Treasury Department Working To Defeat Derivatives Reform. Why?

I just can't figure out why the Obama administration sees this as a bad thing. Maybe it'll cut into Wall Street's obscene profits, but other than

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I just can't figure out why the Obama administration sees this as a bad thing. Maybe it'll cut into Wall Street's obscene profits, but other than that, what's the down side?

A Senate proposal to force banks to shed their lucrative yet risk-laden derivatives units -- which is vehemently opposed by Wall Street -- is gaining steam, picking up the support of some regional Federal Reserve chiefs with more on the way.

Yet President Barack Obama's Treasury Department, led by Timothy Geithner, continues to oppose the measure, Senate aides say, who add that Treasury is supporting Wall Street over Main Street by opposing the measure considered of "utmost importance" to financial stability.

"It shows the access of the major Wall Street banks in the Treasury Department in spades," one Senate aide said on the condition of anonymity. Assistant Treasury Secretary for Financial Institutions Michael S. Barr is said to be leading Treasury's efforts.

Senate aides say that more letters of support from other regional Fed presidents are on the way.

Treasury is joined in its opposition to the measure by the Federal Reserve's Washington-based Board of Governors and the head of the Federal Deposit Insurance Corporation, Sheila Bair.

Meanwhile, supporters include the longest-serving policy maker in the Fed, Federal Reserve Bank of Kansas City President Thomas Hoenig, Federal Reserve Bank of Dallas President Richard Fisher, Nobel Prize-winning economist Joseph Stiglitz and House Speaker Nancy Pelosi.

Hoenig and Fisher wrote letters of support last week to Senate Agriculture Committee Chairman Blanche Lincoln, the author of the provision, referring to it as "of utmost importance to our nation's long-term financial and economic stability."

Seems like a common-sense move, right? Actually, the federal government has been subsidizing the derivatives market for a long time. Robert Reich explains why it should stop:

Bernanke’s logic is absurd on its face. In a May 12 letter to Christopher Dodd, he argues that “depository institutions use derivatives to help mitigate the risks of their normal banking activities.” True, but so what? Lincoln’s measure would allow banks to continue to use derivatives. They just couldn’t rely on their government-insured deposits for the necessary capital.

Banks would have to do their derivative trading in separate entites. This would require them to raise additional capital, but why is that a problem? If derivative trading is so useful to them in order to “mitigate the risks” of other banking activities, the banks should be willing to foot the bill. There’s no reason taxpayers should do so. And absolutely no reason taxpayers should have to pick up the tab when banks make bad bets on derivatives.

Bernanke also says Lincoln’s measure would force derivatives activities “into foreign firms that operate outside the boundaries of our Federal regulatory system,” giving foreign banks “a competitive advantage over U.S. banking firms in the global derivatives marketplace.” Even if Bernanke is right, since when is it the business of American taxpayers to guarantee the profitability of America’s largest banks relative to foreign ones?

If policy makers base their decisions on this specious logic, America’s big banks shouldn’t be required to hold any capital at all – for fear they might lose business to a foreign bank that’s not required to.

The trading of derivatives is not so crucial to the American economy that taxpayers should continue to subsidize the practice. If the last two years have taught us anything, the lesson is just the opposite: Derivatives can generate huge risks for the economy unless carefully regulated. Neither logic nor experience suggests that you and I and every other taxpayer should be subsidizing this gambling.

Worse yet, if we continue to subsidize these derivative trading operations, Wall Street’s biggest banks will grow even bigger. They’re already too big to fail.

About Susie Madrak

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