Geithner Fires Warning Shot on Derivatives

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I wrote yesterday about concerns that on the Senate floor Chris Dodd’s pretty good language on derivatives regulation would be replaced with some hypothetical weaker language from Agriculture Committee Chair Blanche Lincoln. I think the best way to interpret Treasury Secretary Timothy Geithner’s op-ed today in The Washington Post is a warning shot against any such effort:

Transparency will lower costs for users of derivatives, such as industrial or agriculture companies, allowing them to more effectively manage their risk. It will enable regulators to more effectively monitor risks of all significant derivatives players and financial institutions, and prevent fraud, manipulation and abuse. And by bringing standardized derivatives into central clearing houses and trading facilities, the Senate bill would reduce the risk that the derivatives market will again threaten the entire financial system. […]

The Senate bill is strong. It would create an independent agency to better protect American families across the financial marketplace. It would protect against “too big to fail.” And it would bring the derivatives market out of the dark. As the bill moves to the floor, we will fight any attempt to weaken it. The American people have suffered through too much to enact reform that does too little.

I should explain that the main point of controversy on derivatives has to do with the extent to which “end users” of derivatives should be exempted from these transparency and clearinghouse regulations. The idea of an “end user” is that some participants in the real economy use derivatives to smooth their business operations rather than as a way of engaging in financial speculation. The clearest example is that fuel costs are very important to airlines, so you might use derivatives to hedge against increases in the price of oil. You can say, if oil goes up $20 a barrel that will cost us $X, so I’ll place a bet that oil will go up $20 a barrel that would make me $X. That way I’m covered no matter what happens to oil and can focus on running my airline.

Now that’s all well and good—and politically these “end users” are harder to demonize than banks—but I don’t actually understand what the problem would be with having end users on the same exchanges and clearinghouses as everyone else. And it’s easy to see how this exemption could, if you’re not super-careful, become a loophole big enough to drive all of Goldman Sachs through. So be on guard about this.