Obama Seeks To Regulate Derivatives Sales

(AP)  The Obama administration is asking Congress to extend its oversight of the financial system to include the shadowy market of derivatives, the kind of complex financial instruments that helped bring down the giant insurer AIG.

In a draft two-page letter to congressional leaders, the Treasury Department says it wants to create a central electronic-based system that would track the buying and selling of derivatives. It also wants to ensure that financial firms selling the instruments have enough capital on hand in case they default and subject them to stringent standards of conduct and new reporting requirements.

The legislative proposal, to be announced later Wednesday by Treasury Secretary Timothy Geithner, is the administration's first major step in overhauling the nation's financial regulatory system.

"All (over-the-counter) derivatives dealers and all other firms whose activities in those markets create large exposures to counterparties should be subject to a robust regime of prudential supervision and regulation," Treasury wrote in its draft letter.

"Key elements of that robust regulatory regime must include conservative capital requirements, business conduct standards, reporting requirements and conservative requirements relating to initial margins on counterparty credit exposures," the department adds.

Current law largely excludes regulation of instruments, which are referred to as "over-the-counter" derivatives because they are privately traded.

New rules would deter financial firms from taking undue risk, prevent fraud and ensure they are marketed appropriately, Geithner said in the draft letter.

Geithner, who was expected to brief reporters on Wednesday, said in congressional testimony last month that he wants to force these types of contracts to be cleared through a central system.

"Let me be clear: The days when a major insurance company could bet the house on credit default swaps with no one watching and no credible backing to protect the company or taxpayers from losses must end," Geithner told Congress.

The value of over-the-counter derivatives hinges on an underlying figure or commodity â?" ranging from currency rate swaps to oil futures and inflation bets. The derivative reduces the risk of loss from the underlying asset. The global business world holds a staggering $600 trillion of these contracts.

One of the most infamous examples of the derivatives were credit-default swaps sold by American International Group Inc. AIG sold the swaps to investors as a kind of insurance to protect against defaults on mortgage-backed securities. But the company had to accept a hefty federal bailout after it was unable to support the contracts.

Under Treasury's new plan, companies like AIG would have to prove they have enough reserve capital to support its sale of the derivatives.

Also under the plan, the Commodity Futures Trading Commission would establish an "audit trail" for the derivatives and have "clear unimpeded authority to police fraud, market manipulation and other market abuses" involving the derivatives. The Securities Exchange Commission would be given "comparable authority," including tools to prevent insider trading.

The new system should enable the regulators to "detect and deter all such market abuses," Geithner states.

[enriquecaliente]

They need to break up these TOO BIG TO FAIL companies, all of them and re-instate Glass-Stegal Act. Until that is done, these very companies will do the very same thing again and the US tax payer will have to bale them out again. There should have been a wide ranging house cleaning and as of yet all of the Senior Exec's still have their jobs, salaries and bonuses. While the rank and file have lost much.

[midwestkris]

Of course I understand the meaning of ?notional value.? It is what is typically used to measure the value of derivatives market. In a derivative, the value of some underlying is what gives rise to the value of the derivative. The underlying can be anything that two people use as the basis of a contract. For instance, in an interest rate swap, the underlying would be the debt used to calculate the interest payments. The debt itself never changes hands?just the differential caused by the changes in the fixed rate relative to the variable rate interest on the debt. The notional amount is the value that is used to calculate the relative interest rate payments. It may or may not be the face value of the debt as the interest rate swap as the fair value of the debt on the date of the derivative contract would be the more likely bases of the contract. Whatever valuation of the underlying used to calculate the value of the derivatives contract is called the notional value, and this is the amount that is also used to value the derivatives markets.

I also understand that Enron imploded in 2001. Approximately 16 months before the implosion, Enron founded EnronOnline, which was an OTC derivatives trading market. Initially founded to trade energy contracts, it quickly expanded its scope into handling virtually any derivatives contract. A major component of the fraud at Enron was Enron?s fraudulent valuation of derivatives instruments that they were party to. Enron used assumptions that were not supportable to value derivatives contracts. For example, when they traded energy futures with lives that exceeded the normal range of contracts, so that there was not a forward curve available from an outside source such as the New York Mercantile Exchange, Enron traders essentially made up a curve, used that to value the contracts, and increases in valuation was reported as income. Enron also traded OTC derivatives with related parties, those now infamous special purpose entities such as Chewco and Raptor, and these transactions were also used to fraudulently increase income and hide debt.

So OTC derivatives markets were already a significant potential threat to the economy in 2001 when Enron imploded, but nothing was done at that time to regulate either the nature of the contracts, how they were traded, or who could be parties to the trades. So yes, I believe that failure to head some of the lessons of Enron are directly related to the current economic crisis.

The banks were also involved, being parties to many of the derivatives transactions...and not blinking at the huge red flags, such as Fastow being both CEO of a related party and CFO of Enron. They banked them anyhow, even though it is hard to believe they didn't see it was fraud, because they were making money. Lots of it. Sound familiar?

[azfalcon]

"It is about time that they look to regulate the OTC derivatiaves market. That was at least half of the reason that Enron imploded as well. Back in 2002, shortly after ENE imploded, the notional value of exchange-traded derivatives was about $13 trillion..while the estimated notional amount of the unregulated OTC derivatives market approached $100 Trillion. It was thie unregulated OTC market that in many ways facilitated the ENE fraud. Regulators didn't clean up either the OTC derivatives market or the banks and financial institutions that also had a part in facilitating the ENE fraud. And that is at least part of the reason that things got so bad in recent months.
"

Did you copy this from somewhere? Do you have any idea of what you said - or your point? Do you understand that Enron has been gone for seven years and has had NO IMPACT on recent months? Do you have a clue what the purpose is of a derivative market? Hint - You're not going to make any money in it. What exactly is a notional value?

[azfalcon]

WOW!!

These people post their opinions and I suppose others actually read them. Help us all if they are believed. Isn't it amazing what bad grammer, non-existant spelling and the power of owning a computer can cause a person to spew forth into cyberspace.

[midwestkris]

It is about time that they look to regulate the OTC derivatiaves market. That was at least half of the reason that Enron imploded as well. Back in 2002, shortly after ENE imploded, the notional value of exchange-traded derivatives was about $13 trillion..while the estimated notional amount of the unregulated OTC derivatives market approached $100 Trillion. It was thie unregulated OTC market that in many ways facilitated the ENE fraud. Regulators didn't clean up either the OTC derivatives market or the banks and financial institutions that also had a part in facilitating the ENE fraud. And that is at least part of the reason that things got so bad in recent months.

[reality42]

USA needs to join the world in a new banking system which involes the other world country's.
USA has messed up big time and have now lost there top pearch so now work with the world or you will see what it is like to be poor.
The world see what happen and now it's time for USA to take responisablity

[whitemale08]

it's a 'step' but it's no way near enough!

All Tim Gheitner has to do:

1. Imediately re-instate Glass-Steagal Act....that would automaticly seperate these absolutely worthless derivatives and credit-default swaps from normal banking.

2. Imediately put BIG FAILED BANKS, like Goldman Sucks into receivership and bankruptcy re-organization, which would STOP ALL BAILOUTS!

3. Imediately put the entire Federal Reserve System into RECEIVERSHIP and bankruptcy re-organization into a new American Credit-System as Hamiltion intended.

If we do these 3 things, then we have hope, if not then we will plunge further and further into a New Dark Age.

For the solution to our crisis:

larouchepac.com