Still Dangerous

Five years ago, when the economy imploded, the world learned that the global financial system was, in part, a casino built on derivatives, complex instruments that are supposed to reduce risk but are instead widely used by banks and other big investors for speculation. Since then, new rules have been created to rein in derivatives through transparency, oversight and competition. Issued by the Commodity Futures Trading Commission, the agency empowered by the Dodd-Frank reform law to regulate most derivatives, the rules could indeed make the system safer, if they are aggressively enforced.

That is a big “if” for several reasons. For starters, the C.F.T.C. itself is facing a difficult transition. Its reformist chairman, Gary Gensler, will leave the agency when his term concludes at the end of 2013; another Democratic commissioner has announced he will resign in 2014. Whether President Obama will nominate and fight for similarly qualified regulators to succeed them is an open question. Meanwhile, Congress continues to deny the agency the resources it needs to enforce the new rules.

The effectiveness of the C.F.T.C.’s efforts also depends on finishing related Dodd-Frank rules that have been delayed because they require various regulators with various agendas to agree on their final form. Such cooperation is especially difficult with financial reform, because banks, and the politicians and regulators who do their bidding, work tirelessly to derail new regulation.

A case in point is the Volcker Rule, a joint effort of the C.F.T.C., the Securities and Exchange Commission, the Federal Reserve and other agencies to end speculative trading by banks. The banks want a rule with loopholes that preserve their ability to gamble and generate outsize profits and big bonuses. After tolerating years of delay, Obama officials are urging regulators to finalize the Volcker Rule by the end of the year. That will require the agencies to say no, once and for all, to the banks’ wishes. The Fed, which has a history of overprotecting banks, appears to be having a particularly hard time doing that.

A strong Volcker Rule would allow banks to act as middlemen between buyers and sellers of assets, but not to amass those assets and stake positions to make their own trading gains. A strong rule must also ban trading under the guise of hedging. Banks could use derivatives to hedge against direct and specific risks, but not to place broad bets in the hope of big wins.

Another area where cooperation is essential — and hard to come by — is the international regulation of derivatives. Mr. Gensler fought to apply the new C.F.T.C. rules to overseas affiliates of American banks and to foreign banks that do business with them, on the sound premise that the risk in those deals flows back to the United States.

But international regulators and lawmakers of both parties pushed for looser standards. The result was a set of guidelines based on “substituted compliance,” which basically lets foreign rules apply in foreign countries as long as the C.F.T.C. deems those rules comparable. The deadline for assessing comparability is Dec. 21. It is essential that the deadline be met and that C.F.T.C. rules be swiftly applied wherever foreign law is inadequate.

A strong Volcker Rule and international oversight could go a long way toward dismantling the global casino. That’s why banks have resisted them — and why the public needs them.


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