[Corp. Watch] Big Greed: After the bail-out, it's back to business as usual

[Corporation Watch]

  Back to Business

IN CRISIS, BANKS DIG IN FOR FIGHT AGAINST RULES

  By Gretchen Morgenson and Don van Natta Jr.

(NY Times, June 1) -- As the financial crisis entered one of its  
darkest phases in October, a handful of the nation's largest banks  
began holding daily telephone sessions.

	Murmurs were already emanating from Washington about the need for a  
wide-ranging regulatory overhaul, and Wall Street executives girded  
for a fight.

	Atop the agenda during their calls: How to counter an expected  
attempt to rein in credit-default swaps (CDS's) and other derivatives  
-- the sophisticated and profitable financial instruments that were  
intended to limit risk, but instead had helped take the economy to the  
brink of disaster.

	The nine biggest participants in the derivatives market -- including  
JPMorgan Chase, Goldman Sachs, Citigroup, and Bank of America --  
created a lobbying organization, the CDS Dealers Consortium, on  
November 13, a month after five of its members accepted federal bail- 
out money.

	To oversee the consortium's push, lobbying records show, the banks  
hired a long-time Washington power broker who previously helped fend  
off derivatives regulation: Edward J. Rosen, a partner at the law firm  
Cleary Gottlieb Steen & Hamilton.

	A confidential memo Rosen drafted and shared with the Treasury  
Department and leaders on Capitol Hill has played a pivotal role in  
shaping the debate over derivatives regulation, politicians and market  
participants say.

	Today, just as the bankers anticipated, a battle over derivatives has  
been joined, in what promises to be a replay of a confrontation in  
Washington that Wall Street won a decade ago. Since then, derivatives  
trading has become one of the most profitable businesses for the  
nation's big banks.

	The looming fight over regulation is the beginning of a broader  
debate over the future of the financial industry. At the center of the  
argument: What is the right amount of regulation?

	Those who favor more regulation say it would offer early warning  
signals when companies take on too much risk and would help avert  
catastrophic surprises, such as the huge derivatives losses at the  
giant insurer American International Group (AIG), which has so far  
received more than $170 billion in taxpayer commitments. The banks say  
too much regulation will stifle financial innovation and economic  
growth.

	The debate about where derivatives will trade speaks to core concerns  
about the products: transparency and disclosure.

	There are two distinct camps in this argument. One camp, which  
includes legislative leaders, is pushing for trading on an open  
exchange -- much like stocks -- where value and structure are visible  
and easily determined.

	Another camp, led by the banks, prefers that some of the products be  
traded in privately managed clearinghouses, with less disclosure.

	The Obama administration agrees that more regulation is needed. A  
proposal unveiled recently by Treasury Secretary Timothy Geithner won  
plaudits for trying to make derivatives trading less freewheeling and  
more accountable -- a plan that hinges in part on using clearinghouses  
for the trades.

	Critics in both the financial world and Congress say relying on  
clearinghouses would be problematic. They also say Geithner's plan  
contains a major loophole, because little disclosure would be required  
for more complicated derivatives, like the type of customized CDS's  
that helped bring down AIG.

	AIG sold insurance related to mortgage securities, essentially making  
a big bet that those mortgages would not default.

	Rosen and other bank lobbyists have pushed on Capitol Hill to keep so- 
called "customized" swaps from being traded more openly. These are  
contracts written for the specific needs of a customer, whose one-of-a- 
kind nature makes them very hard to value or trade.

	Rosen has also argued that dealers should be able to trade through  
venues closely affiliated with banks, rather than through more  
independent platforms like exchanges.

	Rosen's confidential memo, dated February 10 and obtained by the New  
York Times, recommended that the biggest participants in the  
derivatives market should continue to be overseen by the Federal  
Reserve Board.

	Critics say the Fed has been an overly friendly regulator, which is  
why big banks favor it.

	Rosen's proposal for change was similar to the Treasury Department's  
recently announced plan to increase oversight. Treasury officials say  
that their proposal was arrived at independently, and that they sought  
input from dozens of sources.

	Even so, market participants, analysts, and members of Congress who  
have proposed stricter reforms worry that the Treasury proposal does  
not go far enough to close several important regulatory gaps that  
allowed derivatives to play such a destructive role in the current  
financial crisis.

	But increased transparency of derivatives trades would cut into  
banks' profits -- hence the banks' opposition. Customers who trade  
derivatives would pay less if they knew what the prevailing market  
prices were.

	"The banks want to go back to business as usual -- and then some. And  
they have a lot of audacity now that everyone has bailed them out,"  
said Yra Harris, an independent commodities trader who was involved in  
an effort to regulate derivatives nine years ago.

	"But we have to begin with the premise that Wall Street doesn't want  
transparency," Harris said, "because more transparency means less  
immediate profits."

	Legislators in the Senate and the House of Representatives have  
introduced bills offering stricter controls than those pushed a decade  
ago. The pending legislation goes even further than Geithner's  
proposals.

	"These mathematical geniuses who create these things can find a way  
to turn anything into a customized swap," said Senator Tom Harkin, an  
Iowa Democrat, who has introduced legislation that would require all  
derivatives to be traded on an exchange.

	"You'd get a loophole big enough to drive a truck through," Harkin  
said. "It could be worth trillions and trillions of swaps."

Lessons From History

	Hotly contested legislative wars are traditional fare in Washington,  
of course, and bills are often shaped by the push and pull of  
lobbyists -- representing a cornucopia of special interests -- working  
with politicians and government agencies.

	What makes this fight different, say Wall Street critics and  
legislative leaders, is that financiers are aggressively seeking to  
fend off regulation of the very products and practices that directly  
contributed to the worst economic crisis since the Great Depression.

	In contrast, after the savings-and-loan debacle of the 1980s, the  
clout of the financial lobby diminished significantly.

	The current battle mirrors a tug-of-war a decade ago. Arguing that  
regulation would hamper financial innovation and send American jobs  
overseas, Congress passed legislation in December 2000 exempting  
derivatives from most oversight. It was signed by President Bill  
Clinton.

	The law passed despite the strenuous objections of Brooksley Born, a  
former head of the Commodity Futures Trading Commission (CFTC), who  
left the government after her unsuccessful effort to impose more  
regulation.

	In a recent speech, Ms. Born said big banks are again trying to water  
down oversight efforts.

	"Special interests in the financial-services industry are beginning  
to advocate a return to business as usual, and to argue against any  
need for serious reform," Born, now a lawyer in private practice, said  
at the John F. Kennedy Library in Boston, where she received a Profile  
in Courage Award.

	After the 2000 legislation was passed, derivatives trading exploded,  
helping the biggest traders earn immense profits.

	The market now represents transactions with a face value of $600  
trillion, up from $88 trillion a decade ago. JPMorgan, the largest  
dealer of over-the-counter derivatives, earned $5 billion trading them  
in 2008, according to Reuters, making them one of its most profitable  
businesses.

	Among the companies that expanded rapidly was AIG. Straying from its  
main business of providing property and life insurance, AIG wrote a  
type of contract known as credit-default swaps that protected holders  
of mortgage securities against defaults.

	When millions of sub-prime borrowers stopped paying their mortgages,  
AIG had to provide cash collateral that it did not have to clients  
that had bought its insurance.

	Before the crisis, few market participants knew the size of AIG's  
exposure. Some derivatives transactions occur on exchanges, where the  
value and nature of the contracts are disclosed, but many do not.

	Credit-default swaps trade privately. This kept risk in these trades  
under wraps, leaving regulators unaware of how dangerously stretched  
and poorly managed the market was.

Where to Trade

	On Capitol Hill, banking lobbyists have argued that derivatives  
should be traded on clearinghouses rather than exchanges, legislative  
leaders and their staffs say.

	The Geithner plan favors clearinghouses, where an intermediary would  
guarantee trades between participants, instead of participants dealing  
directly with one another as in an exchange.

	A major New York clearinghouse is Intercontinental Exchange (ICE)  
U.S. Trust, an entity closely affiliated with banks that are also  
members of Rosen's group, the CDS Consortium.

	Although the Chicago Mercantile Exchange is a more established place  
for derivatives trading and is independent from the big New York  
banks, ICE seems to be the clearinghouse of choice, especially among  
policymakers in Washington, said Brad Hintz, a brokerage firm analyst  
at Bernstein Research.

	That is because under the Treasury proposal, the Federal Reserve Bank  
of New York would oversee ICE, while the CFTC would oversee the  
Chicago Mercantile Exchange. Critics say the Federal Reserve has been  
too easy on those it oversees.

	Theo Lubke, a senior New York Fed official, countered Hintz's view,  
saying the Fed wants a market where a variety of clearinghouses can  
succeed.

	Analysts say that because major banks that deal derivatives are so  
closely affiliated with ICE, they could seek to have many of the  
products classified as "customized" -- the only category that would  
keep them off regulators' radar screens under Geithner's proposal.

	This worries Sen. Harkin, the Iowa Democrat, whose constituents  
include agricultural concerns that want better oversight of trading.

	This is needed, he said, to "add openness, transparency and integrity  
in futures trading to rebuild the financial system." Letting  
"customized" derivatives -- like many credit-default swaps -- trade  
without detailed disclosure is a way to keep regulators in the dark,  
he said.

	Harkin said Geithner visited the Democratic caucus on Capitol Hill  
three weeks ago. At that meeting, Harkin said, he challenged Geithner  
to "define customized swaps." Harkin said the Treasury secretary told  
him he would have to get back to him.

	The big dealers, including major banks, say exchange trading would  
impose overly strict rules. But requiring exchange trading would have  
another effect: It would reduce the profits dealers make on derivatives.

	Members of Congress say the lobbying efforts by big banks promise to  
produce one of the most intense political face-offs in Washington in  
years. "The swaps and derivatives people are all over the place up  
here," Harkin said. "They sure are trying hard to win. A lot of money  
is on the line."

	Lobbyists for the banks plan to make a renewed push on Capitol Hill  
this week.

The Financial Lobby

	Through political action committees and their own employees,  
securities and investment firms gave $152 million in political  
contributions from 2007 to 2008, according to the most recent Federal  
Election Commission data.

	The top five companies -- Goldman Sachs, Citigroup, JP Morgan Chase,  
Bank of America, and Credit Suisse -- gave $22.7 million and spent  
more than $25 million combined on lobbying activities in that period,  
according to election data compiled by the Center for Responsive  
Politics.

	All five companies are members of the CDS Dealers Consortium, the  
lobbying group formed in November. Lobbying records show that the  
group has paid Rosen, the Cleary Gottlieb partner, $430,000 for four  
months' work. Rosen declined to comment, a spokeswoman said, citing  
"client sensitivities."

	Rosen, co-author of a treatise on derivatives regulation, frequently  
counsels the industry on these complex contracts.

	In late January, according to e-mail messages, he asked the members  
of the CDS dealer group if they would support his testifying before  
Congress on behalf of the Securities Industry and Financial Markets  
Association (SIFMA), a trade group.

	SIFMA's members include 650 firms of varying size and interests, many  
of which do not trade complex derivatives. The CDS dealers are a much  
smaller group, with a far larger interest in derivatives than SIFMA as  
a whole.

	Rosen received an e-mail response from Mary Whalen, managing director  
for public policy at Swiss bank Credit Suisse, which is active in the  
derivatives market.

	"It is a good idea for Ed to write the testimony and if necessary  
testify," Whalen wrote. "That way we can be sure that the banks' point  
of view is expressed, rather than taking a chance on testimony that  
SIFMA might craft." A spokeswoman for Whalen declined to comment.

	By taking the lead, Rosen was able to position himself as the main  
advocate on derivatives for the securities industry, and make sure  
that the group of nine banks in the CDS Dealers Consortium had a loud  
voice within SIFMA.

Testimony to Congress

	At a House Agriculture Committee hearing on derivatives in February,  
Rosen testified on behalf of SIFMA. He did not mention that he was  
also a paid lobbyist for the CDS Dealers Consortium, whose interests  
might be different from SIFMA's.

	Those testifying at such hearings are not required to disclose all of  
their affiliations. But when asked, Representative Collin Peterson, a  
Minnesota Democrat and the chairman of the House Agriculture  
Committee, said he had not known of Rosen's relationship to the  
consortium.

	Peterson said he would have liked to have known, because it would  
have guided his questioning and interpretation of Rosen's testimony,  
given that his clients in the smaller CDS group represented a narrower  
interest group with a more specific agenda.

	Peterson, whose constituents include farmers who are historically  
suspicious of Wall Street and whose livelihoods depend on efficient  
markets, is a long-standing critic of loose regulation.

	And since his committee oversees the CFTC, he would retain more of  
his prerogatives overseeing the market if the Commission were the main  
regulator.

	Peterson's bill specifically bars derivatives trading in a  
clearinghouse regulated by the New York Federal Reserve, which he said  
in an interview "is a tool of the big banks" that "wouldn't do much"  
to regulate the contracts.

	Because the banks' lobbyists persuaded some of his Republican  
colleagues to resist more sweeping changes, Peterson said, he has had  
to modify a bill he introduced that is similar to Harkin's in calling  
for wide-ranging limits on derivatives.

	"The banks run the place," Mr. Peterson said. "I will tell you what  
the problem is: They give three times more money than the next biggest  
group. It's huge the amount of money they put into politics."

	As a result of the lobbying efforts, champions of broad-based  
regulation are concerned that proposals will be significantly limited  
by banking interests.

	"The outrage among the public means that things have a chance to  
change, if things move quickly," said Michael Greenberger, a professor  
at the University of Maryland Law School and a former director of  
trading and markets at the CFTC.

	"We're in this brief moment of time when the average citizen is on a  
level playing field with the lobbyist," Greenberger said.