A $600 Trillion Bubble? Lobbyists Swarm Derivatives

Published on
by
The New York Times

A $600 Trillion Bubble? Lobbyists Swarm Derivatives

A Finance Overhaul Fight Draws a Swarm of Lobbyists

by
Edward Wyatt and Eric Lichtblau

Timothy Geithner, center, Treasury secretary, with Senators Blanche Lincoln and Saxby Chambliss of the Agriculture Committee. (Jim Watson/Agence France-Presse - Getty Images)

WASHINGTON - Assessing the battle to overhaul the nation's financial regulations recently, Jamie Dimon, the chief executive of JPMorgan Chase, left no doubt about the consequences if Congress cracked down on his bank's immense business in derivatives.

"It will be negative," he said. "Depending on the real detail, it could be $700 million or a couple billion dollars."

With so much money at stake, it is not surprising that more than 1,500 lobbyists, executives, bankers and others have made their way to the Senate committee that on Wednesday will take up legislation to rein in derivatives, the complex securities at the heart of the financial crisis, the billion-dollar bank bailouts and the fraud case filed last week against Goldman Sachs.

The forum for all this attention is not the usual banking and financial services committees, but rather the Senate Agriculture Committee, a group more accustomed to dealing with farm subsidies and national forest boundaries than with the more obscure corners of Wall Street.

A main weapon being wielded to fight the battle, of course, is money. 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.

Much of that lobbying has centered on Senator Blanche Lincoln, the Arkansas Democrat who is the committee's chairwoman and who last week introduced the bill that would prevent banks from trading derivatives directly.

The daughter of a sixth-generation rice farmer, she has found herself navigating a dangerous channel between Wall Street firms, which raised $60,000 at two fund-raisers for her re-election campaign so far this year, and her constituents, many of whom want a crackdown on the speculation that led to the financial crisis.

Other committee members, on both sides of the aisle, also have reaped donations from people and companies in the derivatives business, including Senator Saxby Chambliss of Georgia, who is the committee's ranking Republican member; Kent Conrad, the North Dakota Democrat; and Charles E. Grassley, the Iowa Republican.

The committee will be the main arena for the derivatives fight for reasons dating 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 derivative known as a forward or futures contract that would guarantee a set price for crops and thereby guard against ruinous price swings between planting and harvest.

But the most esoteric derivatives - which also are the most profitable for banks to create and trade - have little economic purpose other than to let investors place financial bets, critics say.

A more complex type of derivative helped to inflate the housing bubble in recent years, as Wall Street repackaged high-risk mortgages into securities that speculators could use to bet on the direction of the housing market. Financial institutions earned millions of dollars in fees for creating the securities. But many of the derivatives became worthless when foreclosures skyrocketed, leading to billions of dollars of losses - and taxpayer bailouts - at the banks and insurance companies that owned them.

Now, these obscure and largely unregulated securities - more than $600 trillion of which are tucked into investors' portfolios, according to the Treasury Department - are at the center of the fight over financial reform led by the Obama administration.

"The best that we can do for the American people is to put in place rules that will prevent firms from taking this risk again, make sure we protect the taxpayer, bring derivatives out of the dark - that's what we can do, " said Timothy F. Geithner, the Treasury secretary.

The lobbying is not just coming from Wall Street. Manufacturers, airlines and other industries, which use derivatives to control their business and foreign currency costs, worry that an important means of protecting their assets could be curtailed by Mrs. Lincoln's bill.

"I think a lot of members of Congress are just getting up to speed on how these markets work," said Paul Cicio, who is president of the Industrial Energy Consumers of America, which represents an array of industries like fertilizers and chemicals. He said he worried that the lobbying prowess and financial resources of Wall Street firms, even when operating in the unusual environs of the agriculture committee, had the potential to outmuscle their opponents, which want greater regulation.

"Of course I'm going to be concerned, because they are big-money companies," and derivatives make up substantial portions of their profit margins, he said. "But this is incredibly important, and it's important to get it right."

On Friday, Mrs. Lincoln introduced a derivatives bill that seemed intended to show that she could be hard-nosed with Wall Street yet accommodating to Arkansas constituents, ranging from Wal-Mart to small community banks, which have a big interest in the derivative fight.

Small-town bankers in Arkansas and elsewhere want to regulate derivative speculation because they believe widespread betting on home mortgages led to bank failures and pushed up the cost of federal deposit insurance for all banks.

The derivatives bill, which is expected to be folded into the sweeping overhaul of the nation's banking system, 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. The bill would also require most derivatives to be traded on an open exchange.

Currently, the only way to trade many derivatives is to call up 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. Investors rarely, if ever, see details on the other side of the trade. Wall Street has signaled that it can live with a clearinghouse approach, but it is strongly opposed to exchange trading of derivatives, which would introduce price competition and lower the profits.

Wall Street bankers were stunned by the most aggressive portion of Ms. Lincoln's bill, one that is opposed even by the Obama administration. That proposal 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.

Mrs. Lincoln, who is facing a tough primary challenge in May to get to the general election in November, said in an interview that she was not sure why the administration did not fully agree with her derivatives approach.

"The people of Arkansas never again want to have to foot the bill for what happens on Wall Street," she said. "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."

 

Share This Article

More in: