Paul Barton reports from D.C. For a little background, John Brummett column-ized on this issue recently.
WASHINGTON – Economic interests of almost every variety buffet Sen. Blanche Lincoln as she prepares to take center stage in the financial derivatives regulation debate.
And she is just one of several Arkansas angles to the issue.
Consumer groups contacted by the Arkansas Times expect Lincoln to unveil her proposals for regulating derivatives any day now and possibly as early as today (Tuesday, April 13). As chairman of the Senate Agriculture Committee, she shares jurisdiction over the issue with the Senate Banking Committee. The connection with agriculture? Farmers have long used a fairly benign form of derivatives known as futures contracts to lock in prices on their crops.
But what Wall Street and its K-Street armies are awaiting is Lincoln’s proposal for dealing with exotic derivatives of the kind the giants of American banking and investment banking have exploited since 2000, when the Commodities Futures Modernization Act became law under former President Bill Clinton. The bill removed a wide range of derivatives from the purview of regulators.
Two particular types of controversial derivatives – credit default swaps and collateralized debt obligations – were widely seen as playing leading roles in the economic meltdown of 2008. Both were often used by investment bankers as a means of speculating on the performance of home mortgages, including the subprime mortgages that came to wreck havoc in the housing markets. The same institutions that sold some of those products were also buyers of the same from others, leading to a tenuous web. When mortgages turned sour, many leading financial institutions lost their shirts and had to be bailed out by taxpayers. Legendary investor Warren Buffet warned long ago that derivatives could be “financial weapons of mass destruction.”
At their simplest, derivatives are a kind of contract or holding that derives its value from the performance of assets such as bonds, stocks, mortgages or credit cards controlled by others. Scholars say derivatives of one sort or another date back to the ancient world. The Greeks for instance had derivative-like transactions involving olives. And something as simple as horse bet, they say, can also be considered a derivative. Bettors win or lose based on the performance of animals they usually don’t own.
Immediately after the economic crisis broke in September 2008, calls went out for regulating “over the counter” derivatives, bets that financial firms made with each other without supervision of a central clearing house, exchange or government agency.
And “bet” is the operative word. Many financial and legal scholars, especially professors Michael Greenberger of the University of Maryland and Lynn Stout of UCLA, charge that derivatives as Wall Street currently employs them amount to gambling with many people’s money - nothing more, nothing less. Greenberger is a former member of the Commodities Futures Trading Commission.
And because of the lack of regulation, intricate derivatives contracts are said to be executed in “shadow” or “dark” markets.
And that leads back to Lincoln. Consumer advocates want her legislation to require, with little or no exceptions, that formerly unregulated derivatives be cleared through central clearinghouses and posted on exchanges, where the amounts and details involved in the deals are transparent to all.
A clearing house guarantees a transaction by requiring both sides to put up capital to cover possible losses.
Lincoln, in a variety of public statements, including a speech late last month to the U.S. Chamber of Commerce, said she is a strong advocate for regulation and transparency - but doesn’t believe in “regulatory overreach.”
Given Lincoln’s generally pro-business voting record during her Senate career, as well as the onslaught of campaign contributions she’s received from securities and financial services firms, such comments have consumer groups worrying.
“Of course we are,” said Lisa Lindsley
, of the American Federation of State, County and Municpal Employees, part of an alliance of union and consumer groups who oppose Wall Street on the issue.
The Center for Responsive Politics, a nonpartisan campaign research organization, shows that Lincoln’s 2010 campaign has received $368,750 from securities and investment firms, trailing only lawyers and law firms and health professionals as benefactors. Federal Election Commission reports show political action committees belonging to firms such as Goldman Sachs and JP Morgan Chase, two major forces in the derivatives market, have given her at least $5,500 and $10,000, respectively. PACs belonging to Wells Fargo, Citigroup and Bank of America, other major players, have given her thousands either for this election or her 2004 race.
Wall Street has “enormous profits at stake,” added Barbara Roper of the Consumer Federation of America. “She [Lincoln] is central to the negotiations.”
Consumer groups, she said, worry that while Lincoln’s legislation may have the patina of regulation but will leave loopholes big enough for Wall Street to drive trucks through.
Lincoln’s campaign staff responded this way to charges she might favor Wall Street:
“In just six months as Chairman of the Senate Agriculture Committee, Sen. Lincoln is on the eve of producing a bipartisan bill that for the first time will provide transparency and oversight to the currently unregulated $600 trillion over-the-counter derivatives market,” spokesman Katie Laning Niebaum said. “Sen. Lincoln’s priority is to bring transparency and unprecedented regulation to Wall Street in a responsible way that prevents future crisis, keeps jobs here in the United States, and does not harm Main Street.”
Senate Majority Leader Harry Reid, Roper said, will probably tab Lincoln’s bill, as opposed to Senate Banking Committee’s, as the one to bring to the Senate floor. The reason? Lincoln is working with Sen. Saxby Chambliss of Georgia, ranking Republican on the Agriculture Committee, to fashion something that can be called “bipartisan.”
That, too, is worrisome to consumer groups because Chambliss’s son is a lobbyist for the Chicago Mercantile Exchange.
Meanwhile, Arkansas farmers would like to see limits on the amount of speculative money from derivative traders that can flood commodity markets and drives prices to unsustainable levels. Many non-market savvy farmers to incur steep losses when prices return to earth, said Gene Martin, economist for the Arkansas Farm Bureau.
One of the groups that took particularly severe damage when prices acted that way in 2008 was cotton farmers.
In testimony before the House Agriculture Committee in 2009, a spokesman for the National Cotton Council complained that speculation related to derivatives “flooded the futures markets with record amounts of cash, throwing the trading fundamentals out of balance, resulting in a widened basis, and thereby making these markets illiquid for those for whom Congress created these markets.”
The Arkansas Truckers Association and the Arkansas Oil Marketers Association have made similar complaints about derivatives-related speculation affecting energy prices.
Both organizations have joined Americans for Financial Reform, one of the groups working with AFSCME, urging Lincoln to take strong steps toward regulation of speculators who overwhelm commodities markets and expose users of more traditional derivatives to “unprecedented volatily and inexplicable price shocks.”
Meanwhile, a lobbying organization that wants Congress to be more cautious about reform points to many of Arkansas’s most high-profile companies who depend on derivatives to maintain their financial standing and preserve local jobs.
A recent report by the Securities Industry and Financial Markets Association says derivatives are vital to firms such as Alltel, Baldor Electric, J.B. Hunt, Murphy Oil and Tyson Foods. For such companies, it said, “over-the-counter (OTC) derivatives, such as interest rate, currency, and credit default swaps, are especially useful because they can be customized to allow companies to hedge their particular risks with precision. These transactions enable companies to focus on their core business activities, rather than diverting their resources to managing incidental risks.”
Other Arkansas-related companies, such as Southwestern Energy, have told congressional committees that having to raise additional capital to cover derivatives-trading requirements would decrease its drilling in the Fayetteville Shale Project, resulting in the loss of 1,500 jobs and costing the state $1.6 billion in economic activity.
Another issue in the derivatives debate involves possibly imposing limits on their use by state and local entities.
The minutes of an Oct. 8, 2008 meeting of the Arkansas Local Police and Fire Retirement System reflects members seeking out the advice of a Stephens Inc. executive, Larry Middleton, about possible use of derivatives, even though the Little Rock firm’s policy is to eschew them. “Mr. Middleton said he does believe it’s appropriate to include derivatives and there is a place for it in our investment strategy,” the minutes said.
But there have been disastrous experiences with derivatives involving state and local governments and agencies. One of the biggest examples cited by experts is the bankruptcy of Orange County, California in the early 1990s.
Another often-cited example involves the Arkansas Teachers Retirement System, which suffered some $30 million in losses related to derivatives in the late 1990s.
Audits by Deloitte & Touche audit concluded that officials of the system did not understand some of the derivatives they became involved in. The retirement system became the only state pension system in the United States to lose money in the offshore limited partnerships at the center of the Enron bankruptcy, according to freelibrary.com.