WASHINGTON — As the House-Senate Conference Committee on Wall Street reform enters its second and final week, compromise still has yet to be found on derivatives language.
The agriculture industry has directly experienced the downside of derivatives as a result of market distortion and volatile pricing. Agricultural derivatives are essentially bets on the future value of commodities.
Rep. Collin Peterson, chairman of the House Agriculture Committee, is the point person in the House on agricultural derivatives. Peterson favors the language (PDF) included in the House financial reform bill that would regulate derivatives while also exempting foreign trade.
“Well before the financial crisis hit in the fall of 2008, many of us on the House Agriculture Committee had serious concerns about increased volatility and speculation in derivatives markets,” said the Minnesota congressman at the opening of the conference committee on June 10. “We were for mandatory clearing before it was cool.”
The original system of derivatives was intended to make contracts to provide price stability from planting to harvest. This system was disrupted by speculation and by those who entered the market and made contracts without the intention of delivering the product.
Sporadic price increases result in drops in demand, and a dip in the market could leave a farmer spending more to harvest a crop than he would receive in return.
The Senate’s proposal, spearheaded by Arkansas Sen. Blanche Lincoln, would require financial institutions covered by federal insurance to spin off derivatives operations — language that isn’t in the House’s draft. Some in the financial services industry argue that this tougher regulation could hurt U.S. banks’ ability to compete with foreign firms that don’t have the same restrictions in their home countries.
Both the proposed Senate and House bills require that derivatives be put through clearinghouses, but the original Senate offer proposed much tighter regulation. The differences between the two plans are expected to be resolved in the coming days.
Week one in the conference committee wrapped up with compromises on a credit rating agency regulatory provision introduced by Sen. Al Franken. The Franken amendment proposed barring banks from choosing which credit agency could rate their products and instead assigned that task to a new federal commission.
The amendment, which the House bill did not contain, was agreed to in part but was reduced to a “two-year study of fee and payment issues.” The study would collect data to “assist in monitoring systemic risk” of financial institutions and give “expertise” on emerging financial markets by creating an office of financial research.
But the committee offered a pro-Franken caveat; Franken’s plan would be implemented unless the study group finds another option and deems it to be superior.
“It’s job, and it’s only job, would be research and analysis,” Sen. Chris Dodd said Thursday of the study.
Yet to come are agreements on assessing the risk of big financial institutions to end the “too big to fail” issues facing the U.S. economy. The committee has considered establishing a liquidation authority that would have the ability to work with and “unwind” bankrupt institutions that could potentially harm the entire financial system, but as of this writing, no consensus had been reached.
The conference committee still needs to revisit proposed legislation under the Volcker rule that would ban banks from risky trading unrelated to the products they provide to customers, as well as a House proposal to create a $150 billion fund that would be used to deal with bankrupt financial institutions. Lawmakers are also expected to decide if any firms will be grandfathered out of some of the new requirements.
Once the conference committee agrees to common language, expected at the end of this week, on the bill it will continue on to a vote in the House and Senate where it is no longer open for amendment.
Lawmakers hope to put the bill on President Obama’s desk by the July 4 recess.
Lauren Knobbe is an intern in MinnPost’s D.C. bureau.
There are different types of derivatives used differently by different industries.
The dangerous ones are those derivatives created and customized by the finance industry for specific clients and thus illiquid, poorly understood, untested, and (most importantly from the perspective of the finance industry) extremely profitable. They are used largely for speculation. Or hiding unsavory bits inside the Nth tranche of an CDO based on interest-only ARMs to the subprime mortgage market (for instance…)
The safe ones are derivatives that allow companies dealing in commodities to hedge their risk and decrease the volatility in their cash flow. They are traded on markets, well understood, have withstood the test of time, and (alas, from a finance industry perspective) not very profitable. These are things like options based on commodities. They allow farmers to lock in prices and manufacturers to acquire ingredients at a known cost (for instance).
My understanding is that the reason the folks on the Agriculture Committee are so intensely interested is that they don’t want everyday use of derivatives by industries using commodities to be subject to the same regulations (and costs) as speculative use of derivatives by the finance industry.
What bothers me, is that you don’t have a lot of farmers on agricultural and a bunch of bankers on banking- you have a bunch of graft-snorkeling supple-handed politicians on both, and the politicians on the agriculture committee have more experience regulating derivatives than those on the banking committee.
No, Lauren Knobbe, agricultural derivatives are not “essentially bets on the future value of commodities.” They are based on contracts to buy and sell commodities in the future at a price committed to today. Collin Peterson gets it, and as I stated before on your last column on this issue, rice futures were traded in Japan in the 1700s and grain futures were traded in Chicago well before the Board of Trade was established in 1848. Without agricultural futures trading, assuring many people of enough to eat would be harder than it is today, even in this country.