mistakes when you can just repeat them?
The decision boils down to who, for the purposes of regulation, will be considered a “Swap Dealer” and who will not be. Swaps or in the specific case of the 2008 Financial Crisis Credit Default Swaps, are bets taken out on someone or some organization defaulting on a loan or some other financial obligation. Essentially gambling on someone busting.
In fact, swaps resemble gambling so much that Wall Street successfully lobbied to have swaps legally exempt from state gaming laws:
The Commodity Futures Modernization Act of 2000 (“CFMA”), signed by President Clinton on December 21, 2000, created a “safe harbor” by (1) preempting state and local gaming and bucket shop laws except for general antifraud provisions, and (2) exempting certain derivative transaction on commodities and swap agreements, including credit default swaps, from CFTC regulation.
Nice try state and local governments, Wall Street will run this casino… well until it all comes crashing down then Wall Street is going to need taxpayer money paid by your residents. Suckers!
Back to the SEC and CFTC’s decision on who is and who is not a “Swap Dealer.” The original regulation was going to set the bar at $100 million, as in anyone that handled swaps less than $100 million a year was not a dealer. This was unacceptable to Wall Street. To be clear, under the original proposed regulation if you, or rather your firm, handled $99 million per year in swaps you were not regulated as a swaps dealer.
After Wall Street was done twisting arms the level was moved, to a whopping $8 billion. To be clear, if you or rather your firm handles $7.9 billion per year in swaps you are not any longer a “Swaps Dealer” and subsequently not subject to regulation as a swap dealer. An unbelievable and ridiculous cave to Wall Street by the public’s regulators.
And just in case it was not clear that Wall Street will continue to do exactly what it did before the crisis, another loophole was created by the regulators. Firms can rename their swap trades to bypass regulation. If a firm decides to call their trades “hedges” which takes them out of the $8 billion cap to be regulated:
After heavy lobbying from energy companies and big commodity traders, the final version bumps the threshold up to $8 billion for most asset classes as an initial phase-in. Eventually, that threshold could drop to $3 billion.
The CFTC also added a more explicit exemption for swaps that are done to hedge market risks, such as reducing exposure to interest-rate fluctuations or oil price moves. Those trades will not count toward the threshold that triggers the swap dealer designation.
For the love of God, really? So let me rephrase my previous statement to include the new loophole – a firm can handle $7.9 billion in swaps per year and another $7.9 billion (or more!) in swaps that it calls “hedges” and still not be subject to regulation. So really, there is no regulation of swaps. Or to put it another way, Wall Street has won again.
Under an $8 billion de minimis exemption, a swaps entity could advertise itself as a dealer to the market and conduct 1,600 such transactions a year, without any requirement to register with the either the SEC or the CFTC. Commodity companies able to take advantage of the hedge exemption, or hedge funds and commodity trading desks able to use a possible own book trading exemption, could expand even further without designation.
Risky products, such as illiquid bonds, credit default swaps (CDS), and other complex derivatives, were precisely those instruments that contributed to the financial crisis in 2008, and those that this legislation sought to expel from federally-backstopped banking entities. We find it disingenuous to suggest that this was not commonly understood by the banking entities, the regulators, and the public long before this Proposed Rule was drafted…
Consensus on the measurement of trading account size does not currently exist among the global regulators. The Market Risk Capital Rules referred to in the trading account definition in § _.3 refer to the current proposed Market Risk Capital rules. There is considerable debate among regulators and practitioners about appropriate measurement methodologies for structured products like credit default swaps. Therefore, should the Agencies decide not to require reporting across all banking entities, the final reporting trigger should be set low enough to compensate for these measurement shortcomings
But let’s face some facts, the failure to regulate Wall Street is not due to a lack of comprehension or nuance by the regulators. Wall Street is not subject to regulation because it is regulating the regulators with political influence bought with campaign cash.
As long as political leaders are concerned more with the welfare of Wall Street than the welfare of the country, regulating Wall Street will be a dream deferred. The crony capitalism now endemic in our system guarantees Wall Street a free pass on crimes and any societal restraints on its power. As long as money rules, Wall Street will remain above the law.