Deregulation efforts from the late 1990s were blocked

There is a lot of anecdotal fodder in support of my last post tagging deregulation as a root cause for the build up of excesses in the financial services industry. Let me give you one example from 1998 (hat tip Marshall).

U.S. Lawmakers to Try Again for 6-Month Ban on CFTC Swaps Rules
Washington, Oct. 19 (Bloomberg) — The regulator of the nation’s futures markets would be blocked from proposing new rules for the $30 trillion over-the-counter derivatives market until March 30, under a provision in a $221 billion spending bill the U.S. Congress expects to vote on tomorrow.

The measure is contained in agriculture spending legislation that U.S. lawmakers melded into the overall appropriations bill after President Bill Clinton vetoed the Republicans’ first agriculture budget because he wanted more aid for farmers.

The Commodity Futures Trading Commission provision stems from a controversial commission study of OTC derivatives that derivatives dealers, rival federal regulators, and some members of Congress said could hurt the industry and force it overseas.

The bill “allows crucial decisions about OTC derivatives to be made, as they should be, in Congress,” Senate Agriculture Committee Chairman Richard Lugar said last month. “Restoring legal certainty to swaps will also help to calm markets.”

Lugar sponsored the CFTC measure and plans a hearing in December to review OTC derivatives regulation.

Derivatives are instruments whose value relies on underlying assets such as commodities, currencies, stocks, and bonds. Companies and money managers use derivatives, such as interest rate swaps, to protect against or profit from price swings.

The agriculture committees in Congress, which oversee the CFTC, plan a top-to-bottom review of the U.S. futures and derivatives laws and regulation next year. The moratorium aims to prevent the CFTC from placing new restrictions on OTC derivatives before Congress has a chance to act, while leaving the commission power to act in an emergency or to expand permitted derivatives activities.

Opposition From Banks
The major banks and securities firms that conduct the bulk of derivatives trading had pushed for the moratorium.

“If Congress passes the legislation, it will help reduce the range of problems we have to deal with in markets today, said Mark Brickell, a managing director at J.P. Morgan & Co. on the board of the International Swaps and Derivatives Association, in a Bloomberg forum.

CFTC Chairman Brooksley Born has said every federal regulator has a responsibility to review the OTC derivatives market, especially in the wake of Long-Term Capital Management LP’s losses. The Connecticut hedge fund’s problems, largely due to OTC derivatives, led to a $3.6 billion emergency takeover.

Opponents say that just by asking questions about the derivatives market, the CFTC is improperly suggesting that some OTC derivatives are futures contracts. Since futures generally must be traded on exchanges under tight regulation, this could imply that certain derivatives are illegal futures, they say.

Some varieties of OTC derivatives are in a safer position, because they are explicitly exempt from CFTC regulation under previous policy statements and interpretations.

Derivatives dealers, the Federal Reserve, Treasury, and Securities and Exchange Commission have urged Congress to step in to sort out the proper regulation of OTC derivatives.

Congress has asked the President’s Working Group on financial markets, headed by Treasury Secretary Robert Rubin, to study the OTC derivatives markets and hedge funds and determine whether new regulation or legislation is needed.

Since the regulators disagree on whether new rules are needed, that study is likely to be an analysis and explanation of their different positions, rather than a consensus recommendation to Congress, Fed official Patrick M. Parkinson said last week.

I think you know how this one ended — with deregulation being blocked and a subsequent mushrooming of OTC derivatives exposure, AIG leading the charge. The meltdown of AIG is directly attributable to these events in 1998 and the lack of regulation.  There are many more examples of this variety on the Internet.

Related articles
The Lessons of Long-Term Capital Management – Brooksley Born, 15 Oct 1998
Never Say You’re Sorry – The Nation