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The Embedded Derivative in Financial Regulatory Reform Legislation

In Le Gardien on April 25, 2010 at 9:09 PM

Last Wednesday, the Senate Agriculture Committee voted to move forward with proposed legislation concerning derivatives contracts regulation. Ranking minority leader Saxby Chambliss (R-GA) impressively opposed the bill; however, the Vote ended 13-8 in favor of passage anyway, with one Republican, Chuck Grassley (R-IA), voting in favor of the legislation. Lobbying dollars from IntercontinentalExchange (ICE) arguably won out over voter sentiment again in this instance for Chambliss, just as similar in fashion to Chambliss’ rejection of the bipartisan Dorgan-McCain healthcare amendment that would have adopted zero-arbitrage parallel trading of prescription pharmaceutical medications at the country-level.

Majority leader Chairman Blanche Lincoln (D-AR) provided the legislation aimed at forcing approximately 90 percent of derivatives into a more conforming, standardized setting to be marketed on publicly-visible exchanges. From an information symmetry standpoint, many are applauding the measure; though, it is difficult to discern to what extent the move will create heightened levels of guaranteed income for exchange-oriented businesses like ICE of Atlanta, GA. Newspaper columnist Jay Bookman examined the nexus of lobbying meeting legislating in a more recent article from last week – read A case study in power, politics and very big money.

Politico and C-SPAN offer the play-by-play on the Lincoln legislation: Senate Agriculture Committee passes derivatives bill and Wall Street Transparency and Accountability Markup, respectively.

Are Derivatives Dangerous?

Recall Warren Buffett famously described derivatives in the headlines, referring to them as “financial weapons of mass destruction” – watch The Bet That Blew Up Wall Street. The St. Louis Fed is to a large extent in agreement – read The Regional Economist from April 2009. Major news organizations too have been reporting on the embedded leveraging power of such instruments – especially credit-default swaps, the variety insurance contract dominantly responsible for the record collapse of American International Group (AIG) in 2008. Many experts familiar with these younger financial hedging instruments are arguing for regulating and standardizing the contracts, in effect, by placing them on clearinghouses or exchanges.

Former New York Fed president Timothy Geithner, for instance, notably pushed early on in his pre-Treasury career for more counterparty disclosure and collateral strengthening in this market while working in New York – read Atlantic Magazine’s Nouriel Roubini commentary from July 2009. Former Commodity Futures Trading Commission (CFTC) director Michael Greenberger memorably pre-dated Geithner’s efforts alongside former CFTC chairman Brooksley Born as early as the late 1990s – read Greenberger’s opinion of the current Lincoln proposal. For more detail, The Warning, a Frontline documentary, offers a wider glimpse into the breakdown in policing of the derivatives market that occurred under the Clinton administration period.

Chambliss — The Evolution is Not Here

For added background on Sen. Chambliss, it is interesting to chart his philosophy on financial regulation and the role of government in dealing with financial intermediation before and during the current Epic Recession. Interesting because he voted for H.R. 1424, i.e., the so-called Troubled Asset Relief Program (TARP) Act in 2008 – recall October 1, 2008. It is worth remembering that the entirety of Georgia Republicans in the House of Representatives opposed that same legislation – recall October 3, 2008. Reaching even further back in time, Chambliss voted to repeal the Glass-Steagall Act in 1999, passing S. 900 — recall November 4, 1999 — just as he moved to deregulate the ENRON loophole in the Commodity Futures Modernization Act authored by Sen. Phil Gramm (R-TX) in 2000, passing H.R. 4577 – recall December 15, 2000.

One may recall the very close Georgia run-off election for Senate in 2008 (one that could have been avoided entirely – read Instant Gratification (IRV)) where Chambliss edged out Democratic contender Jim Martin. In that race, Chambliss raised and spent over $18 million, obtained from a wide variety of campaign donation sources – read The Center for Responsive Politics for specific numbers.

For protective measure, Chambliss might better follow the lead from Rep. Barney Frank (D-MA) and move to restrict ICE staffer-turned-lobbyist Peter Roberson from lobbying him and/or his legislative staff on the subject of derivatives regulatory reform – read Barney Frank rips staffer-turned-lobbyist. Unfortunately, following the advice of special interests has been rewarding for Chambliss.

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