The Ostriches in the Sand - Regulation Hearings & Frameworks

The Obama administration is pre-announcing the regulatory reforms announcements (see their outline below), so much so one might miss what is coming out of Congressional hearings on the topic.

From the Systemic Risk and Insurance hearing, subcommittee chair Kanjorski said:

I believe that only ostriches can now deny the need for establishing a federal insurance resource center and a basic federal insurance regulatory structure.

Geither's response? Let's ignore the entire insurance industry. What's in a name? (AIG)

Rep. Kanjorski:

Insurance is a complex and important part of the U.S. financial industry with more than $6.3 trillion in assets under management and $1.23 trillion in annual premiums.

Here is a CNBC interview from last month with Subcommittee Chair Kanjorski overviewing the need for insurance regulation:


Last week, House Financial Services Committee Subcommittee, Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, held a hearing, The Effective Regulation of the Over-the-Counter Derivatives Markets.

Chair Kanjorski's statement on the Wild, Wild West of the Financial World.

Today, we meet to consider another area of our capital markets woefully lacking in effective regulatory oversight: over-the-counter derivatives. Within less than three decades over-the-counter derivatives have become a staggering $500 trillion market, in notional value.

This market also has the potential to cause considerable harm. Last year, AIG infamously came crashing down because its lightly regulated Financial Products unit engaged in credit default swaps in the over-the-counter markets without holding sufficient capital to hedge the risks.

Clearly, some of these customized contracts cannot easily fit within a mandatory clearing or exchange trading regime. We therefore must find a delicate balance. Subjecting all contracts to mandatory exchange trading may cast too wide a net. Yet the clearing of most products – not all – through a central clearing entity seems appropriate and should not impose an undue burden on the affected parties. However, carving out too many exemptions as we tackle regulatory reform could create widespread economic harm in the long term.

Even where clearing of contracts proves unfeasible, transparency can still exist. By mandating the collection of relevant data in a repository, we can help to ensure that regulators maintain access to useful trading information and perhaps detect warning signs of systemically risky transactions. Electronic trading also increases transparency. Further, electronic execution streamlines trading, minimizes mistakes, and enhances monitoring of the over-the-counter derivatives markets.

Contrast that with the below Obama administration derivatives framework.

Utah Law School Professor Johnson believes a system needs to designed carefully (what a concept for our government!):

Congress should proceed in efforts to reduce counterparty credit risk. However, I believe that the effort to clear all OTC derivatives through regulated central counterparties (CCPs) should be done slowly and methodically and with substantial input from OTC derivatives market participants. Congress should be aware that requiring OTC derivatives to be cleared through CCPs represents a seismic and unproven shift as to how OTC derivatives are traded, processed, assessed and function.

Most of this hearing is various corporate interests blasting the regulatory proposals on derivatives, especially an open exchange. Hedge funds scrabble to hire more lobbyists to prevent legislation and companies issue that infamous threat to simply move offshore.

Congressman Lynch notes the soft shoe on derivatives:

Taking a "soft approach" to regulating over-the-counter (OTC) derivatives would be a mistake, but that appears to be the direction lawmakers are leaning, said U.S. Representative Stephen Lynch on Tuesday.

"I get the sense who's winning this fight and I don't think it's the American taxpayer," said Lynch at a House of Representatives capital markets subcommittee hearing on proposals to crack down on OTC derivatives.

At the hearing, faced with a panel of industry executives testifying as witnesses, many lawmakers from both parties called for a balance between too much and not enough centralized clearing and exchange trading of OTC derivatives.

Lynch said: "By allowing a significant part of the derivatives market to just go off unregulated ... We're setting ourselves up to fail."

He said, "We're not going to regulate this, I get the sense of it right now.

Here is the Obama administration pre-announcement announcement of their regulatory reform structure as Summers & Geither layout the proposed framework:

  1. Increased Capital and Liquidity Requirements
  2. Federal Reserve as Systemic Risk Regulator
  3. Coordinate Existing Regulatory Agencies
  4. Improve Reporting on ABS
  5. Reduce Reliance of Credit Rating Agencies
  6. Financial Consequences throughout securitization chain
  7. All derivatives regulated
  8. more security safeguards in futures, securities trading
  9. consumer regulatory protection agency
  10. resolution "mechanism" for institutions who impose systemic risk
  11. Coordination with other national systems

Ah, so you're going to coordinate with other nations. Here is the EU on insurance industry regulation, just announced to be ignored by the administration.

EU Parliament member Skinner's proposal is an independent council body to oversee European Systemic Risk. The proposed framework is:

  1. collect and analyse all information relevant for monitoring and assessing potential threats to financial stability that arise from the macro-economic developments and developments within the financial system as a whole
  2. identify and prioritise such risks
  3. issue warnings where risks appear to be significant;
  4. where necessary give recommendations on the measures to be taken in reaction to the risks identified
  5. monitor the required follow-up to warnings and recommendations
  6. liaise effectively with the IMF, the Financial Stability Board and other third country counterparts

In contrast, the United States currently regulates 6,000 insurance entities through a patchwork of state regulators and Geithner mentions none of the insurance sector will be addressed (to date).

The EU should release their reports and proposals on OTC derivatives regulation tomorrow.

So, to sum, what does all of this mean? Frankly we must see the actual legislation in some detailed final form. But I would read the hearing and pre-annoucement announcement tea leaves as:

Regulation on derivatives is a major war, we have much more power being handed to the Federal Reserve and we have the Obama administration wanting to ignore the entire insurance industry.

Here is an older piece which gives an excellent background on derivatives.



The problem is the legislative process and big money.

Policy makers can't take their time with very important issues because lobbyists and their benefactors will tear it up or kill it. But if they rush it through they sacrifice well thought out policy. The rushed product in the end is just a patch work of existing problems with no real durable reform.

Yves Smith, this morning, was lamenting about why can't we have lasting durable legislation like the Securities Exchange Act of 1933 & 1934. The answer is because of big money special interests.

Yves (NC) link?

Yves is one of the few economics bloggers who is really pouring over every detail so can you give a link and a block quote on this?

I'll tell ya, this is so complex, we need everyone digging around, understand it but that obvservation is correct.

Those F@+#@ing lobbyists! They need to be banned from D.C. Simple as that. No more paid lobbyists.

Honestly, even if one is not corrupt, I have no idea how Congress gets anything done with those buzz flies swarming the halls and barging into offices, demanding meetings trying to write bills.

Here is the link


Sadly, the US seemed able to do that in the Great Depression. The provision of the securities laws of 1933 and 1934 were astute and durable. I wonder why devising good regulatory regimes has become a lost art.

One reason

Too Big to Succeed.

In 1933, the total GDP of the United States was $56.4 Billion. Today it's $13.5 Trillion. Sure, we have computers now, but I don't think we were keeping up on hiring regulators.

Which is why I'm for using the antitrust laws to break up the FED.
Maximum jobs, not maximum profits.

Maximum jobs, not maximum profits.

Robert would it not just be easier to determine

that a derivative is a security. Then you would have your federal oversight. Oh wait, we had federal oversight and old Madoff got away with his deeds, big wirehouse's got away with their misdeeds, we have found that the SEC was a bit political.

Other than the insane deritive market, (which few insurance companies participate) how have the States not done their jobs?

Nah, I'd rather have the States take back more power.

I mean, how can I want the feds to have more power if the President can illegally fire the IG without any ramifications?

I think we need

to go back through the deregulation which created derivatives in the first place. I need to go into further study frankly but my overall impression is they are trying to preserve the shadow banking system because it represents $500 trillion dollars in mythical money.

What bothers me so far is no one mentions that the actual models are flawed. The treasury has some of this in that they want "less reliance on credit ratings agencies" but no real mention of structured finance models.

Remind us of what IG is again?

If we eliminate "too big to fail" institutions

do we need a systemic risk regulator? It seems like the systemic risk regulator is attempting to compensate for the size of the institutions.

Besides, the Fed as a systemic risk regulator is a joke. They grossly neglected any regulatory responsibilities under Greenspan and probably do it again. Even if they did their job it probably will be too late because any "too big to fail" institution will have already started the ball rolling down the hill before any regulator catches it partly because regulators are out gunned.

Out gunned not because of the number of personnel but because of the technology and sophistication and lack of transparency (shadow banking system).

consumer action

one thing I think people can do is move their money out of the big banks and into local credit unions.

I agree, this idea that the Federal Reserve should get more power when they act as an ind. body, no real oversight beyond the appointments is beyond scary.

The whole point of the Federal Reserve Transparency Act is to find out what the Fed did with that est. $12 trillion in commitments, who they gave the money to, etc.

The idea now they should expand as this ill defined systemic risk regulator is really scary.

I'm hoping all participants on EP start reviewing the past deregulation laws that got us into this mess.

I am wondering (without analysis) why we cannot simply just reinstate those regulatory laws which were ripped asunder?

The FED itself

Has become a "too big to succeed" institution.
Maximum jobs, not maximum profits.

Maximum jobs, not maximum profits.

baseline scenarios "10 questions" to ask for tomorrow

If it were not so serious I would find this list hilarious, but check out the questions (and asking for suggestions) to be asked at tomorrow's official Obama administration announcement for regulatory reform.

your poll is missing an option

Your poll is missing an option for "Heayyyyyylllll no"