Friday, January 16, 2009

Sheila Bair Hearts Derivatives

Sheila Bair has become something of a hero to some progressives, supposedly because she's "a principled regulator who stood up against the good ole boys club." Apparently all you have to do to become a "principled regulator" is spit out a bunch of vague platitudes to naïve journalists about how we should help "ordinary Americans" instead of Evil Wall Street Banks. Must be nice. But back when Bair was the head of the CFTC, and there was an intense debate over whether more regulation of derivatives was needed, here's what Bair had to say (from an October 1993 Bloomberg article):

THE Commodity Futures Trading Commission (CFTC) has given the US$ 4.8 trillion derivatives market a clean bill of health, saying that fundamental changes in the way the market is regulated are not needed. ... "We have a strong affinity for derivatives at this agency," said acting CFTC chairman Sheila Bair. "We like them."
The article doesn't appear to be available online (I'll excerpt more below), but if you have a Bloomberg, the article is from October 26, 1993, and the headline is "CFTC Study Finds Little Risk from Derivatives." Here's some more from the Bloomberg article, which shows that Bair is almost the opposite of a "principled regulator who stood up against the good ole boys club":
In January this year, the CFTC largely exempted certain swap agreements from most commission regulations. In addition, members of House and Senate committees are likely to be sceptical of any report that finds few immediate risks posed by derivatives markets. Consider the comment from a recent speech by Jeffrey Duncan, senior finance policy analyst with the House sub-committee on telecommunications and finance: "In almost every instance, before the catastrophe hit, we were told not to worry - Wall Street's financial wizards had everything under control." "While the chief financial officers of Fortune 500 companies can probably be expected to understand and manage the risks associated with derivatives, what about the municipal governments that are getting into this market?" Mr Duncan said. [ed: Sure enough, in 1994 Orange County lost over $2 billion through derivatives bets, and was forced to file for bankruptcy.] A case in point is Van Wert County, Ohio, which lost about $ 100,000 on its holdings of interest-only mortgage securities. The loss was equivalent to the county's entire payroll for almost two weeks. ... Some regulators have expressed concern that a failure by one bank or corporation to meet its derivatives payments could trigger a banking crisis. Felix Rohatyn of investment banking firm Lazard Freres has warned of "26 year olds with computers creating financial hydrogen bombs". That prompted some members of Congress to question whether more rules were needed for the largely unregulated market. House Banking Committee chairman Henry Gonzalez, for example, has scheduled hearings on derivatives trading, and has expressed concern about the involvement of banks in derivatives markets. For her part, Ms Bair said there was "no cause for concern at this time" because most derivatives market participants "are adhering to sound risk management practices". ... Derivatives trading had exploded over the past decade, the CFTC said. The commission said the total notional principal amount in the interest rate and currency swap markets alone came to about $ 4.8 trillion at the end of last year, up from about $ 870 billion just five years earlier. The number of new interest rate and currency swap contracts rose to 104,000 last year from 63,000 in 1990, an annualised growth rate of 28.5 per cent.
Sheila Bair, principled regulator? Please.

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