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House financial reform bill full of loopholes
NewsNotes, January-February 2010

In the summer of 2009, it appeared that the Congress and administration would seriously address financial reform to avoid another meltdown. In the important area of excessive commodity speculation, Gary Gensler, President Obama’s appointee to head the Commodity Futures Trading Commission, made bold proposals to rein in this practice and reduce systemic risk. Proposed bills from key committees in both houses of Congress contained strong measures that would create a safer, saner market. Yet in the bill that finally passed in the House in late December legislators caved to Wall Street concerns and allowed four major loopholes that make the bill practically worthless. The over-the-counter (OTC) markets – unregulated, opaque markets that greatly affected today’s crisis – will remain open for business unless the Senate’s bill is stronger.

The following analysis of the four loopholes is from Adam White, director of research at White Knight Research & Trading:

1. Foreign exchange exemption: Foreign exchanges, which represent approximately eight percent of total OTC derivatives exposure, would remain opaque and unregulated. “Think of it this way,” writes White. “Would you be happy to know that for every 100 people boarding your airline flight, there were eight people that did not have to pass through the metal detectors?”
2. End-user exemption: Wall Street swaps dealers have scared their corporate clients into opposing reforms that would be to their own benefit. Responding to this pressure, Congress excluded a number of end users from clearing on exchanges, which would have increased transparency and reduced systemic risk. These end user exemptions are between 16-21 percent of the OTC markets.
3. “Balance sheet risk” exemption: This exemption would allow hedge funds to participate in unregulated OTC markets in order to circumvent possible financial losses. Under this loophole, another 15-16 percent of all derivatives exposures would not be cleared on exchanges. Combining these three loopholes together, Congress is effectively exempting between 40-45 percent of all derivatives from clearing.
4. Alternative Swaps Execution Facility (ASEF): The final loophole is perhaps the most impressive. Congress has also bowed to Wall Street’s request to allow it to avoid trading on a public exchange altogether. Instead swaps dealers can use ASEFs instead of exchanges. These alternatives can include even “voice brokerage,” or, in other words, a telephone call between swaps broker and client. With this loophole, “100 percent of all OTC derivatives can trade through ASEFs” which would be almost completely unregulated.

As Chris Whalen, managing director of Institutional Risk Analytics in Torrance, CA, said, “The OTC reform has gotten to be basically irrelevant as far as change. … There are some things in there that are irritating to [Wall Street], but compared with what we thought we were going to get over the summer, it’s night and day.” Paul Miller, an analyst with FBR Capital Markets in Arlington, VA, added, “Wall Street is probably happy with the slowness of the process because the slower the process is, the more you can drag it out and water it down.” Recipients of TARP money have spent $344 million in 2009 alone to defeat derivatives reform regulation.

Faith in action:

Contact your senators to demand that these loopholes be removed from any Senate financial reform bill. Go to for an easy way to send a letter to your Congresspersons on the issue. Explore the site for more information on the issue.

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