Warren Buffett famously called derivatives financial weapons of mass destruction. That was before they detonated, propelling the financial system toward the brink of collapse. Then, as part of the Dodd-Frank law meant to prevent future crises, Congress last year demanded a new system of regulation for the financial instruments.
Now a battle is brewing over the details of that regulatory regime.
Corporate groups are protesting that some of the derivatives regulations could be bad for business, and they are urging the government to move more slowly. House Republicans, who overwhelmingly opposed Dodd-Frank, are arguing that regulation could undercut the U.S. derivatives industry, destroying jobs and driving business overseas.
Democrats countered that unregulated derivatives have already destroyed jobs and forced the government to bail out Wall Street.
“There seems to be a mass case of amnesia,” Rep. Ed Perlmutter (D-Colo.) said.
Derivatives, which can be used to insure against risks or to make speculative investments, are contracts tied to some financial benchmark, such as mortgages, commodities or interest rates. Some of them bear daunting names such as “synthetic collateralized debt obligations.” For the most part, they have gone unregulated.
Dodd-Frank generally calls for them to be traded in markets like stock exchanges, where the prices would be plain to see and it would be harder for firms in the business of minting derivatives to extract outsize profits.
In addition, Dodd-Frank calls for steps to make sure the parties to those contracts have the financial wherewithal to make good on their commitments — for example, by putting down collateral. But business groups are arguing that such a requirement, known as “posting margin,” could force them to tie up capital they could use more productively.
Though derivatives are often associated with financial institutions such as hedge funds and banks, whose systemic importance can make them “too big to fail,” Tuesday’s hearing showcased a more sympathetic face of the derivatives user: MillerCoors.
Critics of regulation tried to drive the potential costs home in the plainest of terms — the potential cost of a six-pack.
In a statement to the committee, MillerCoors risk management director Craig Reiners said the brewing company uses derivatives not to speculate in the financial markets but to control for fluctuations in the price of barley, corn and hops — plus the energy that runs the breweries and the aluminum that goes into all those cans.
The “prudent use of derivatives by end-user companies, such as MillerCoors, does not generate risk or instability in the financial marketplace and played no role in the financial crisis,” Reiners said.
The chairman of the Commodity Futures Trading Commission, one of the agencies responsible for translating D0dd-Frank into detailed rules, agreed that the money-down, or “margin,” requirements should apply only to financial companies, not to “end users” such as MillerCoors trying to insulate themselves from swings in the cost of raw materials. “We’re aware [of] and focused on the cost of a six-pack,” Gary Gensler said.
But for many users of derivatives, the commodity regulator is less relevant than the bank regulators, and one bank regulator staked out a different position Tuesday.
Daniel K. Tarullo, a member of the Federal Reserve Board of Governors, said the Fed could adjust the margin requirements to reflect the fact that most end users pose a lower risk to the financial system.
J.P. Morgan Chase, a big middleman in the derivatives trade, argued that current proposals could put a damper on the financial system by making it too expensive to manage risk through the use of derivatives.
“Without care, there is a real risk that the current proposals will drive liquidity out of U.S. markets,” said Don Thompson, a managing director at J.P. Morgan.