While Congress has focused on dealing with the immediate fallout of our economic crises and building a brighter future for America in education, energy and health care, we have also been working hard on developing legislation to prevent this economic crisis from happening again.
The excessive speculation in home mortgage interest rates, credit default swaps and some commodities are at the core of the worldwide economic meltdown. Much of the trading done was behind closed doors in "over-the-counter' transactions between big investors and not over our regulated and transparent exchanges or clearing houses. It involved the selling and reselling of complex financial deals called derivatives that even sophisticated accountants had more and more trouble understanding. These derivatives involved bets on stocks, bonds, your mortgage, currency values, interest rates, and the future price of commodities like oil, energy, cotton, and milk. Transactions through the exchanges regulated by the Commodity Futures Exchange Commission and Security Exchange Commission clearing houses worked well. It was the unregulated over-the-counter market that failed. Here the yields were great but the real risks unknown.
Any meaningful reform proposal would have to drive almost all derivative transactions to be done over the exchanges or clearing houses. It would also be important that any major players whose motivation was speculation had adequate "skin-in-the-game' for the life of the transaction so they would invest responsibly. The Treasury proposal that was further watered down by the Financial Services committee just didn't get us there and the bill became a partisan issue.
My House Agriculture Committee has been insistent that we craft a tough bipartisan bill that really gets at the big guys that speculate and pose the risk to our financial system while not penalizing the smaller-end users. I believe we have been very successful.
Our bill requires most all derivative transactions to be standardized and cleared through the regulated exchanges and clearing houses. Only those transactions that are so unique and pose no systemic risk to our financial system would be allowed unregulated over-the-counter, including foreign exchanges.
The Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) are given clear areas of jurisdiction to avoid long drawn out battles that would undermine market safety and they would be encouraged to harmonize their respective rules.
Derivative dealers and major participants are registered and defined as those that have all or a substantial part of their business in making markets, buying and selling derivatives. They have higher clearing and capital requirements since they pose greater risk to the entire financial system should they get in over their head. Over-the-counter trades will also have higher capital requirements to encourage exchange based trading and clearing. Large investment type banks are included in the higher clearing and capital requirements even in transactions with end users. Community and smaller independent banks are exempted as are end users that pose no systemic financial risk.
Clearing requirements are established by the clearing agencies in advance and not on a piecemeal costly case by case basis. All clearing agencies are reviewed for safety/soundness, anti-competitive practices and risk management by the CFTC or SEC as applicable. The CFTC and SEC can limit the degree of investment by various participants if they feel there is significant risk to the market and public. As an added safeguard, all over-the-counter derivative trades must be reported to a qualified trade repository.
Our overall goal is to regulate the big actors that pose a real risk to the entire financial system and not add a lot of unnecessary regulation to small banks or businesses not significantly engaged in derivative trading as a part of their normal business. This approach has allowed us to craft the bipartisan bill that passed out of our House Agriculture Committee with only one dissenting vote.