The Commodities Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) have authority to oversee different portions of the derivatives (or “swaps”) market. And in the wake of the financial crisis, the Dodd-Frank financial reform bill approved new regulations for derivatives, requiring the two agencies to come up with new enforcement rules, including how derivatives should be regulated when one portion of the trade is in the United States and another side is overseas, which regulators call “cross-border.” The SEC’s proposed cross-border rule is weak and allows U.S. banks to dodge rules governing derivatives if portions of their deals are done in their foreign branches.
But the CFTC has signaled that it will take a much tougher approach. When the industry got rules that limited their ability to speculate in commodities (which can drive up the price of food and oil) overturned in court, Gary Gensler, the CFTC’s chairman, vowed to fight back. Gensler has long been hated by the financial industry for his tough stances. It was the CFTC under Gensler that vigorously pursued the LIBOR-fixing scandal, where banks were found to have been deliberately manipulating a key benchmark for short-term interest rates. They continue to pursue an investigation into whether banks manipulated yet another key market benchmark, ISDAfix. Gensler has led the CFTC to complete 40 Dodd-Frank rules, more than any other financial regulator, despite the fact that his agency has the smallest budget of the financial watchdogs. He has also been fighting hard to ensure that U.S. rules will govern derivatives traded overseas so that banks can’t just sneak past U.S. regulations by trading out of, say, London. And that’s exactly the kind of spine that H.R. 1256 wants to snap.
Wall Street won’t stand for such strength coming from the CFTC, especially since, between the two regulators, the CTFC regulates the majority of the swaps market. The bill is sponsored by one of Wall Street’s favorite House members, Rep. Scott Garrett (R-N.J.) . The New York Times reported that Garrett received more than a half-million dollars in contributions from Wall Street in the last election, and that, according to Garrett himself, the banks asked in return that he “Put as much pressure as possible on the CFTC.” The bill forces the two regulatory agencies to “harmonize their rules,” which is Beltway-speak for “weaken the side that’s fighting back against Wall Street.”
But that’s not all the bill does. It makes a crucial, and dangerous, blanket assumption: If a U.S. bank does derivatives trading in one of the nine largest swaps markets, that country’s rules are assumed to be as strong as the United States’, so the U.S. rules need not apply.
This is a ridiculous assumption, because if the rules were truly equivalent, there would be no need for this bill in the first place. In fact, this would allow U.S. banks to dodge U.S. rules in favor of weaker rules overseas. Yet as the last crisis showed, even when banks attempt to hide the risk overseas, that risk remains at home. AIG failed because of derivatives traded out of their London office. More recently, JPMorgan Chase lost more than $6 billion last year due to their infamous “London Whale” trades, which were the subject of a devastating report from the Senate’s Permanent Subcommittee on Investigations. In fact, Wall Street lobbyists attempted to pass this very same bill last year, but after the “London Whale” story hit the press, the Agriculture Committee, which was due to mark up the bill, canceled it.
There are some signs of opposition to the bill, but those aren’t entirely encouraging. Treasury Secretary Jack Lew did criticize this and several other anti-Dodd-Frank bills that were up before the House Financial Services Committee, but as the New York Times noted, his words were “hardly a full-throated defense of financial reform.” On Tuesday, the White House stated that it doesn’t support the bill, but it did not go so far as to issue a veto threat.
And the pull of money is strong on Capitol Hill. Another bill that passed the same House committee, the Swaps Regulatory Improvement Act, only garnered six “Nay” votes from Democrats, despite being written by a Citigroup lobbyist. As the group MapLight pointed out, the Democrats who voted for H.R. 992 received 2.6 times more money on average than did those on the committee who voted “Nay.” Will the Democrats vote with the White House, or will they continue to vote with monied Wall Street interests, hoping that the public simply won’t see it? This Wednesday, we’ll find out.