3 Agencies Vie for Oversight of Swaps Market

Sen. Maria Cantwell (D-Wash.) says the Commodity Futures Trading Commission is too close to private industry players to be the regulator.
Sen. Maria Cantwell (D-Wash.) says the Commodity Futures Trading Commission is too close to private industry players to be the regulator. (Alex Wong - Getty Images)
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By David Cho and Zachary A. Goldfarb
Washington Post Staff Writers
Tuesday, October 21, 2008

The government is moving forward with its first significant effort to bring oversight to a vast, unregulated corner of Wall Street that has severely exacerbated the financial crisis.

But a turf war is brewing among three leading federal agencies that have contrasting visions for how the $55 trillion market for speculative financial instruments known as credit-default swaps should be regulated.

While the credit crisis has upended global financial markets and given a lift to advocates of heightened regulation, it has not resolved traditional disputes in Washington over how deeply the government should be involved in free markets.

Some regulators say the market can operate largely on its own but simply needs more transparency. Others say that the credit crisis has exposed wide gaps in oversight that require a much more direct role by the government.

The battle has mobilized the financial industry and lawmakers who are holding a hearing today on market regulation. Some industry players are lobbying sympathetic members of Congress for light oversight. Powerful financial firms, eyeing new fees, are campaigning to play a major role in running the market for swaps, which originated as a form of insurance against bond defaults but grew into a wildly popular vehicle for speculation.

Last month, insurance giant American International Group nearly collapsed partly because it had issued $440 billion in swaps to traders around the world and was not going to be able to cover many of the promises it had made to cover defaults on debt. Government officials realized that swaps could pose a threat to the global financial system.

AIG was kept alive by a $85 billion loan from the Federal Reserve, which grew a few weeks later to about $123 billion, the Fed's largest bailout ever for a single firm.

"If there's a sense that another AIG could happen and a whole swath of financial institutions could be jeopardized, then the efforts to restore confidence are really undermined," said Henry Hu, a law professor at the University of Texas. "Without that confidence, there's no free flow of credit, and without the free flow of credit, there's a risk to the real economy."

Regulators have much at stake as well. The focus in Washington on swaps presents an opportunity for the Securities and Exchange Commission to restore its reputation as an active supervisor of the markets after being criticized as lax during the early stages of the financial crisis, analysts said. The agency is considering regulating swaps with some of the same scrutiny it does for stocks and bonds.

That could put it at odds with the Commodity Futures Trading Commission, which could inherit some oversight responsibilities under one industry proposal for establishing a new means of settling swap contracts. The commission's acting chairman told lawmakers at a hearing last week that current law exempts swaps from regulation and that "wholesale regulatory reform will require careful consideration."

Meanwhile, the Federal Reserve Bank of New York is proceeding with its own plans to set up a private-sector process under its jurisdiction for settling swap contracts. The goal is to bring some transparency and stability to the market.

The fate of the credit-default swap market will largely rest on how Congress defines these contracts in law.

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