Gary Gensler, the top regulator of the commodities markets, sees the U.S. financial system still "vulnerable" to the murky world of privately negotiated derivatives.
As chairman of the U.S. Commodities Futures Trading Commission (CFTC), Gensler wants to comprehensively oversee the trading of these complex financial contracts for the first time. While some forms of derivatives are traded on regulated exchanges, federal regulators including Gensler, who was appointed by President Obama in December, have almost no power over derivatives that are traded privately on the phone or electronically. This over-the-counter derivatives market, which internationally is valued at nearly $600 trillion, is blamed for compounding the current financial crisis.
"We stay particularly vulnerable because we haven't filled the [regulatory] gaps," Gensler told the Huffington Post Investigative Fund in an interview this week.
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Although derivatives are intended to hedge risk or act like insurance on an underlying asset, they also can be used to speculate on prices. Credit default swap derivatives, some of which insured toxic mortgage-backed securities, drove the financial tailspin of the insurance giant AIG.
Since last year's calamity, the nation's five largest commercial banks have become even more exposed to derivatives, to the tune of almost $200 trillion, according to a recent report by the U.S. Comptroller of the Currency. Those five banks--JPMorgan Chase, Goldman, Bank of America, Citibank and Wells Fargo-- hold about 97 percent of all derivatives in the U.S. banking industry, the report said.
The agency that Gensler heads was created in 1974, primarily to oversee futures contracts based on commodities such as wheat or oranges. When the instruments expanded beyond commodities, the CFTC lacked the authority and staff to intervene.
Gensler now wants that authority, although his agency is hard-pressed to meet its demands. CFTC staff remains at 580, the same number the agency had at its inception. The CFTC computer system that oversees markets also is outdated.
"We don't have enough people to oversee the 200,000 transactions that happen every day in this marketplace," he said in the interview.
Gensler, 51, wasn't always so gung-ho about derivatives oversight. When he was an assistant treasury secretary in the Clinton administration, Gensler helped design the very law that prevents the CFTC from regulating over-the-counter derivatives.
Before joining Treasury in 1997, he had an 18-year career at Goldman Sachs, where he was a partner. He later was a senior advisor to Sen. Paul Sarbanes (D-MD), then-chairman of the Senate Banking Committee, while the post-Enron corporate responsibility and accounting reform known as the Sarbanes-Oxley Act was crafted. Gensler also was an adviser to Hillary Clinton's presidential campaign and later Obama's.
Gensler has now become one of the strongest voices calling for derivatives regulation. Perhaps even more than Obama.
Less than a week after Obama unveiled a plan for derivatives regulation, Gensler sent his own recommendations to Congress. He added 20 pages of regulations intended to "improve" Obama's plan.
The highlights of Obama's plan include requirements for standardized derivatives to be traded on a regulated exchange or similar facility and to pass through clearinghouses that serve as a backstop if one party defaults. The plan also mandates increased capital and margin requirements for those trading more customized or non-standardized derivatives and increased transparency of all derivatives by making public some trading details.
Gensler identified several loopholes in Obama's plan, noting that it would exclude foreign exchange swaps from regulation, possibly encouraging swap dealers to tailor products to fit this foreign exclusion.
"These exceptions could swallow up the regulation," Gensler said in his package to Congress.
At a House Financial Services Committee hearing today, Gensler was vocal about gaps in the committee's derivatives regulation bill, which is widely regarded as being looser than either Obama or Gensler's plan.
The committee is expected to vote on the bill next week.