Legislation by Representative Barney Frank to tighten derivatives regulation contains an exemption that may let most financial firms escape new collateral and disclosure rules, the head of the Commodity Futures Trading Commission said.
It's time to watch Wall Street flex its political muscle. The financial magicians do not want the government to regulate the fantasy finance securities that were instrumental in our crash - specialty derivatives. These one-of-a-kind securities garner enormous fees for the traders who crate and sell them to investors. They also are what Warren Buffet calls "financial weapons of mass destruction."
It appears that Barney Frank has been lobbied so hard that he is willing to exempt nearly all derivatives from regulation if they are "used for risk management purposes." Come on, Barney! It doesn't take a financial engineer to figure out that you can say any derivative is serving "risk management purposes."
As a result, Barney's bill will continue to allow the kind of rip-offs that were inflicted on the five school districts in the Milwaukee area. In 2006, the Royal Bank of Canada (RBC), through investment advisors at Stifel Nicolaus, sold to the school districts $200 million worth of synthetic CDOs which they claimed where AA-AAA rated. What they really did was turn the Milwaukee schools into an insurance company covering Royal Bank's reckless gambles.
Without knowing it, school board money was being used to insure a high risk tranche of junk debt held by the bank. The money was stashed in a Grand Cayman Island account in case Royal Bank needed it to cover the defaults on their junk debt. From RBC's point of view it was all done for "risk management purposes" -- and of course to make money. The bank took a sweet $11.5 million in up-front fees. Believe me: I saw tapes of the school board meetings and it was like stealing candy from a baby. (See Chapter 1: "The Hooking of Whitefish Bay" in The Looting of America.)
Instead of making safe investments to ensure adequate funding for children's education and to cover other liabilities the five school boards inadvertently ended up paying RBC for the dubious pleasure of insuring it against losses in the bank's junk debt portfolio. Dubious indeed. The schools' investment is now valued at about $6 million. Not only have the taxpayers lost $194 million but they still owe other banks and bond holders they borrowed from to buy the synthetic CDOs.
Barney's bill would exempt such transactions from regulation.
But why is Barney bailing out? Because our bailout money is being used by banks to lobby the bejesus out of Congress. Wall Street lobbyists are on a holy crusade to make sure that their fantasy finance casinos can roll along without interference, just like the old days before the crash. In fact they see renewed riches because everyone knows that the government will again bailout the banks that are too big to fail. So come one, come all to the casino. You can't lose. (Especially when you own the casino.)
Unless an irate public gets into the act, Barney and friends will continue to water down any and all financial regulations on anything Wall Street thinks can earn it riches, especially high-fee specialty derivatives.
Wall Street is counting on the public getting bored and bewildered by the technical details, and distracted by other - admittedly important - issues, like health care reform, Afghanistan, global warming. And they are counting on overwhelming Barney with lobbying and electioneering contributions. Right now it looks like its going to bring sweet paydays to the rich. And if the financial system crashes again, Wall Street is betting that the public will blame the government and not the big banks.
Barney Frank should heed the advice of George Soros who has said we should ban any derivative product regulators can't understand. For sure, Congress doesn't understand them any better than the Milwaukee school boards did.
You want to bet on whether Barney bites or barks? I'm offering deregulated credit default swaps on the outcome -- mind you, just for "risk management purposes."
Les Leopold is the author of The Looting of America: How Wall Street's Game of Fantasy Finance destroyed our Jobs, Pensions and Prosperity, and What We Can Do About It, Chelsea Green Publishing, June 2009.