Yesterday, after three days of preventing Sen. Chris Dodd’s (D-CT) financial regulatory reform bill from coming to the Senate floor, Republicans finally relented. Debate on the bill is slated to start this afternoon, and first up on the docket is the section dealing with derivatives, which has Wall Street up in arms.
The Republicans are hoping to weaken the derivatives section of the bill by portraying it as harming businesses that aren’t connected to Wall Street. Senate Minority Leader Mitch McConnell (R-KY) displayed a bit of this earlier in the week, when he said that reform of the derivatives market would impair Mars’ ability to hedge against changes in sugar prices (which is obviously integral for a candy company). Sen. Kit Bond (R-MO) grabbed this ball last night and ran with it, claiming on CNBC that Dodd’s bill would “stick it” to farmers who use derivatives to protect themselves against price changes:
What I’m worried about is Main Street, and the derivative section as written now would stick it to energy companies, utility companies having to hedge, as well as farmers. We’ve got to get that part out of it. That’s the bad part…What I want is spinning off Main Street, get them out of the derivatives. It was not derivatives on Main Street that caused this problem. Get Main Street out. That’s what we want. We want out of it. Fix Wall Street, don’t kill Main Street.
Sen. Richard Shelby expressed a similar concern, saying “I want to make sure that the bona fide end user is protected — the people who are not casino gamblers with derivatives that did not cause the problem, that hedge and manage risk for their own well-being.”
These concerns are vastly overblown, as the legislation already contains exemptions for those entities legitimately hedging against risk. But furthermore, the commodities futures market (which deals with products like corn and wheat) is already regulated in much the way that Dodd’s bill would regulate the rest of the derivatives market, using clearinghouses to ensure that both parties involved in a trade have adequate collateral to back up their deal. And as Commodity Futures Trading Commission Chairman Gary Gensler explained, the commodities market has survived decades of financial turmoil largely without incident precisely because it’s regulated:
Derivatives themselves are not new: They have existed since the Civil War, when farmers and grain merchants began using them to hedge against future changes in the price of corn and wheat. So they entered into derivatives contracts with other parties to lock in the price of corn or wheat for harvest time. These first derivatives — called futures — have been comprehensively regulated since the 1930s. Futures markets functioned largely without incident during the 2008 financial crisis in part because these contracts are cleared by regulated clearinghouses.
It’s the rest of the $300 trillion derivatives market that is the concern, and which the Democrats want to regulate in much the same way that futures contracts are already overseen. For every $1 used by a company or a farmer to legitimately hedge against risk, there are $78 in derivatives that are traded for the sake of being traded. As former President Bill Clinton put it, “I think too much of this stuff has no economic purpose…Too much of our growth in the last decade was in finance.” And prudent regulation is needed to make sure that this huge market can’t bring the economy to its knees again.