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April 15, 2012

Industry’s Bogus Arguments for a De Maximus Exception to Swap Dealer Rules

Almost everyone knows that the biggest banks want to kill financial reform, but the banks don’t come right out and say that because people are still upset with Wall Street for ripping them off and creating the worst economy since the Great Depression.  So when they talk about financial reform, they hide behind phony theories of customer service and trumped up statistics to conceal their real agenda – protecting their profits and boosting their bonuses.

The latest example relates to their ongoing attempts to keep the $700 trillion derivatives market in the dark and as unregulated as possible. That, of course, is what brought us the AIG collapse and the CDS payoffs to Goldman Sachs and the rest of Wall Street.  Nothing could be better if you’re a huge bank or Wall Street and nothing could be worse if you’re a taxpayer or if you care about keeping their hands out of the pockets of the U.S. treasury and the Federal Reserve.

The latest battle in their war against financial reform is over the “de minimis” exemption for swap dealers.  “De minimis” – as everyone who isn’t in de business of de manipulating know – means “so minor as to merit disregard; or trifling.”   

The SEC and the CFTC, after lengthy and careful analysis, which included the usual vast and unlimited industry lobbying, proposed a rule that set the de minimis exception at $100 million.  That threshold would exempt between 12% and 17% of the firms acting as swap dealers, which, frankly, is higher than any common sense understanding of de minimis.  (And, the $100 million threshold was also established based on undisputed data.)

Nevertheless, the industry still found exempting “only” 12% to 17% as “de minimis” to be intolerable.  So they’re insisting that regulators increase the de minimis exemption from $100 million to as much as $8 billion.  Only on Wall Street can you call $8 billion de minimis and not be laughed at. Talking pigs and George Orwell have got nothing on these guys.

The truth is that $8 billion would be a “de maximum” exception.

But Wall Street and its allies like Chatham Financial – which complained to Politico’s Morning Money – insist that the industry needs the $100 million de minimis exception increased to $8 billion.  Why?  They say $8 billion is needed so small and medium-sized dealers can survive in the new marketplace.  Really? A company doing $8 billion of swaps a year is some mom-and-pop swap store that shouldn’t be regulated? Come on.

Chatham Financial tries to avoid these facts by focusing on “notional” amounts, but everyone knows – including most especially the industry – that notional numbers can be highly misleading and they certainly are in this context.  The five largest banks according to the most recent OCC data control about 95% of the derivatives markets and, therefore, to base anything on percentages of total notional amounts will almost certainly exclude all dealers other than them.  But, the risks don’t only arise from today’s 5 largest dealers and, if reform is properly implemented, the oligopoly of those 5 firms will be decreased over time and many others will become significant swap dealers.

The fact is, Dodd-Frank derivatives regulation is supposed to apply to the marketplace as a whole, not just to a few institutions, and it is supposed to address existing and future market conditions.  This is particularly important given that the entire derivatives infrastructure is designed to move the dark OTC markets into the light does not yet exist. Excluding the very biggest dealers that do hundreds of billions of dollars of business a year, an $8 billion threshold would exclude 60% of those that remain. No matter how creative and confusing the industry tries to be with its numbers, excepting 60% of all swap dealers outside of the largest institutions is not de minimis.

The requirements on swap dealers are necessary, logical and straightforward, and are based on principles that any responsible firm dealing in derivatives should already operate on: accurate record keeping, sound risk management, and honest dealings with customers.  Equally important, the swap-dealer rule is meant to protect swap market participants as a whole, not just those who do business only with the very largest firms.

Regulators should not make a mockery of the law and the English language by increasing the $100 million de minimis exception to an $8 billion de maximum exception.  If they did that, it would be arbitrary and capricious, as well as subject to a legal challenge as entirely unsupported by data, facts or analysis.

Regulators would also leave American taxpayers and the treasury exposed to what Warren Buffett famously called derivatives: “financial weapons of mass destruction.” Leaving 60 percent of the swap nukes unregulated and hidden isn’t arms control.  It’s another 2008 financial mushroom cloud waiting to happen.



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