Greg Ip

Articles by The Economist’s U.S. Economics Editor

Gary Gensler, derivatives cop: A new sheriff

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Sep 3rd 2009 | WASHINGTON, DC
From The Economist print edition

Long marginalised, the CFTC reasserts itself under a new chairman

Bloomberg
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This OTC derivatives market ain’t big enough for the both of us

 

[Greg Ip] WHEN Gary Gensler was named late last year to head the Commodity Futures Trading Commission (CFTC), the financial industry may have thought him an ally. After all, he had been a partner at Goldman Sachs and later served under Bill Clinton’s famously deregulatory Treasury secretary, Larry Summers. But a book that Mr Gensler coauthored in 2004 might have been a better guide to his predispositions. The cover of The Great Mutual Fund Trap shows a faceless banker playing a shell game. Inside, Mr Gensler warns investors that Wall Street is continuously trying to rip them off.

Barack Obama’s financial appointees have all tended to be pro-regulation, but few are as enthusiastic as Mr Gensler. In July he proposed limiting the size of positions that many market participants, such as exchange-traded funds, can take in energy futures (contracts to buy or sell commodities at a set price in the future). In August he sent a letter to Congress arguing that Mr Obama’s proposal to regulate over-the-counter (OTC) derivatives does not go far enough. “There’s a new sheriff in town,” says Michael Greenberger, a former CFTC official who is now an academic at the University of Maryland.

The CFTC has long been one of America’s smallest and most hands-off financial regulators, overshadowed by the much larger and more prosecutorial Securities and Exchange Commission (SEC), which oversees the cash-securities markets. Its staff shrank under George Bush. Its very existence is an anomaly: it ought to have been merged with the SEC long ago, but its oversight is jealously guarded by Congress’s agricultural committees. But thanks to Mr Gensler’s muscular style and the financial crisis, its star is now rising.

Two developments in particular have turned the tide. The first is the role OTC credit derivatives played in amplifying the financial crisis. The CFTC’s traditional focus has been on exchange-traded futures contracts for agricultural, energy and financial products. But exchanges’ share of derivatives has shrunk as that of banks’ OTC dealing-rooms has grown. The CFTC tried to claim jurisdiction over OTC markets in 1998, but was sent packing by the banks, Mr Clinton’s Treasury department and Alan Greenspan, then the Federal Reserve chairman. In 2000 Congress formally exempted OTC derivatives from the CFTC’s oversight, leaving the agency a bystander as credit derivatives exploded in popularity. Ironically Mr Gensler, as an aide to Mr Summers, helped pass that law. Mr Obama has now asked Congress to require most OTC derivatives to be settled through CFTC- or SEC-regulated central clearing-houses, or be subject to SEC or CFTC margin requirements.

The second turning-point for the CFTC was last year’s surge in oil prices to over $140 a barrel, which many in Congress blame on alternative investors such as exchange-traded funds which hold large commodity positions for extended periods. Whether such speculators were behind the spike in oil prices is a matter of fierce debate. A CFTC study last year appeared to exonerate them. Mr Gensler has not repudiated that study but he does plan to release the underlying data for public examination. Although he thinks commodities experienced an asset bubble, he says his real interest in position limits is to prevent a growing concentration of trading among a few players that could permit speculative swings in prices in the future.

How much influence the CFTC will ultimately obtain is still an open question. Mr Obama’s financial reforms would leave the Federal Reserve as the main regulator of the biggest OTC dealers. The CFTC and SEC have to work out their respective responsibilities, the subject of hearings this week. Overhauling finance is not at present the main priority of Congress or Mr Obama. But Mr Gensler is likely to get a hefty boost to his budget and staff. Someone may even get around to posting his picture in the CFTC’s lobby, still adorned with that of his Republican predecessor.

The original article is linked here.

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Written by gregip

September 3, 2009 at 8:01 am

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