David Dayen: Jack Lew Shows His True Colors By Forcing Deregulation of Derivatives on the CFTC

I don’t know of any clear-eyed analyst who held out much hope that the handover of the Treasury Department from Tim Geithner to Jack Lew would herald a new era of stringent financial regulatory reform. Lew, outside of a stint at Citi, didn’t have much expertise with the matter; he’s more of a budget wonk. And when, at his confirmation hearing, he pronounced that Dodd-Frank solved the Too Big to Fail problem, he told you exactly who would have his ear at Treasury. This was further confirmed when Mary Miller, the undersecretary for domestic finance, denied the existence of TBTF in a speech to the Minsky conference in April.

But the most obvious reminder of the Geithner-Lew continuity was the recent upending of what would have been Gary Gensler’s final and most triumphant act at the Commodity Futures Trading Commission. Gensler was trying to finish off the cross-border derivatives rule from Dodd-Frank, which would have given CFTC oversight of any affiliates which execute more than $8 billion in trades, no matter where the location of the entity. This would have arrested a race to the bottom, where the mega-banks that control 95% of all trades fan out overseas to park their trading desks away from CFTC oversight.

Gensler was putting the screws to his commission and demanding a clean vote, intimating that he would allow a temporary exemptive order to expire July 12, putting the plain language from the Dodd-Frank statute (which clearly permitted cross-border regulation) into effect. This was some real hardball designed to get Mark Wetjen, a bank-friendly Democratic commissioner, to play ball.
Enter Jack Lew. We knew the hints of his intervention previously (I wrote about it in July), but Silla Brush and Robert Schmidt have done a deep dive into the matter for Bloomberg. The details on the July 3 meeting with Lew, Gensler and the SEC’s Mary Jo White are fascinating.

Banks and lawmakers, as well as financial regulators from around the world, had besieged Lew with complaints about Gensler’s campaign to impose U.S. rules overseas. 

The July 3 meeting in Lew’s conference room with a view of the White House grew tense, according to three people briefed on it. Gensler argued his plan was vital if the U.S. hoped to seize meaningful authority over financial instruments that helped push the global economy to the brink in 2008, taking down American International Group Inc. (AIG) and Lehman Brothers Holdings Inc. and igniting the worst recession since the 1930s. 

Lew insisted that Gensler coordinate better with the Securities and Exchange Commission, whose new chairman, Mary Jo White, was also present. Gensler, who was deep into negotiations with his European counterparts, was surprised by Lew’s demand. He’d been hearing the same request from lobbyists seeking to slow the process, and he told the Treasury chief it felt like his adversary bankers were in the room, the people said. 

Gensler subsequently apologized to Lew for the outburst. He also softened his demands, cutting a deal with the European Union a week later. Gensler, chairman of a historically obscure agency called the Commodity Futures Trading Commission, had again pushed an idea to the brink until forced to settle.

What we got was the concept of “substitute compliance,” meaning that any overseas regulator deemed comparable to US rules would oversee derivatives trades made in their own countries. In actuality, that drives a stake through the heart of the regulation; the rule starts from the presumption that foreign rules are equivalent.

This was a pure power play. The CFTC budget is a scant $200 million. By contrast, the IT budget for a major global bank is about $1.3 billion. Giving this relative backwater agency control over the multi-trillion-dollar derivatives market is something of a designed failure. And that’s particularly true when a political actor like Jack Lew basically calls the chairman of the agency on the carpet for daring to want to regulate. This is Robert Rubin and Brooksley Born all over again.

Brush and Schmidt estimate that the final rule will cover less than 20% of the entire derivatives market, a far cry from the initial goal. If you remember, the long-departed Blanche Lincoln, then-chairwoman of the Senate Agriculture Committee, faced a challenge from the left in a primary, and subsequently surprised everyone by writing a fairly strong derivatives rule for Dodd-Frank. That got whittled down in the conference committee, cut back to a nub in what got signed into law (the article plays it with Gensler giddy about the law’s language, but it definitely changed from the Lincoln draft to the final version), and further dulled by the rule-writing process, including one of Geithner’s final acts, exempting foreign exchange swaps. Banks have also taken to calling their swaps “futures” to get around the regulations.

Gensler tried to make the best of a bad situation and he had some victories along the way, but the deck was so stacked against him (particularly with the bank shill in his midst, Mark Wetjen) that any rule he successfully navigated through the process could only be described as “the best he could do under the circumstances.” The cross-border rule mattered more than all of them, because if mega-banks could just pass off derivatives trading to one of their thousands of affiliates overseas to evade scrutiny, you can bet they’ll do it. Gensler said that a bad cross-border rule would mean “we will have repealed derivatives reform altogether.” Well, we got a bad one.

Some will blame “lobbyists,” in this case from Wall Street banks to multinationals that do a lot of hedging, for this outcome. The article does this in part. Bull-pucky. Lobbyists don’t win unless sympathetic regulators in a position of power allow it. Gensler, a Goldman alum who preferred deregulation during a previous stint at Treasury, but got religion after seeing derivatives play a starring role in the financial crisis, wouldn’t budge. Wetjen, and ultimately Jack Lew, would. And they held enough power to take whatever teeth remained out of the rules. Meanwhile, Gensler, for daring to try to do his job, ruined his career:

In the end, Gensler also sacrificed his ambition, creating so many political enemies in Congress and the industry that his chances for a second term as chairman are dim.
“He burned a lot of bridges getting it all done, within the commission and internationally,” said David Hirschmann, president of the Center for Capital Markets Competitiveness at the U.S. Chamber of Commerce.

I’ve heard the Administration wouldn’t offer him anything above an ambassadorship.
The story is really good. It goes into detail about Wetjen’s betrayal of the swap execution facility rules (particularly on the number of bids sellers would have to solicit before making a trade, which got whittled down to two, the least possible improvement from a fully private system). It highlights the changes to the definition of a “swaps dealer,” allowing major traders like BP, Shell and Koch Industries to get out from under the CFTC’s watch. It calls out Chuck Schumer for flacking for the banks in a letter to the CFTC urging them to stop the cross-border regulations, essentially arguing in favor of outsourcing from New York City and moving derivatives desks overseas.

The big story here, however, is Lew. In the end, even Geithner, who at least paid lip service to the importance of cross-border regulation in 2011, comes out looking better. Lew asking that Gensler “better share information with his European counterparts and the SEC” is tantamount to telling him to back off. The Euro regulators didn’t want the CFTC overseeing European banks (who represent a large percentage of registered swap dealers). Sarah Bloom Raskin, the Fed Governor with a consumer protection profile, is headed over to Treasury to become Lew’s #2, and an important counsel on financial reform matters. The derivatives debacle shows the Raskin appointment to be window dressing, and probably more of a way to get a liberalish voice out of Larry Summers’ Fed while “proving” that the Administration can promote women. In reality, Lew will follow the bankers’ dictates.

Gensler puts a brave face on this in the article, claiming the system is safer. In reality, Treasury ensured that the banks will still get to gamble virtually at will, without any pesky regulator monitoring their risk. This quote says it all:

“The banks are going to be fine,” said Sunil Hirani, chief executive officer of trueEX Group LLC, who helped pioneer electronic trading of derivatives. “They are going to make a ton of money.”

Indeed.

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