Tags: Dodd-Frank | CFTC | derivatives | farmers

Derivatives End Users Rail at CFTC

By    |   Monday, 29 July 2013 02:02 PM

For the second day in a row, the House Agriculture Committee's Subcommittee on General Farm Commodities and Risk Management, chaired by Michael Conaway, R-Texas, acted out its ambivalence with regard to the derivatives title of the Dodd-Frank Act as it held yet another hearing to allow industry lobbyists to argue that their clients should be exempt.

Gary Gensler, chairman of the Commodity Futures Trading Commission (CFTC), the focus of the industry's ire, has said that at least 500 entities have contacted the Commission to seek exemptions.

Dodd-Frank was a bogus exercise from the outset. When Hank Paulson was named Treasury Secretary in 2006, I predicted a bailout of his previous firm, Goldman Sachs. As the scenario unfolded the following year, with a presidential election looming, Paulson asked for funding to stave off the crisis that was also building. He said the money would be used as a "bazooka" and would probably not have to be spent.

Congressman who attended the meeting with Paulson said they were threatened that the survival of Western civilization was at stake. Paulson's demand for $700 billion was backed by a 2 2/3-page memo, which works out to a little less than $300 billion per page.

There followed the aptly named Troubled Asset Relief Program (TARP), which was advertised as an asset purchase program, but the Treasury came to realize that if it overpaid for the assets as a means of channeling money to Goldman Sachs and the rest of the "too big to fail" banks, they would be found out, so they might as well just give the banks the money.

Then came the travesty of calling the CEOs of the banks to Washington and forcing them to take billions in federal aid, all the while insisting that these were healthy banks. So the banks were forced to take boatloads of money because they were healthy, right?!

By the time Dodd-Frank was written in the spring of 2010, brigades of lawyers had more time to do their billable work, so instead of 2 2/3 pages, a stack of 2,300 pages stood for the same principle — that the largest banks are too big to fail and will continue to enjoy federal supports as, in effect, government-sponsored enterprises (GSEs).

The sponsors and the administration cleverly coupled their bailout program with a claim that Dodd-Frank provided regulators with new tools they didn't have in 2008 and would make sure such an event could never happen again.

At the time, I declared Dodd-Frank "dead before arrival" and predicted that the industry would progressively gain exemption from it in three stages: 1) during the drafting of the bill; 2) during the drafting of implementing regulations; and 3) during judicial review and interpretation of the regulations.

As the years have passed in the "limplementation" of Dodd-Frank, industry lobbyists have gained confidence in their ability to present themselves, not as mass tortfeasors or worse, but as victims of excessive regulation by the same government agencies that have rescued them repeatedly whenever the business cycle exposed the inherent weakness of the business model of the highly leveraged financial intermediary. Now they are innovators and job creators again.

The derivatives title of Dodd-Frank is a microcosm of what is wrong with the latest landmark solution to the perpetual financial crisis. It provides new tools to reduce the threat rampant derivatives trading poses to the global financial system, but since the enactment of Dodd-Frank, the House has switched parties, and the Agriculture Committee, which drafted the derivatives title, lends a receptive ear to industry complaints.

The National Council of Farmers Cooperatives helps farmers manage risk by arranging hedging transactions for them, but of course, they want to be treated as end users, rather than as dealers, and they contend they should be exempt from derivatives regulation. Perhaps the best argument they have is that if everyone is going to be exempt, they want to be in line, too.

In their testimony before the subcommittee, they expressed satisfaction that they will be exempt as end users, but they're not satisfied. They complain that agriculture is a "high-volume, low-margin industry," so they don't like to have to spend money on compliance and technology, and they further object to bank regulators proposing to require the banks they regulate to collect margin from end users, because (not making this up), "The additional capital requirements will siphon away resources from activities and investment in cooperatives' primary business operations."

To drive home the point, they insist that Congress made clear that end users were to be exempt. The coops also object to plans to require posting of margins after one business day, rather than three.

Amazingly, this lobby also objects to requiring futures commission merchants (FCMs), some of which are owned by coops, to maintain at all times enough funds to cover deficits in customer accounts. In this they were joined by another lobby, the Commodity Markets Council, which put protection of customer accounts at the top of its list of concerns, then complained "that the proposed requirement that FCMs maintain a residual amount sufficient to cover on a constant basis the aggregate of customer margin deficits could create considerable liquidity issues and increase costs for FCMs, producers and end users."

So it looks like they want to protect customers accounts, but they strongly oppose doing the things that would have to be done to protect customer accounts.

For good measure, the electricity lobby complains that margin requirements would impair it ability to spend the $90 billion per year needed to upgrade the electric system. Southwest Airlines objects to being required to tie up capital in margin requirements when it could otherwise be invested in planes. The American Gas Association reminds legislators that end users did not cause the financial crisis.

This implies denial that derivatives are a major source of systemic risk, and it will take a coordinated effort to manage the many forms of risk derivatives pose around the clock and around the world.

On the other side of the argument, Democrats marshaled the Commodity Market Oversight Coalition, a group of derivatives end users that submitted a lengthy statement in support of derivatives market reforms as well as a 0.03 percent excise tax on all securities trades.

In conclusion, by insisting that regulations touted as protecting the financial system from another crisis episode exempt end users, Congress doomed this effort from the outset. Worse still, it empowered the industry to say, see, we're supposed to be exempt.

This reinforces a culture in which farmers, who are already taxing the country through subsidies that are about to be extended even when prices are high, to push the costs of their admittedly risky operations on someone else, anyone else. With attitudes and policies like these, there is no reason to expect this country ever to get out of the cycle that transmits the risk of the boom-bust cycle in agriculture to the rest of the economy and compounds the effect through financial leverage.

Both CFTC Chairman Gensler and Securities and Exchange Commission Chairman Mary Jo White are slated to testify Tuesday before the Senate Banking Committee, and it is virtually certain that they will be asked detailed questions about the difficulties they are having, both separately and together, in completing the extensive regulatory agenda created by Dodd-Frank three years ago.

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For the second day in a row, the House Agriculture Committee's Subcommittee on General Farm Commodities and Risk Management acted out its ambivalence with regard to the derivatives title of the Dodd-Frank Act.
Monday, 29 July 2013 02:02 PM
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