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One More Step Toward The Next Meltdown

Economy Memo Pad Politics

One More Step Toward The Next Meltdown


The delaying tactics we told you about nearly two years ago have worked beautifully. The bailout worked (if not for homeowners, at least for the banks). It worked so well that the underlying problems that led to the financial crisis have remained largely ignored.

The regulations that have been written (and continue to languish during their extended comment period) are on their way to being eliminated or weakened yet again by Congress. The House helped out this week by passing a bill (HR 4413) that ensures that if any regulations do get approved, they will be difficult to enforce.

As we reported back in 2012, JPMorgan Chase in London managed to avoid examination and enforcement by the Commodities Futures Trading Commission simply by labeling their massive speculation in credit default swaps as “portfolio hedging.” It was a loophole big enough for a whale to swim through.

Another loophole made enormous by HR 4413 is the cutoff separating “end users” from “swap dealers.” In the CFTC draft regulations written after Dodd-Frank initiated oversight on the swap business, any market player with more than $100 million in swaps per year was considered a dealer, and subject to stricter oversight and capital requirements.

After the industry complained, the CFTC agreed to delay that stronger oversight for two years and put in a temporary $8 billion cap that was due to drop to $100 million later this year. The bill that passed the House makes that $8 billion cap permanent. Now any firm that wants to do $100 billion in business without regulation has the option to create 13 separate companies.

From the point of view of the people who profit from the lack of regulation, streamlining the lack of oversight is financially sound. After all, real estate values in waterfront Greenwich estates, the Hamptons, and even Park Avenue will likely suffer if bankers and hedge fund managers make less money.

For those who trade in opaque markets, profits are maximized when some participants have information that their customers and competitors don’t have. An open market with published prices and capital reserves would limit profits and return on equity. Complying with regulations and keeping records available for supervisory review costs money. It all cuts into profits.

And if profits get squeezed by an overbearing, overregulating government, how can a valuable part of our capital markets survive? It’s not cheap, after all, to employ the people needed to execute this business that virtually no one understands and that the government doesn’t want to regulate.

Remember when AIG Financial Products blew up? Even though there were traders, accountants, clerks, lawyers and others from Lehman who found themselves jobless, the Treasury Department decided to pay more than a million dollars in bonus payments to each of the valuable AIG employees that had bet so big, and so badly.

Thankfully, the lobbyists hired by the industry have figured out how to keep the business profitable, and how to turn the task of complying with new regulations into a potential new profit center. They helped incorporate a brilliant strategy into HR 4413, and got 265 members of the House to vote for it.

The CFTC will be required to create and publish cost-benefit studies prior to adopting new compliance policies, and those studies will be subject to judicial review. That will take some time. After the CFTC rules go into effect, market participants will be free to argue that the cost estimates were inaccurate. Because the studies are subject to judicial review, the companies being regulated can theoretically get the government to pay them for any additional costs they incur when complying. With a little creative accounting, maybe the swap dealers will turn a profit on compliance departments.

While the delaying tactics written into the bill keep regulation at bay, trading in credit default swaps will continue as it has, with the risks it has, here and abroad. Over half of the hundreds of trillions of dollars in swaps on the books of our banks belong to foreign subsidiaries. A condition of the new bill requires the CFTC and the SEC to certify that derivatives regulations are not already in place in those foreign jurisdictions before they become subject to the new “regulations.” All a bank or hedge fund needs to do is dispute the nature of existing derivatives regulations in their legal places of business overseas, and any oversight can come to a grinding halt while they all work it out. In the meantime, they can enter into lots of credit default swap contracts.

Perhaps the most brilliant part of HR 4413 is hidden in the budget. The congressionally mandated increased workload has no accompanying increase in the commission’s budget. It won’t be easy to run thousands of legal and economic analyses without the people to do it or the money to hire them.

Speaking of people, the bill passed in the House also peculiarly reinvents the org chart. Key regulatory and enforcement personnel currently report directly to the commissioner of the CFTC, but under the new law, those people would instead report to five different members of the commission. Hiring, firing, and departmental budgeting will be decided by all five members together.

Have you ever reported to five bosses at the same time? I did, for about a year, and it’s nearly impossible to get anything done.

By the way, in case you thought our government didn’t have a sense of humor, Congress tells us we can call HR 4413 the “Customer Protection and End User Relief Act.”

Howard Hill is a former investment banker who created a number of groundbreaking deal structures and analytic techniques on Wall Street, and later helped manage a $100 billion portfolio. He writes and blogs at mindonmoney.wordpress.com

Correction: The “hundreds of trillions of dollars” figure cited in the 12th paragraph refers to all swaps, not just credit default swaps as this post originally stated.

Photo: mlmdotcom via Flickr



  1. Sand_Cat June 27, 2014

    And who was it saying “Clinton” repealed financial protections and thus helped bring about the last crash?

    1. Independent1 June 30, 2014

      It was the same people (Republicans) who keep blaming Clinton while failing to tell the true story: that it was primarily Republicans which fought hard to push through the repeal of the financial protections in the late 1990s which the vast majority of Democrats opposed. Clinton was left with little choice other than to sign the legislation because of the brainwashing the GOP had done of the American populace (and maybe even him). Had Clinton vetoed the legislation, it’s quite possible the GOP could have put enough Democrats from battleground districts on the spot that they could have gotten more than just the handful of Dems who originally voted for the repeal to support an override of his veto as the GOP had built quite a persuasive media blitz supporting the repeal.

      1. FAMULLAR July 3, 2014

        There are stories some people might not expect to read about Iran – and its progressive drugs policy is one. As a number of countries begin to slowly reconsider their approach towards illicit drugs, following the avant-gardiste move of José Mujica’s Uruguay, the issue of drugs and treatment of drug abuse might be one where Iran could provide some meaningful contribution to the rest of the world.

  2. Bruce June 28, 2014

    What sized increase in interest rates will make the derivatives implode? There are a lot of AIG look-alikes out there with trillions of dollars of exposure.

    1. charleo1 June 28, 2014

      I think the plan is to put the economy back so far out there on the
      proverbial limb. The Fed’s raising of the prime, will become once again tantamount to pushing the destruct button. Thereby the free
      money at the Fed window can be perpetuated far into the future. This policy, known on the Right, as, “the magic hand in the taxpayer’s pocket,” T-Party extraordinaire, Cooter Jones, describes this situation as the result of inner city parasites, sucking at the tit of a bloated, Federal Gov. And thereby losing their work ethic. His solution is to stop all the regulation, and welfare spending immediately!

      1. Independent1 June 30, 2014

        Jones is obviously just one more totally delusional Republican, given that if the government reduces welfare spending, it won’t be “inner city parasites” that will suffer the most, it will be 20 plus red states that may well be driven to the point of bankruptcy given that more than 80% of welfare dollars, including food stamps go to people living in red states. And that’s because the vast majority of red states have purposely structured their budgets on drastically reduced taxation based on the expectation that a large portion of their funding will come into the their states via welfare from the feds; so if that’s cut off, more than 75% of red states will have to scramble to realign their state funding, maybe by increasing taxes in order to keep from drowning in red ink.

        1. charleo1 June 30, 2014

          I was reading yesterday where SCOTUS and it’s five, anti-labor ideologues, are going to make a ruling this week concerning public sector unions. And if money is speech, as the thinking goes, how may unions levy dues to members who don’t agree with their union, or don’t believe unions ought to exist? So, for those of us who believe our Democratic Party has been a bit too cozy with Wall Street, and financial regulation, and a lot too generous with corporate welfare. We may be seeing a situation being created, where big business money is the only game in town to fund the runaway pay to play system the Court set up a while back. The problem is, too many people are living in the past. Thinking about economic matters in ways that haven’t been the case for a couple of decades now. Where if businesses were successful, the whole proposition worked for all parties. Profitable businesses in a diverse economy, paid a good, or fair portion of the necessary taxes. Wages lagged a bit, but there was a connection between wages, productivity, quality of the product, and sales. And that’s the picture many have in their minds, especially on the Right, when the subject turns to economics. If wages are too low, they ask by what measure? Believing wages are still directly tied to work. So, work harder is their solution. The minimum wage becomes gov. interference in the free market. Or the tax burden must be too high, and businesses don’t have enough after taxes to invest, and grow, and create new jobs. So this old timey version of 1950s, Americana is how many Americans believe the economy still works. And can’t imagine why. anyone would believe it needs regulation. In fact they’ll swear to you, regulation, the gov. and people who refuse to work, are the problem. Add to this the nuttery of just a ton of plain old snake oil. And I believe, brick by brick, they are getting away with building what will become a feudalistic, global system. Eventually run by a relatively small number of corporate giants, that will, in a very corporate way, control money supplies, means of production, the water supply, (very important,) and of course, as we already see here, governments, armies, and just as important the public conversation, and information populations are given to explain all the breakdown of civil society, and the various, “necessary measures,” that will be used to keep a lid on the broiling pot. Now Indy, I am totally aware that sounds as bad as some of the Right Wing, conspiracy nuts. And, if you think so, it won’t hurt my feelings a bit to hear it. Knowing what you know about all this, I’d actually feel much better, having you call me a nut anyone I can think of. And that includes my wife, who calls me a nut all the time!

          1. Independent1 June 30, 2014

            Charle, I can’t disagree with a thing you said. Just by nature, conservatives are reluctant to accept change due to fear of the unknown (progress). That’s why they’re trying to hold on so hard to the past. As you point out, they love the idea of the feudal system where little changed and the wealthy had total control over the masses. Before 1900, few ever thought about bucking the system and creating things like unions, which is why they’d love to see the world go back to the time before the labor movement got started.

            And they know that the only way they can bring America, and the world, back into the past, is to have total control of the governments; which is why here in America they’ve worked to stack the SCOTUS with corrupt judges that can be bought , so they can have the SCOTUS push through mandates like: money is nothing more than free speech, rulings which allow corporations to buy elections by using their money to brainwash the weak minded in the masses and even when necessary, pass down rulings that let conservatives win elections which they would have lost if the election was run fairly.

            If there are people who think you’re nuts for believing what you described in your latest post, then there are at least two nuts running around America because I agree with what you said.

          2. charleo1 July 1, 2014

            Thanks for that. I’ll cancel my psychiatrist for now.

  3. Elop Dev June 30, 2014

    A society of merit is a society of chores performed rather than success achieved; a society subject to the whims of those who judge merit.

    1. charleo1 June 30, 2014

      So how would you judge the success of that lame as hell, comment?


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