Derivatives & Regulation

Today's big financial news comes from the Senate Agriculture Committee, which passed the derivative regulation bill championed by Chairman Blanche Lincoln (D-AR). Sen. Chuck Grassley (R-IA), ranking member on Finance, was the only Republican to vote for the bill.

The reaction has and will be a mixed bag. Many financial reform advocates have been pushing for airtight derivative regulation provisions and some thought that Lincoln would produce a bill with strong restrictions. Lincoln is facing a serious challenge from her left in Arkansas and her opponent, Lt. Gov. Bill Halter, has been pandering to the liberal base. The idea was that Lincoln would release a robust regulatory package in order to undermine Halter's support and win the affection of primary voters. Yet the bill passed out of markup has some serious flaws.

Clearinghouses are at the core of the Agriculture bill. Currently only a select few types of derivatives are subjected to clearinghouse procedures (which basically enhance accountability and transparency). But under Lincoln's legislation practically all derivatives would be subject to clearinghouses. That's a plus.

But the bill starts to run off of the rails when it comes to direct regulation. Derivatives would be traded on exchanges (primarily the Commodity Futures Trading Commission) and subject to regulation by those exchanges. Problems arise out of exemptions granted on several types of derivatives. For example, foreign exchange swaps are exempt and placed under regulatory frameworks determined by Treasury. This is a massive loophole. By failing to create a strict set of rules, Lincoln has opened up foreign exchange swaps to undue influence from special interests. Moreover, every time you exempt something from exchange oversight you create the potential for more bailouts, more taxpayer dollars wasted, and thus fewer votes at the polls.

More on this later.

-Mike Pawlows