I wanted to know a little bit more about this late-in-the-game derivatives loophole that is potentially holding up Wall Street reform, so I talked to Michael Greenberger, a professor at the University of Maryland School of Law and the former Director of the Division of Trading and Markets at the Commodity Futures Trading Commission under Brooksley Born. He’s about as knowledgeable about derivatives and their import as anyone involved in this debate, and he believes that Maria Cantwell did the right thing in holding up cloture on the bill in order to tighten the language around trading and clearinghouses. A lightly edited transcript of our conversation follows.
Q: So is this a legitimate problem with the bill? Is the language on derivatives trading and clearinghouses toothless without these proposed changes?
A: Sen Cantwell is absolutely right in what she’s doing. The bill got somehow, through the work of magic, or not so much magic, when they merged the Senate Banking Committee language with the Agriculture Committee, they dropped out something that said, if you don’t comply with the rules on clearing trades, it’s unlawful. Another part said, if the swaps dealer doesn’t comply, the penalty would not be mandatory. Essentially, they’ve removed the ability to enforce the central regulatory tenet of the legislation. They turned statutory requirements into statutory suggestions.
Q: Could this change even get through on a vote at this point, given Republican obstruction?
A: I know that the interest groups stand with her, and when you explain the language to people, and the problem this creates, there’s widespread agreement across both parties. What’s getting her traction right now is that Olympia Snowe said she would support her. Had she not brought this to people’s attention, it just would not have been fixed. So I think she did something courageous. Now there are also issues like the Levin-Merkley amendment on proprietary trading, and the amendment to bring back Glass-Steagall. But for me, the derivatives statute is a joke without this fix. I think with this move, she now has a fighting chance to get the changes. Many of us feel she’s right.
Q: Harry Reid, or his people, said that this could be fixed in conference committee or down the road. Why don’t you agree with that?
A: You have to look at the fact that there’s a similar problem in the House bill. So it can’t be fixed in conference. I’ve seen Phil Gramm produce wonders in a conference, but if you follow the rules, if the statute in question is not in the House version and not in the Senate version, it’s not supposed to get added. The only way it would get fixed, would be maybe through a technical addition.
Q: You mean like what happened during the health care bill, when Stupak tried it? An enrollment?
A: Well that, or what would be easier, is if they threw it in the manager’s amendment. But that’s all very iffy. So Cantwell’s right to push this.
Q: Obviously, derivatives is your speciality. Do you believe that this Senate bill, as written, fixes the major problems with derivatives and will help to prevent the severity of future financial crises?
A: I think it goes a long way in that direction. Because what it says is that all these toxic products can’t be done under cover of darkness. You have the transparency of exchange trading, with a ready price minute-by-minute, and no more market to myth or whatever they used to price these instruments. The other thing is the banks have made a fortune masking the cost of the products, there’s no competition in the market, it’s dominated by the big banks. Goldman Sachs, Bank of America, JP Morgan, Morgan Stanley and Citigroup control 90% of the market. This will help pry open the market. You won’t have Goldman getting paid by Greece $300 million dollars to hide their debt through derivative trades. So if they get the Cantwell changes, I think it goes a long way.
Q: What do you think will happen with the section 716 of the bill, forcing banks to spin off their swaps trading desks? Chris Dodd offered a proposal to basically kill that off, and then he pulled it back.
A: What he proposed was that after 2 years, the banks would have to stop doing prop trading in swaps. But after 1 year, the Financial Stability Oversight Board would vote. And they would report to the Treasury Secretary on their findings. So Geithner would have had some say. Bernanke would have had a lot of say.
Q: That board is made up of people who have basically come out against 716.
A: Right, so the effect is that it would have died one year before it went into effect. I think Sen. Dodd was made to realize that this was not a solution. I even heard that the banks were upset about it, because they didn’t want their prop trading in doubt for even a year.
I believe that if 716 doesn’t get through, something close will. We’re going to give a clear price for banks, and benefit for the taxpayer. And what we’ll say is that banks will have to fill the hole in economy or go out of business. They will not be able to get rich off these unregulated securities anymore.
Q: You don’t think that section 716 would be on the chopping block in a conference committee? The White House doesn’t seem to support it, and the House bill doesn’t have anything like it in there.
A: Yes, but Barney Frank has made several statements about derivatives, saying he wished he would have been tougher on that piece. And remember that his chief derivative advisor, after they finished the House bill he went to work for the banks. That was a severe blow for Frank.
The other thing is that the world has turned financially since November, December. We have the lawsuit against Goldman by the SEC. Just yesterday there was a New York Times article about Goldman customers troubled by their allegiance to no one. And the euro crisis becomes more and more serious, and could be another global calamity. So I think there’s a lot of aggravation in Washington over the role that these instruments played. The swaps blew a hole in the economy and could do so again. I think there’s a lot less tolerance for giving the banks the benefit of the doubt.