Zach Carter reports on a blow to efforts to regulate the runaway derivatives market. Just as most derivatives are set to be put onto clearinghouses, Treasury Secretary Timothy Geithner exempted a large group of derivatives, foreign currency swaps, from the regulations.
The Treasury Department plans to exempt foreign exchange derivatives from new Wall Street reform regulations, a Treasury official said Friday, dismissing concerns about a market that prompted $5.4 trillion of emergency support from the Federal Reserve in late 2008.
Assistant Secretary for Financial Markets Mary Miller told reporters on Friday that the foreign exchange market already functions effectively and would not benefit from new rules. Subjecting the market to new rules, she claimed, would introduce a new and unnecessary “process” into “a very well-functioning market.”
But a 2009 study by Naohiko Baba and Frank Packer of the Bank for International Settlements concluded that there were major “dislocations” in the foreign exchange market in the aftermath of the Lehman Brothers bankruptcy — problems that were only resolved after the Fed pumped money into foreign central banks in order to ensure that global banks had access to dollars.
“After the bankruptcy of Lehman Brothers, the turmoil in many markets became much more pronounced,” wrote Baba and Packer. “In FX and money markets, what had principally been a dollar liquidity problem for European financial institutions deepened into a phenomenon of global dollar shortage.”
Even beyond the foreign exchange market’s problems post-Lehman, which are well-documented, simple common sense would dictate that you don’t keep a $30 trillion segment of the market unregulated. When I wrote about this possibility in March, I said just that: “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.”
The other fear is that derivatives traders could attain an exemption simply by attaching a ForEx trade to their standard derivative deal. So this decision could be a cro-bar to pry the entire derivatives market away from regulation. Before long the entire market could wind up back in the shadows. And your humble blogger isn’t the only one saying this: it’s the argument of CFTC Chairman Gary Gensler, the guy who would be responsible for regulating the derivatives market.
The decision will be subject to public comment, with a final rule written afterwards. So here are some public comments. From Senator Maria Cantwell (D-WA):
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.
From Americans for Financial Reform, the lead coalition in the Dodd-Frank debate, made up of over 250 organizations:
We are deeply disappointed by Secretary Geithner’s decision to exempt the foreign exchange (FX) market from regulation and oversight. It is the wrong policy decision. We hope and expect that Sec. Geithner, and the Administration as a whole, will reconsider this decision and take other steps to vigorously enforce the new law.
This blanket FX exemption opens up an unacceptable loophole in Dodd-Frank derivatives reforms. FX derivatives can approximately simulate many of the interest rate swaps that make up almost 80 percent of the world OTC swaps market, so the FX exemption could open up avenues to evade other derivatives rules. We believe that requiring these transactions to be cleared and traded on exchanges is a crucial part of increasing market transparency and avoiding future threats to the financial stability of the United States.
From the watchdog group Better Markets:
The Treasury decision ignored the fact that the Federal Reserve pumped $5.4 trillion dollars into swap lines with foreign central banks to prevent the collapse of the foreign exchange swap markets after the Lehman Brothers bankruptcy. This was done because the foreign exchange market stopped working as a mechanism to get U.S. dollars overseas. The Fed’s swap lines were a mechanism to replace that broken market.
“It is very disappointing that the secretary disregarded the independent evidence and rubber-stamped an unsupported request by the financial industry,” said Dennis Kelleher, president and chief executive officer of Better Markets. “This decision will needlessly put taxpayers at risk.”
And my favorite comment, via the Zach Carter article, from former top CFTC official Michael Greenberger:
If the too-big-to-fail banks gave out academy awards, Geithner would be best supporting regulator year in and year out.