I’ve said for many months now that Dodd-Frank was not a bill, but a promise to write a bill later. The implementation process lay ahead, and that meant that regulators would have the ability to interpret the will of the Congress. Congress gave them this power very willingly – there are dozens of studies and rulemaking processes called for in the law.

For example, regulators would have to determine the scope of derivatives rules, one of the biggest points of contention. Congress wanted all derivatives to be publicly traded on exchanges or clearinghouses, though at the last minute some exemptions were added to that. Now, Treasury Secretary Timothy Geithner could blow another loophole in the rule by exempting foreign exchange swaps.

The Dodd-Frank bill signed into law in July allows Geithner to decide whether the vast market in foreign-exchange swaps – a type of financial instrument that businesses often use to guard against fluctuations in foreign-exchange rates – should be subject to heightened regulations as other derivatives are.

“It will be very significant,” Karen Shaw Petrou, managing partner at Federal Financial Analytics, said of Geithner’s decision, adding that it will have major implications for the global, multitrillion-dollar foreign-exchange market [...]

Meanwhile, the decision about foreign-exchange swaps, which could come this week, has placed Geithner at the crossroads between big banks, which argue that such deals do not require additional oversight, and some regulators and lawmakers who believe they do.

Big banks claim that foreign exchange swaps played no role in the financial crisis and carried less risks. But this is a disingenuous take – it’s obvious that whatever financial innovation exists in the shadows will be the one used most frequently to maximize risk. So it’s not the type of instrument but how well-regulated it is relative to others that matters. And indications are that Geithner will exempt the foreign exchange swaps, instantly making them more attractive to Wall Street. Geithner is on the record that foreign exchange swaps are “different,” even though he knows well that if you don’t regulate the whole market, the money will move into the shadows. Geithner’s own draft of FinReg exempted the foreign currency market. Gary Gensler, the head of the Commodity Futures Trading Commission, who would have authority over derivatives oversight, wants foreign exchange swaps included in the new rules, but he may not get his wish. And he understands the issue: derivatives traders could simply attach foreign currencies to a standard derivative trade to attain the exemption.

Robert Kuttner gets what amounts to a confirmation from a Treasury Department spokesman on this:

Update: Treasury Deputy Assistant Secretary Steve Adamske, after reading our story, said, “This in no way diminishes our commitment to enforce the rest of Title VII,” [regulating derivatives], in effect confirming that a decision from Geithner to grant the foreign exchange exemption is imminent.

This is basically just a way to keep the casino running. As Sen. Maria Cantwell says:

Sen. Maria Cantwell, one of the most effective advocates for strong derivatives regulation during the Dodd-Frank debates, says, “I can’t believe the first decision the administration would make to carry out Dodd-Frank would be an anti-transparency decision. The idea that the foreign-exchange markets are not at risk is preposterous — we now know that they required multitrillion-dollar bailouts. Anytime you have a lack of transparency, there is potential for abuse.”

The bank lobbyists are pushing hard for this exemption, which should tell you a lot about it. And Geithner appears to be right there with them. I do have to blame Congress for this as well, however. They invested the Treasury Secretary with an extraordinary amount of power under Dodd-Frank. They could have said definitively that all derivatives must be exchange-traded or cleared. They chose to give this escape hatch, allowing Treasury to rework the law without a check. That’s on them.

More from Yves Smith, who thinks that Kuttner is defining the foreign currency market a bit too broadly, but also that Geithner is clearly trying to stifle transparency with this move.