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The White House picks a fight on derivatives

Timothy Geithner has an op-ed in today's Washington Post arguing that "as the Senate [financial regulation] bill moves to the floor, we must all fight loopholes that would weaken it." But the loopholes he's arguing against haven't actually been unveiled yet. So this op-ed applies the Bush Doctrine to legislative politics: Anticipate the threat and strike before it reveals itself. To paraphrase Condoleeza Rice, you don't want the smoking gun in the form of a bipartisan deal on a bad bill.

The concern is over the derivatives language that Blanche Lincoln and Saxby Chambliss are writing. Because of a Senate quirk -- yes, another one -- derivatives are under the control of the Agricultural Committee, which Lincoln and Chambliss run. So notice the industries Geithner bows towards in his op-ed:

Transparency will lower costs for users of derivatives, such as industrial or agriculture companies, allowing them to more effectively manage their risk. It will enable regulators to more effectively monitor risks of all significant derivatives players and financial institutions, and prevent fraud, manipulation and abuse. And by bringing standardized derivatives into central clearing houses and trading facilities, the Senate bill would reduce the risk that the derivatives market will again threaten the entire financial system.

Wall Street and the Republicans appear to have dropped their fight against the Consumer Financial Protection Agency because it doesn't much matter for Wall Street and it's bad politics for Republicans. Instead, Wall Street's main priority now is keeping the derivatives market from being moved out of the shadows and into the light. It's simply much, much, much more profitable for them to write these complicated contracts when their customers don't have access to a standard price.

But that's not the argument, of course. The idea is to get non-banks to lobby for a wide exemption from the derivatives regulation -- wide enough that financial players can sneak inside it as well. But this alliance between the banks and the other users is a bit of an odd one. That's why Geithner is arguing, correctly, that transparency will lower costs for users. Put simply, if Wall Street is making a ton of money off of these trades, then the people who are paying them are not getting a good deal.

For more on the fight over derivatives, see Damian Paletta's article in today's Wall Street Journal. But the more decisive pressures may come not from the White House or Wall Street, but from Arkansas, where Lincoln is running for reelection. On the one hand, she could sure use a massive supporting expenditure from the banks. On the other hand, her primary challenger is threatening to attack her as a servant of Wall Street if she does their bidding on this.

By Ezra Klein  |  April 13, 2010; 7:53 AM ET
Categories:  Financial Regulation  
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Next: Contracts are sacred only when rich people are getting paid


Ezra, you need another cup of coffee this morning. There is an unusual amount of grammatical mistakes in this post.

Posted by: counselorking | April 13, 2010 8:37 AM | Report abuse

Ezra, I think you've taken a cynical view of Senator Lincoln's motives here. From my understanding, agricultural producers (and many other industries) use derivatives to hedge against swings in commodity prices. It's not the transparency they're worried about, it's capital or margin requirements that would make tie up capital they usually invest in producing crops - making hedging much more difficult or impossible. I think the Chairwoman is much more motivated by their concerns than by Wall Street's.

Posted by: BTW123 | April 13, 2010 8:57 AM | Report abuse

The problem isn't an exemption for ag companies. The problem is writing it broad enough that banks can get through as well.

Posted by: Ezra Klein | April 13, 2010 9:13 AM | Report abuse

This seems like a good issue for the WH, because they have policy and politics on their side. They can cite transparency and information symmetry as free market principles, while also resonating with people's mistrust of Wall Street.

Posted by: jduptonma | April 13, 2010 9:15 AM | Report abuse

The fact that derivatives are under the control of the Agriculture Committee isn't so much a quirk; it's more of a legacy, back when derivatives were mostly about wheat, pork bellies and the like. These days, of course, derivatives have exploded into almost every conceivable financial market (mortgages, currencies, indexes), so it's time to move derivatives out of Ag into Banking and/or Finance. Not so sure that will happen anytime soon, however.

Posted by: gateway_joe | April 13, 2010 11:37 AM | Report abuse

Ezra, as someone who has mentioned regulatory capture in the past, why do you think this time will be any different? The U.S. is riddled with examples of government failure but I don't remember one post from you addressing it. If you haven’t studied Coase or Tullock you need to do so immediately and incorporate their insights into your blogging.

Posted by: kingstu01 | April 13, 2010 2:02 PM | Report abuse

The Crime: Naked Shorting.

n reality, of course, the “special machines” that bankers and hedge fund managers are using are not actual physical machines, and what they are destroying are not “small island nations,” and what they are printing is not “currency.” In reality, the “special machines” are loopholes in our legal system, what the bankers and hedge funds are destroying are small companies, and the “currency” they are printing off to do so are shares of stock in those small companies.

It may be hard to believe, but such loopholes really do exist (I will be explaining several of them in subsequent blogs). In reality, however, neither you (if you are like most Americans) nor I can actually use them. Only large hedge funds and broker-dealers can access these loopholes to create IOU’s (just as, in the story of St. Smallcap, only hedge funds were allowed to own the currency machines with which to print off that “temporary” currency). As we will see in more detail, these hedge funds and broker-dealers have learned how to manipulate these loopholes in the stock settlement system so as to flood the market with over a billion IOU’s (maybe many billion) in hundreds of companies. In doing so, they have disrupted the market for shares of companies that are researching cures for cancer and other illnesses, figuring out how to make blood substitutes to treat cases of acute blood loss, and building mine-resistant vehicles for troops in Iraq. Hundreds of such corporate “St. Smallcaps” have been damaged or destroyed. Thus, cancer patients are being deprived of treatments, accident victims are dying of acute blood loss, and soldiers in Iraq are dying from IED’s, so that some hedge fund ass-clowns can drive new Ferraris.

Posted by: Bixbyte | April 13, 2010 6:52 PM | Report abuse

Look at these three small company charts: NVLT, SNSS, MIPI to see how naked shorting destroys investment in companies that have experimental treatments for cancer. You can see the naked shorting activity that the SEC says is illegal but they also maintain a NAKED SHORT journal of all short activity. There is no SEC enforcement of illegal naked shorting. The SEC never watches the big guys. They get to keep all our money.

Posted by: Bixbyte | April 14, 2010 9:51 AM | Report abuse

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