Nearly three years after Congress passed the Dodd-Frank financial law to limit risky activities on Wall Street, a series of bills could weaken regulation of derivatives — the exotic securities that helped fuel the crisis.
On Tuesday, the House Financial Services Committee passed six bills that limit reforms in the complex market of derivatives, including adding more flexibility for financial services companies that deal in them. A bipartisan group of lawmakers hailed the measures as necessary repairs to statutes that could hinder U.S. firms in doing business.
But the Obama administration has warned that the package of bills weakens critical reforms.
“In many instances, [the proposed] legislation is premature and aspects would be disruptive and harmful to the implementation of key reforms,” Treasury Secretary Jack Lew wrote Monday to the panel’s chairman, Jeb Hensarling (R-Tex.). Regulators should be given time to “complete their ongoing rulemakings, and then determine what changes, if any, might be necessary to improve the effectiveness of reforms.”
A similar set of bills cleared the House last year but died in the Senate. The new legislation is likely to face a similar fate, but opponents have grown worried that individual measures could be tucked into broader pieces of legislation that would be difficult to defeat.
In their simplest form, derivatives are financial bets on the future value of such things as mortgages or airline fuel. Airlines, for instance, use derivatives to hedge against price fluctuations for jet fuel. But in the run-up to the crisis, Wall Street firms used more complex forms of derivatives to place risky, and ultimately fatal, bets on the mortgage market.
Insurance giant American International Group teetered on the brink of bankruptcy in 2008 because of its exposure to complex derivatives known as credit-default swaps. AIG’s near collapse and subsequent government bailout prompted derivatives provisions in Dodd-Frank to improve transparency and reduce risks for market participants.
The financial services industry, however, has pushed for a series of exceptions to narrow the scope of the regulations and who has to follow them.
“We have heard from our farmers, our ranchers, our factory owners how problematic the current interpretation of these laws may be,” Hensarling said during the hearing. “We know that how companies hedge their risk, so goes their employment opportunities.”
But Rep. Maxine Waters (Calif.), the ranking Democrat on the committee, cautioned the panel against passing “legislation that might tie [regulators’] hands or constrain their ability to respond to evolving markets.”
Reps. Gwen Moore (D-Wis.) and Marcia L. Fudge (D-Ohio) sponsored a bill that would allow U.S. firms to trade derivatives with their affiliates in other countries, commonly known as inter-affiliate swaps, without adhering to the new regulations.
The Commodity Futures Trading Commission recently issued a rule that exempts many such types of swaps from a variety of new regulations. But the agency’s rule is more restrictive than Moore and Fudge’s provision.
Rep. Stephen Lynch (D-Mass.) called the provision “a wish-list of the financial industry. . . . We’re taking accountability and throwing it out the window.”
One hotly contested bill would allow banks to keep certain types of derivatives trades in-house, rather than spin them off into separate uninsured subsidiaries as called for under the Dodd-Frank law. Industry groups say the carve-out will spare firms from costly and inefficient regulations, but opponents say it could lead to future government bailouts of swaps dealers.
“People would be able to take exotic swap dealings and put them inside the public safety net and we could all get stuck bailing these guys out like we did in 2008,” said Marcus Stanley, policy director at Americans for Financial Reform.
Another bill would effectively delay the application of new derivatives rules to foreign branches of American banks by requiring the CFTC and the Securities and Exchange Commission to issue a joint rule.
Both agencies have issued separate proposals, which supporters of the legislation passed Tuesday say offer conflicting guidelines. But Dodd-Frank supporters say Wall Street is simply trying to avoid tough regulations.
“CFTC has taken a transaction-by-transaction approach to judging foreign regulators’ rulemakings, versus the SEC’s more reasoned and comprehensive outcome-level basis,” said Kenneth E. Bentsen Jr., acting president of the Securities Industry and Financial Markets Association. “This has already led to real-world consequences, with business leaving our shores.”