Senate Panel Passes Derivatives Rules Despite Swarm of Lobbyists

Posted Apr 21, 2010 by Bill Lindner
Despite more than 1500 lobbyists, executives, bankers and others swarming to Washington as the Senate took up legislation to rein in derivatives -- the complex securities at the heart of the financial crises -- a Senate panel passed tougher rules
Washington: Capitol Hill.
Washington: Capitol Hill.
More than 1,500 lobbyists, executives, including Chamber of Commerce executives, bankers and others reportedly made their way to Washington as the Senate Committee took up legislation to rein in derivatives -- the complex securities at the heart of the financial crisis, the mufti-billion dollar bailouts and the fraud case filed by the Securities and Exchange Commission against Goldman Sachs last week.
Attempts by Goldman Sachs and other financial giants to curb financial reform have kicked into overdrive as donations to politicians in Washington are at record levels. Despite having fraud charges leveled against them, it's business as usual for Goldman Sachs: they're preparing to shell out another $5 billion on bonuses to employees -- for the first three months of this year.
This time it's the Senate Agriculture Committee dealing with the reform instead of the Senate Banking and Financial Services Committee.
Money is the main weapon being used to fight the battle over financial reform. Agriculture Committee members have received $22.8 million in this election cycle from people and organizations affiliated with financial, insurance and real estate companies -- two and a half times what they received from agricultural donors, according to the Center for Responsive Politics.
Esoteric Derivatives Have Little Purpose Other Than Letting Investors Place Financial Bets on Them
Much of the lobbying is centered on Senator Blanche Lincoln of Arkansas, the committee's chairwoman who introduced a bill last week that could prevent banks from trading derivatives directly. Wall Street has raised $60,000 at two fundraisers for her re-election campaign so far this year. Other committee members have also reaped donations from people and companies in the derivatives business.
According to the New York Times (NYT), the Agriculture committee will be the main arena for the derivatives fight for reasons dating back to an era when farming was more important to the nation's economy than finance.
In their simplest form, derivatives can provide financial protection on the value of an investment or commodity. For example, by putting up a relatively small amount of money, a farmer could buy a forward or futures contract guaranteeing a set price for crops, guarding against disastrous price swings between planting time and harvest time.
Esoteric derivatives -- like those used by Goldman Sachs that have resulted in their being sued for fraud -- are the most profitable for banks to create and trade, and have little if any economic purpose other than letting investors place financial bets on them.
Derivatives Are the New Ticking Time Bomb
Derivatives helped inflate the housing bubble. Wall Street repackaged high-risk mortgages into securities that speculators used to bet on -- and profit greatly from -- the direction of the housing market. Million of dollars in fees were earned by financial institutions for creating the derivatives. Many of those derivatives became worthless when the foreclosures ballooned, which ended up leading to billions of dollars in losses and taxpayer bailouts at the banks and insurance companies that owned them.
The total notional amount of futures derivatives was $81 trillion by the end of 2008. Tailor-made derivatives traded on over-the-counter markets totaled $596 trillion at the end of 2007. Derivatives, as noted by Market Watch in early 2008, are the new ticking time bomb.
The extremely overinflated price consumers paid for gas in 2008 -- and the reason gas prices are beginning to rise now -- was due to manipulation and speculation because of unregulated international derivatives trading in oil futures, effectively creating a bubble, just like the housing bubble, that will burst. Hedge funds and banks have been driving oil and gas prices for more than a decade.
The swarm of lobbyists that descended on Capitol Hill aren't just from Wall Street. Manufacturers, airlines and other industries that use derivatives to control their business and foreign currency costs worry about protecting their assets that could be controlled by Senator Lincoln's bill.
Wall Street Strongly Opposes Legislation That Introduces Price Competition and Lowers Profits
On Friday, Senator Lincoln introduced a derivatives bill which, according to the NYT, is expected to be folded into the sweeping overhaul of the nation's banking system and would also require most derivatives trades to be routed through a third party, known as a clearing agent. That would provide each of the parties a guarantee that they would be paid if the other party defaulted or went out of business. Senator Lincoln's bill would also require most derivatives to be traded on an open exchange.
As of now, the only way to trade many derivatives is to call various dealers and ask for the price at which they are willing to buy or sell. The securities dealer profits from the difference between the prices at which it buys from one party and sells to another. Wall Street has signaled that it can live with a clearinghouse approach, but strongly opposes an exchange trading of derivatives because it would introduce price competition and lower their profits.
Part of Senator Lincoln's bill, which even the Obama administration opposes, would essentially ban banks from being dealers in swaps or other derivatives by taking away their access to federal deposit insurance and their ability to borrow from the Federal Reserve if they kept those businesses. It's not known why the Obama administration is opposed to it, but there is some speculation that donations of almost $1 million to the Obama campaign by Goldman Sachs when he was running for President may have something to do with it.
Senator Lincoln, up for re-election, faces a tough primary challenge in May to get to the general election in November according to the NYT, who she told “The people of Arkansas never again want to have to foot the bill for what happens on Wall Street. If banks want to be in that kind of risky business, they should have to separate it off in a way that lowers the systemic risk.”
Tougher Derivatives Rules Passed Despite Swarm of Lobbyists
Despite the swarm of lobbyists, the Agriculture Committee reportedly voted 13-8 to approve Senator Lincoln's bill. In approving the bill, the committee decided to allow for an exemption of derivatives used to hedge against movements in foreign currency exchange rates.
A staff review of the bill said the exemption would depend on a written determination by the Treasury secretary that so-called foreign exchange swaps should be exempted.
According to the NYT, Senator Lincoln decided to make the change after she spoke with Senators in both parties and some companies that use foreign-exchange derivatives to protect against swings in the value of profits earned in overseas operations.
The Treasury Department indicated that it could support some exemptions in derivatives coverage for certain commercial end users such as businesses trading derivatives in order to protect their operations from swings, such as fuel costs or other raw materials.